---

# UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

# FORM 20-F

# ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

# For the fiscal year
ended December 31, 2006

Commission File Number
1-04212

---

# AMERICAN ISRAELI PAPER
MILLS 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 142, Hadera
38101, Israel
(Address of principal executive offices)

---

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

|Title of each class
Ordinary Shares par value NIS .01 per share | Name of each exchange on which registered
American Stock Exchange
|--------------------------------------------------------------- | -----------------------------------------------------------------

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

# None

Securities for which there is a reporting obligation  
pursuant to Section 15(d) of the Act:

# None

---

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

# 4,032,723 Ordinary
Shares, par value NIS 0.01 per share

Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes    No

If this report is an annual or
transition report, indicate by checkmark if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Yes  
No

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    No

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

|Large accelerated filer | Accelerated filer | Non- accelerated filer
|----------------------- | ----------------- | ----------------------

Indicate by check mark which
financial statement item the registrant has elected to follow: Item 17   Item 18

If this is an annual report, indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes 
No



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# PART I

# ITEM 1 - IDENTITY OF
DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable to Annual
Reports

# ITEM 2 - OFFER
STATISTICS AND EXPECTED TIMETABLE

Not applicable to Annual
Reports

# ITEM 3 - KEY INFORMATION

# A.    Selected Financial
Data

American
Israeli Paper Mills Ltd. (AIPM or the Company) prepares its
financial statements in accordance with Israeli GAAP. Israeli GAAP and U.S. GAAP vary in
certain respects,as it relates to the Company, as described in Item 17.

The
following selected financial data is derived from the audited consolidated financial
statements of the Company.

The
financial data is presented in New Israeli Shekel (NIS) as follows:AIPM made a
transition to reporting in nominal New Israeli Shekels (NIS) in 2004, pursuant to the
directives of Standard 12 of the Financial Accounting Standards Board in Israel. Prior to
2004 AIPMs reports were in NIS, adjusted to changes in the exchange rate of the
U.S. dollar against the NIS.

The
comparison figures for the years 2002 - 2003 are the dollar figures, as reported in the
past, multiplied by the exchange rate of the U.S. dollar as at December 31, 2003, the day
of the transition to NIS-based reporting pursuant to Standard 12 ($1 = NIS 4.379). See
also note 1b to the Financial Statements.

1



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# Five Fiscal Year
Financial Summary

|According to Israeli GAAP
(In Thousands of NIS Except Per Share Amounts) |  | Year Ended December 31
|------------------------------------------------------------------------ |  | ----------------------
|
|Sales                                                                    |  |                       
|Income from ordinary operations                                          |  |                       
|Share in profits (losses) of associated companies, net                   |  |                       
|Net income                                                               |  |                       
|                                                                         |  |                       
|Selected balance sheet data:                                             |  |                       
|Total assets                                                             |  |                       
|Fixed assets                                                             |  |                       
|Long-term debt                                                           |  |                       
|Shareholders' equity                                                     |  |                       
|                                                                         |  |                       
|Per Share Data:                                                          |  |                       
|Shares outstanding at end of year                                        |  |                       
|Amount in NIS                                                            |  |                       
|Net income per NIS 1 par value:                                          |  |                       
|Primary                                                                  |  |                       
|Fully diluted                                                            |  |                       
|Dividend declared per share                                              |  |                       

---

|* |  | Reclassified
|- |  | ------------

|** |  | Consists
of two dividends that were declared in 2005 (see comment 2 below).
|-- |  | ---------------------------------------------------------------------------

|*** |  | As
a result of implementing retroactively the change of accounting policy.
|--- |  | --------------------------------------------------------------------------

|**** |  | Amount does not include the cumulative affect
of a change in accounting policy of associated company of NIS (461).
|---- |  | ------------------------------------------------------------------------------------------------------------------

|(1) |  | The
net income includes gains in the years 2005, 2004           and
2003 (in the sum of 8,000 thousands, NIS 14,440 thousands and NIS 2,700
          thousands respectively, which relate to certain tax benefits  for a further discussion of these items,
see Item 5  Operating Financial Review and Prospects.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Dividend
for 2002, in the sum of NIS 6.31 per share ($1.44 per share) was           declared in
March 2003 and paid in April 2003.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------

| | Dividend
paid in 2003 includes a           special dividend for 2003 in the sum of NIS 18.81 per
share ($4.29 per share).
| | -------------------------------------------------------------------------------------------------------------------------

| | Dividend
for 2003 in the sum of NIS 25.12 per share ($5.54 per share) was           declared in
August 2004 and paid in September 2004.
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | Dividend
for 2005 in the sum           of NIS 12.50 per share ($2.71 per share) was declared in
August 2005 and paid in           September 2005. Additional dividend for 2005 in the sum
of NIS 12.49 per share           ($2.71 per share) was declared in December 2005 and paid
in January 2006.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Dividend
for 2006 in the sum of NIS 24.85 per share ($ 5.64 per share) was           declared in
June 2006 and paid in July 2006.
| | ---------------------------------------------------------------------------------------------------------------------------------

2



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|According to U.S. GAAP
(In Thousands of re-measured NIS except per share amounts) |  | Year Ended December 31
|--------------------------------------------------------------------------------- |  | ----------------------
|
|Sales                                                                             |  |                       
|Income from ordinary operations                                                   |  |                       
|                                                                                  |  |                       
|Share in profits (losses) of associated companies, net                            |  |                       
|Net income                                                                        |  |                       
|Total assets                                                                      |  |                       
|Fixed assets                                                                      |  |                       
|Long-term debt                                                                    |  |                       
|Shareholders' equity                                                              |  |                       
|                                                                                  |  |                       
|Per Share Data:                                                                   |  |                       
|Shares outstanding at end of year                                                 |  |                       
|Share outstanding to compute:                                                     |  |                       
|Basic net income per share                                                        |  |                       
|Diluted net income per share                                                      |  |                       
|Amount in NIS                                                                     |  |                       
|Net income per share (re-measured NIS)                                            |  |                       
|Basic                                                                             |  |                       
|Diluted                                                                           |  |                       
|Dividend declared per share                                                       |  |                       

For further information about the
effect of application of U.S. GAAP, see Item 17.

---

** Consist of two dividends were
declared in 2005 (see comment 2 below)

|(1) | The net income includes losses in the years 2005 and
          2003, in the sum of NIS 10,000 thousands and NIS 16,986 thousands respectively,
          [representing other than temporary impairment of investment in associated
          companies (see Item 17-e)]. Net income in the
          years 2005, 2004 and 2003, includes gains of NIS 8,000 thousands, NIS 14,440
          thousands and NIS 2,700 thousands respectively, originated from certain tax
          benefits.  For a further discussion of these items,
see discussion in Item 5  Operating Financial Review and Prospects.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Dividend for 2002, in the sum of NIS 6.61 per share ($1.44 per share) was
          declared in March 2003 and paid in April 2003.Dividend paid in 2003 includes a
          special dividend for 2003 in the sum of NIS 19.04 per share ($4.29 per share).
          Dividend for 2003 in the sum of NIS 25.12 per share ($5.54 per share) was
          declared in August 2004 and paid in September 2004.Dividend for 2005 in the sum
          of NIS 12.50 per share ($2.71 per share) was declared in August 2005 and paid in
          September 2005.Additional dividend for 2005 in the sum of NIS 12.49 per share
          ($2.71 per share) was declared in December 2005 and paid in January 2006.
          Dividend for 2006 in the sum of NIS 24.85 per share ($ 5.64 per share) was
          declared in June 2006 and paid in July 2006.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

3



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# Exchange Rates

The
exchange rate between the NIS and U.S. dollar published by the Bank of Israel was NIS
4.033 to the dollar on May 31, 2007. The high and low exchange rates between the NIS and
the U.S. dollar during the six months of December 2006 through May 2007, as published by
the Bank of Israel, were as follows:

|Month         |  |  | High            |  |  | Low             |  | 
|------------- |  |  | --------------- |  |  | --------------- |  | 
|              |  |  | 1 U.S. dollar = |  |  | 1 U.S. dollar = |  | 
|              |  | 
|December 2006 |  |  | 4.234 NIS       |  |  | 4.176 NIS       |  | 
|January  2007 |  |  | 4.260 NIS       |  |  | 4.187 NIS       |  | 
|February 2007 |  |  | 4.254 NIS       |  |  | 4.183 NIS       |  | 
|March 2007    |  |  | 4.222 NIS       |  |  | 4.155 NIS       |  | 
|April 2007    |  |  | 4.135 NIS       |  |  | 4.014 NIS       |  | 
|May 2007      |  |  | 4.065 NIS       |  |  | 3.932 NIS       |  | 

The
average exchange rate between the NIS and U.S. dollar, using the average of the exchange
rates on the last day of each month during the period, for each of the five most recent
fiscal years was as follows:

|Period                              | Exchange Rate |  | 
|----------------------------------- | ------------- |  | 
|January 1, 2001 - December 31, 2001 | 4.219 NIS/$1 
|January 1, 2002 - December 31, 2002 | 4.736 NIS/$1 
|January 1, 2003 - December 31, 2003 | 4.512 NIS/$1 
|January 1, 2004 - December 31, 2004 | 4.483 NIS/$1 
|January 1, 2005 - December 31, 2005 | 4.878 NIS/$1 
|January 1, 2006 - December 31, 2006 | 4.456 NIS/$1 

# Forward Looking
Statements

This
Annual Report on Form 20-F contains 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 (the 1934 Act) (collectively, the
Safe Harbor Provisions). These are statements that are not historical facts
and include statements about our beliefs and expectations. These statements contain
potential risks and uncertainties and actual results may differ significantly.
Forward-looking statements are typically identified by the words believe,
expect, intend, estimate and similar expressions. Such
statements appear in this Annual Report and include statements regarding the intent,
belief or current expectation of the Company or its directors or officers. Actual results
may differ materially from those projected, expressed or implied in the forward-looking
statements as a result of various factors including, without limitation, the factors set
forth below under the caption Risk Factors (the Company refers to these
factors as Cautionary Statements). Any forward-looking statements contained in
this Annual Report speak only as of the date hereof, and the Company cautions potential
investors not to place undue reliance on such statements. The Company undertakes no
obligation to update or revise any forward-looking statements. All subsequent written or
oral forward-looking statements attributable to the Company or persons acting on the
Companys behalf are expressly qualified in their entirety by the Cautionary
Statements.

4



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# B.    Capitalization and
indebtedness

Not
applicable.

# C.    Reason for the offer
and use of proceeds

Not
applicable.

# D.    Risk factors

# Macro-economic risk
factors

A slowdown in the
market may result in a reduction of profitability

A
slowdown in the global markets as well as in the Israeli market may cause: a decrease in
the demand for the Companys and its associated companies products, an increase
in the competition with imported products and a decrease in the profitability of export
and that could result in a reduction in the Groups* sales and a decline
in its profitability.

Future legal
restriction may negatively affect the results of operations

The Companys
activities and its subsidiaries and associated companies activities are confined by
legal constraints (such as government policy on various subjects, different requirements
made by the authorities supervising environmental regulations and governmental decisions
to raise minimum wages) . These restrictions may affect the results of operations of the
Group.

Any future rise in the
inflation rate may negatively affect business

Since
the Company possesses a significant amount of CPI-linked liabilities, a high inflation
rate may cause significant financial expenses. Consequently, the Company occasionally
enter into hedging transactions to cover the exposure due to the liabilities. A high
inflation rate may also affect payroll expenses, which, at the long run, tends to be
adjusted to the changes in the CPI.

Exposure to Exchange
Rate Fluctuation

The
Company, its consolidated subsidiaries and associated companies are exposed to risks due
to changes in the foreign exchange rates, either due to importing raw materials and
finished products or due to exporting to international markets. Changes in the foreign
exchange rates of the different currencies compared to the New Israeli Shekel may cause
erosion in profitability and cash flow.

# Risk Factors relating to
the Company

The Company faces
significant competition in the markets the Company operates in

The
Company operates in the packaging paper and office supplies industries, both of which are
highly competitive. In the packaging paper industry the Company faces competition from
imported paper. In the office equipment sector the Company faces competition from many
suppliers that operate in the Companys markets.            The associated companies
are also exposed to competition in all of their           operations. This competition
may negatively affect the future results. For           further information see the
section titled  Competition in           Item 4B below.

5



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The Company is exposed
to increases in the cost of raw materials.

The
increase in the activity of the paper machines, which are based on paper waste as a
recycled fiber, makes it necessary to increase the collection of paper waste and seek
wider range of collection sources. The lack of enforcement of the Israeli recycling laws,
which require waste recycling, makes it difficult to find alternative resources at a
competitive cost, but the enactment of the Clean Environment Act in January 2007, which
charges a landfill levy on waste may, if effectively enforced, significantly improve the
ability to collect paper waste.

There
is an exposure in the associated companies resulting from fluctuation of prices of raw
material and of the imported products, which arrive to Israel without tariffs or entrance
barriers. Exceptional price increase of raw materials and imported products may have an
adversary effect on these Companies profitability.

The Company is
dependent on energy prices.

AIPMs
activities are highly dependent on the consumption of energy and therefore are influenced
by fuel and electricity prices. AIPMs profitability may suffer if there is an
exceptional increase in energy prices.

Account Receivable
Risks

Most
of the Companys and its subsidiaries sales are made in Israel to a large
number of customers. Part of the sales is made without full security of payment. The
exposure to credit risks relating to trade receivables is usually limited, due to the
relatively large number of our customers. The Company performs ongoing credit evaluations
of its customers to determine the required amount of allowance for doubtful accounts. An
appropriate allowance for doubtful accounts is included in the financial statements.

The operations in
Turkey may suffer as a result of the Turkish economy.

The
Company is exposed to various risks related to its activities in Turkey, where
Hogla-Kimberly Ltd (H-K) operates through its subsidiary, Kimberly Clark
Turkey (KCTR). These risks result from economic instability and high inflation
rates and exchange rate fluctuations, which have characterized the Turkish economy during
the past years, and may be repeated and adversely affect KCTRs activities.

Risks Associated with
credit from banks

The
Company forms part of the I.D.B. Group and is influenced by the Israel Banking Supervisors
Correct Banking Management Regulations, which includes amongst other things,
limits to the volume of loans an Israeli bank can issue to a single borrower; a single
borrowing group(as this term is defined in the said regulations), and to the
six largest borrowers and borrowing groups at a bank corporation. I.D.B.
Development, its controlling shareholders and some of the companies held thereby, are
considered to be a single borrowing group. Under certain circumstances, this
can influence the AIPM Groups ability to borrow additional sums from Israeli banks
and to carry out certain business transactions in partnership with entities that drew on
the aforesaid credit.

For
further information, see Item 11  Quantitative and Qualitative Disclosure
about Market Risk.

6



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# ITEM 4 - INFORMATION ON
THE COMPANY

# A.    History and
Development of the Company

American
Israeli Paper Mills Ltd. was incorporated in 1951 under the laws of the State of Israel,
and, together with its subsidiaries and associated companies (which together with the
Company are referred to as the Group) is Israels largest manufacturer of
paper and paper products.

The
Companys principal executive offices, and also the Companys registered
offices, are located at 1 Meizer St., Industrial Zone, P.O. Box 142, Hadera, Israel, Tel:
(972-4) 634-9349, fax: (972-4) 633-9740.

The
organizational structure of the Company and certain subsidiaries was changed as of January
1, 1999. This change was intended to result in an operational separation between various
activities, especially in the paper and board divisions, to allow for better business
focus, greater operating efficiency and the formulation of business strategies that
facilitate the establishment of additional international strategic alliances.

Within
the framework of the organizational changes, different fields of operations were defined
and separated, including printing and writing paper and packaging paper. For each of them
a separate management team was assigned.

Over
the last few years, the Group has participated in several joint ventures as follows:

1.       
          In July 1992, the Group purchased 25% of the shares of Carmel Container Systems
          Ltd. (Carmel), a leading Israeli designer, manufacturer and marketer
          of containers, packaging materials and related products. As of December 31,
          2006, the Group held 26.25% of the shares of Carmel shares. As a result of a
          self acquisition by Carmel, the Groups holding in Carmel increased as of
          June 01, 2007, to 36.2% of the shares of Carmel shares. Another major
          shareholder in this company is Kraft Group LLC (an American shareholder)
          (49.6%). Carmel shares were traded on the AMEX and were deregistrated and
          delisted in 2005.

2.       
          In 1996, Kimberly Clark Ltd. (KC) acquired 49.9% of the shares
          of Hogla, a wholly-owned subsidiary of the Company and a leading Israeli
          consumer products company, which was then renamed Hogla-Kimberly Ltd (H-K). H-K
          is engaged in the production and marketing of household paper products, hygiene
          products, disposable diapers and complementary kitchen products. The partnership
          was intended to expand the local production base in Israel, in order to serve
          both local and regional demand, and to offer H-K access to international
          markets. In 1999, H-K purchased Ovisan, which was renamed to
          Kimberly Clark Turkey (KCTR), a Turkish manufacturer and
          marketer of diapers and paper products. On March 31, 2000, KC increased its
          holdings in H-K to 50.1%.

3.       
          Effective January 1, 2000, AIPM entered into a joint venture agreement with
          Neusiedler AG (NAG), pursuant to which NAG acquired 50.1% of AIPMs
          printing and writing paper operations. The printing and writing paper operation
          was separated from AIPM upon the completion of this transaction and was sold to
          Neusiedler Hadera Paper (NHP), a subsidiary that was established for this
          purpose, of which NAG acquired 50.1%. NHP was renamed in 2004 and is now called
          Mondi Business Hadera Paper (Mondi Hadera).

4.       
          Amnir Recycling Industries Ltd. (Amnir) (a wholly owned subsidiary of AIPM),
          which is engaged in the collection and recycling of paper and plastic waste and
          in the confidential data destruction, acquired in 1997 and 1998 20% and 10%,
          respectively, of Cycle-Tec Recycling Technologies Ltd. (Cycle-Tec), a research
          and development company which develops a process for manufacturing of a high
          strength / low cost composite material, based on recycled post consumer plastic
          and paper, treated with special chemical additives. As of May 31, 2007, Amnir
          owned 30.18% of Cycle-Tec.

7



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5.       
          In July 1998, the Company signed an agreement with a strategic partner,
          Compagnie Generale dEntreprises Automobiles (CGEA), for the sale of 51% of
          the operations of Amnir Industries and Environmental Services Ltd. (Amnir
          Environment) in the field of solid waste management (waste disposal and
          management of transfer stations and landfills). CGEA is an international French
          company, which is part of the Veolia group and one of the worlds leading
          companies in the field of environmental services. The agreement did not apply to
          Amnirs operations in collecting and recycling paper and plastic. As of
          February 13, 2007, the Company is no longer a shareholder in Amnir Environment,
          see clause 6 below.

6.       
          In March 2000, AIPM and CGEA, on the one hand, and Tamam Integrated Recycling
          Industries Ltd. (T.M.M.) and its controlling shareholders, on the other hand,
          entered into an agreement pursuant to which AIPM and CGEA acquired through a
          jointly held company, Barthelemi Holdings Ltd (Barthelemi) from
          T.M.M.s controlling shareholders 62.5% of the share capital of T.M.M., an
          Israeli company in the solid waste management field. Simultaneously therewith,
          100% of Amnir Environments shares were transferred to T.M.M. in return for
          an allocation of 35.3% of the shares of T.M.M. to the shareholders of Amnir
          Environment. Following such transaction, AIPM and CGEA owned, together, 75.74%
          of the shares of T.M.M. In August and September 2000, T.M.M. acquired
          approximately 3% of its own share capital. In December 2001 and in August 2003
          AIPM and CGEA acquired additional shares of T.M.M.s share capital through
          the jointly held company Barthelemi, resulting in an increase in the ownership
          of shares of T.M.M. by AIPM and CGEA to 88%, and as of December 31, 2006, AIPM
          held directly and indirectly 43.08% of T.M.M.s shares and CGEA held 44.92% of
          T.M.M.s shares. On January 4, 2007, an Agreement was signed between the
          Company and CGEA, according to which, the Company sold to CGEA its holdings in
          Barthelemi, and the rest of its holdings in T.M.M. The aforesaid transaction, for
          the total amount of $ 27 million, was accomplished in February 13, 2007, and
          since then, the Company is no longer a shareholder in T.M.M.

7.       
In June 2005, C.D. Packaging Systems Limited (C.D., an associated
company of AIPM, held jointly with Carmel), which is engaged, in the designing,
manufacturing and marketing of consumers packages, acquired the business
activity of Frenkel and sons Ltd., in exchange for allocation of shares in C.D.,
and was renamed to Frenkel- CD Ltd. Both companies are engaged in the field of
folding boxes. The goal of the new entity is to join the activities in the field
and create a significant entity in the competitive market, while combining the
advantages of the two companies and fulfilling the potential of cost savings, as
a result of the synergy between the activities. The merger is effective as of
January 01 2006. As of May 31, 2007, the Group holds 35.16% of C.D.s
shares (directly and indirectly through Carmel that holds 27.85% of C.D.s
shares) and Frenkel and sons Ltd. holds 44.3% of C.D.s shares.

Capital
Expenditures and Divestitures

2006

The investments in fixed assets
totaled about NIS 53.1 million (about $ 12.5 million). These investments included:

| |  | Investments
of approximately NIS 3.0 million ($ 0.7 million) in environmental expenditures.
|- |  | -------------------------------------------------------------------------------------------

| |  | An
investment of approximately NIS 2.5 million ($ 0.6 million) in a conversion to a conversion to gas system.
|- |  | -------------------------------------------------------------------------------------------------------------

| |  | Investments of approximately NIS 13.9 million ($ 3.3 million) in conversion and
improvement of steam tanks.
|- |  | -----------------------------------------------------------------------------------------------------------

| |  | Investments of approximately NIS 1.7 million ($ 0.4 million) in real estate in Hadera as a
reserve for the Companys future development.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------

| |  | Investments totaling NIS 32.0 million ($ 7.5 million) in buildings, equipment,
transportation and information technology.
|- |  | -------------------------------------------------------------------------------------------------------------------------

8

---

2005

The investments in fixed assets
totaled about NIS 71.1 million (about $15.4 million). These investments included:

| |  | Investments
of approximately NIS 4.6 million ($1.0 million) in environmental expenditures.
|- |  | ------------------------------------------------------------------------------------------

| |  | An
investment of approximately NIS 1.8 million ($0.4 million) in a conversion to a gas system.
|- |  | ----------------------------------------------------------------------------------------------

| |  | Investments
of approximately NIS 36.8 million ($8 million) in real estate in Hadera an Naharia.
|- |  | -----------------------------------------------------------------------------------------------

| |  | Investments totaling NIS 27.9 million ($6 million) in buildings, equipment, transportation
and information technology.
|- |  | ----------------------------------------------------------------------------------------------------------------------

2004:

The  investments in fixed
assets of the Company totaled about NIS 31.0 million in 2004 (about $6.9 million). These
investments included:

| |  | Investments
of approximately NIS 2.2 million ($0.5 million) in environmental expenditures.
|- |  | ------------------------------------------------------------------------------------------

| |  | An investment of approximately NIS 2.2 million ($0.5 million) in a machine for the
manufacturing of cores based on Cycle-Tec technology.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------

| |  | Investments totaling NIS 26.6 million ($5.9 million) in buildings, equipment,
transportation and information technology.
|- |  | ------------------------------------------------------------------------------------------------------------------------

# B.     Business Overview

| | I.   The Groups Operations and Principal Activities
| | ----------------------------------------------------

The
Company is engaged through its subsidiaries in the manufacture and sale of packaging
paper, in the collection and recycling of paper and plastic waste and in the marketing of
office supplies, mainly to the institutional and business sector. The Company also holds
interests in associated companies that deal in the manufacture and marketing of printing
and writing paper, household paper products, hygiene products, disposable diapers,
complementary kitchen products, corrugated board containers and packaging for consumer
goods.

In
order to serve the paper production activities, the Company, through a wholly owned
subsidiary, supplies engineering services, maintenance, steam and energy, water supply,
sewage treatment etc. to different paper machines located at the Companys main site
in Hadera in return for cost sharing.

The
Company operates in its main production site in Hadera according to the following
standards:

ISO
9001/2000  quality management

ISO 14001
 environmental regulations

Israeli
Standard 18001 - safety

The
principal products produced and/or marketed by the Group (indicating its subsidiaries and
associated companies) are as follows:


   Grades of Paper and Board

Printing
and writing paper, publication papers in reels, coated paper, carbonless paper, cut-size
paper for copy laser and inkjet, copy-book paper, paper for continuous forms, paper for
envelopes and direct mailing and various grades of packaging paper and board.

9



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
    Packaging Products

Folding
cartons, corrugated containers, consumer packages solid board containers and pallets.


    Household Products

Bathroom
tissue, toilet paper, kitchen towels, facial tissue, napkins, disposable tablecloths,
sanitary towels, panty shields, tampons, disposable baby diapers, training pants, baby
wipes, disposable adult diapers, incontinence pads.


    Industrial, Hospital and Food Service Products

Toilet
paper, towel rolls, C-fold towels, napkins, place mats, coasters, bed sheets, wadding,
paper toilet seat covers, disposable bed-pans and urinals, sterilizing paper, bathroom
tissue and paper towel dispensers, dispensers for liquid hand soaps and room deodorizing
dispensers for washrooms and cleaners, detergents and cleaning complimentary products,
cups and plates, examination gloves.


    Other Products

Aluminum
food wraps, cling-film wraps, garbage bags, oven baking and cooking trays, office
supplies, recycled ground and palletized plastics used by the plastic products industry.

Sales and Marketing

The
Groups packaging products are sold mostly to four main customers in Israel (one of
them is an associated company) which operate in the corrugated board sector with whom the
Group has long standing business relationships.

The
Groups office supplies products are sold to thousands of customers in the Business
to Business sector and to institutions such as governmental offices and banks. About 30%
of the sales are made through tenders.

The
Groups paper grades products are sold to publishers, big and medium size printers,
converters, and wholesalers some of which are part of the Group, as well as other direct
customers.

The
Groups household products are marketed mainly through retail marketing chains,
stores and the institutional market.

The
Groups packaging products are sold to a wide range of customers in different sectors
(e.g., industry, agriculture, food and beverage industry), including direct marketing to
ultimate customers through subcontractors and agents.

The Groups main marketing
strategy has the following objectives:

|(a) |  | Maintaining its existing dominant share in the Israeli market of paper grades
                    and household products produced by the Group and imported by it, through short
                    delivery times and prompt service, while constantly improving the quality of its
                    products.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) |  | Meeting the growing and changing requirements of the market by adding new
                    products and improving the quality of existing grades of paper in order to meet
                    the technological changes required by new printing equipment and the needs of
                    the customers.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(c) |  | Exploring new business opportunities in Israel and abroad and increasing the
                    range of its products and the production capacity.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

10



---

In
March 2007, KCTR signed a principles agreement with Unilever, according to which Unilever
shall distribute and sell KCTRs products in Turkey, excluding distribution and sales
to the food chains which will be done directly by KCTR. The agreement was signed to enable
KCTR to increase its market cover and volume of sales, following the approval of a
strategic plan by KCTR, for the expansion of its activities in Turkey for the coming
decade. The complete strategic plan is designated to expand the activities of KCTR, from
the current yearly sales turnover of $50 million to a turnover of $300 million in the year
2015, and improve its profitability through constructing it as a significant factor in the
Turkish market in the field of disposable diapers, women hygienic products and various
tissue products, based on international brands of Kimberly- Clark worldwide.

The
following table sets forth the consolidated sales in NIS millions(**) by categories of the
consolidated segments of operations:

|** |  | AIPM made the transition to reporting in nominal New Israeli Shekels (NIS) in 2004,
pursuant to the directives of Standard 12 of the Financial Accounting Standards Board in
Israel. Prior to January 1, 2004, AIPMs reports were in NIS, adjusted to changes in
the exchange rate of the US dollar against the NIS.
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Packaging Paper
Manufacturing
and Recycling (1) |  | Marketing Office
Supplies (2) |       | Total | 
|----------------------------------------------- |  | ----------------------------- | ----- | ----- | 
|
|408.0                                           |  |                               | 368.9 |       | 

The above mentioned segments include
the following activities:

|1. | Packaging paper manufacturing and recycling  manufacturing and marketing
          of packaging paper, including collecting and recycling of paper waste. The
          manufacturing of packaging paper relies mainly on paper waste as raw materials.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2. | Marketing office supplies - Marketing of office supplies and paper, mainly to
          institutions.
|-- | -----------------------------------------------------------------------------------------------------

# Raw Materials

The
raw materials required for paper and board production are different wood pulps, secondary
fibers (i.e., waste paper) and various chemicals and fillers. Pulp is imported primarily
from major suppliers in Scandinavia, the United States, Portugal, Austria, Brazil and
Spain on a regular basis. The bulk of the pulp tonnage purchased is secured by revolving
long-term agreements renewed on a yearly basis. All of the pulp for the printing and
writing paper manufactured by Mondi Hadera is purchased by Mondi Business Paper (the
Austrian parent company), which purchases pulp for its subsidiaries around the world. This
ensures fluent supply and better prices.

The
pulp for the household products is being imported by H-K with the assistance of K-C.

About
65% of the fibers required in paper production by the Group (including printing and
writing paper and household products for the operation of its associated companies) come
from waste paper, which in some paper grades, is used in lieu of relatively more expensive
pulp. The production of packaging and brown wrapping paper is based mostly on recycled
fibers. Therefore, the main raw material used for the production of packaging and brown
wrapping paper is paper waste most of which is collected from various sources by Amnir, a
wholly owned subsidiary of the Company. Approximately 210,000 tons per year of waste paper
are collected and handled by Amnir, most of which are used by the Group for the production
of fluting and tissue paper and some of which is sold to other tissue paper manufacturers.
Apart from the waste paper collected by Amnir there is a use of residue which is created
during the production of packages and purchased from the manufacturers of corrugated
board.

11



---

The
absence of supporting enforcement of the Recycling Act, which mandates waste recycling,
detracts from the companys ability to expand waste collection, due to financial
considerations. On January 16, 2007, however, the Clean Environment Act (9th amendment) -
2007 (Clean Environment Act) was enacted, imposing a landfill levy on waste.
Pursuant to the provisions of this act, a landfill charge will be levied against waste, at
the rate of NIS 10 per ton in 2007, rising up to NIS 50 per ton from 2011 and thereafter.
The enforcement of this act may lead to improved capacity in paper waste collection.

Also,
Amnir is preparing to increase paper waste collection over the coming years, due to a
board approval for an investment in a new machine for packaging paper, at a cost of
approximately $140 million (see also section D below). The construction of the new
packaging machine, will require twice the volume of paper waste collection to serve as raw
material in the production of packaging paper over the coming years. Amnir is gearing up
to increase collection volumes, in anticipation of the installation of the new packaging
paper machine. For further details please refer to the Item 4.D. Property, Plants and
Equipment below.

The
main raw material required for the manufacture of corrugated board is board paper. Carmel
purchases paper from two main suppliers which are also shareholders of Carmel.

Since
1996, NHP, an associated company, has been using precipitated calcium carbonate (PCC), a
special pigment used for filling and coating paper in order to improve quality. In 2005,
an agreement was signed between Mondi Hadera and the Swedish company Omya International AG
(Omya) for the supply of PCC for a period of ten years commencing in April
2006.The parties are currently negotiating for the extension of the Agreement to fourteen
years in return for the reduction of the PCC cost. Omya constructed and operates a PCC
plant in Israel. In September 2005, the Agreement was converted to an Israeli fully owned
subsidiary of Omya. The PCC purchased from Omya replaced a former PCC purchase from
another PCC supplier, and led to a significant PCC cost saving.

The
cost of paper production is affected by fluctuating raw material prices and the cost of
water, energy and fuel oil. At the associated companies, there exists exposure to the
fluctuations in raw material prices and the prices of products purchased for imports that
arrive in Israel with no tariffs and no entrance barriers. Unusual rises in the cost of
raw materials and imported finished products could impair profitability.

Competition

Most
of the Groups products that are sold on the local market are exposed to competition
with local and imported products. The imported products arrive in Israel exempt from
import tariffs, especially from the EEC, EFTA and the USA. The tariffs on imports of fine
paper from other countries are in the range of 0% - though 12%.

The
main competitors of the Group in the different fields of operation are Israeli companies
which sell mainly imported products, except for sales of baby diapers and hygienic
products in which the Groups main competitor is Proctor & Gamble Co.

In
the market for office supplies that are sold directly to institutions and businesses there
are numerous local suppliers that compete with the Company.

The
sector of office supplies with direct delivery to organizations and businesses includes
two dominant competitors (Office Depot and Kravitz), which together with Grafiti primarily
dominate the tender and strategic business customer segment; and number of competitors
which have a combined together on approximately 20% market share. In addition, in the
business big/ medium/ small a large number of competitors exists, , and which mostly
operate within a limited geographical area. In late 2006 and early 2007, several General
Accountant tenders were issued for office supplies and consumables office supplies; the
tenders were secured by Office Depot, whose market share is therefore expected to grow to
about 11%. Graffiti and Kravitz each possess an estimated 10% market share after
implementation of the General Accountant tenders. Below is a listing of major competitors:
Kravitz, Office Depot, Ofek, Alpha Beta, Yavne Pitango, Pythagoras, Lautman and Pan.
Graffiti competes and maintains its position by adhering to elevated standards of quality
and service.

12



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The
Group collection and paper recycling operation is exposed to local competition by local
companies which operate all over the country.

The
competition has influence over the selling prices that the Group can charge. The Group
competes with the imported products by emphasizing the advantages of having a local
supplier by ensuring the customers uninterrupted supply and service on short notice and
excellent quality of products.

Competition
in packaging paper is against imports, made directly by customers with no barriers.
Imports into Israel include all paper types produced in Israel at different paper
qualities, depending on the suppliers production machinery. To the best of the
Companys knowledge, the primary overseas suppliers include: Varel  Germany,
Emin Leidlier France, Saica  Spain, Hamburger  Austria, SCA 
Italy, Otor  France. The sector competes by ensuring continuous supply and service
with short lead times, which provide it with the advantage of a local supplier.

The
Company operates in a competitive market, with competition in the paper and recycling
sector against imported paper on the one hand, and with many collectors operating in raw
material collection in Israel.

Companys
operations depend  to a great degree  on energy consumption, and are therefore
strongly impacted by fuel prices. Profit margins may be eroded if fuel and electricity
prices surge.

In
December 1989, the Company was declared a monopoly in the manufacture and marketing of
packaging paper by the Israel Antitrust Authority- there are no special provisions for the
packaging paper.

Regarding
seasonality of the Companys business, H-K products are generally sold on a regular
scale all year round, and during the Jewish holiday season (Rosh Hashanah, Passover),
there is some increase in the scope of sales beyond the ordinary monthly average.

# C.    Organizational
Structure

As
of May 28, 2007, Clal Industries and Investment Ltd. (Clal) beneficially owned 37.83% of
the ordinary shares of the Company and Discount Investment Corporation Ltd. (DIC)
beneficially owned 21.37% of the ordinary shares of the Company. Clal and DIC agreed to
coordinate and pool their voting power in the Company. To our knowledge, IDB Development
Corporation Ltd. owns 74.76% of DIC and 60.52% of Clal. See Item 7 - Major Shareholders
and Related Party Transactions.

13



---

|Significant subsidiaries and associated companies                                   | 
|----------------------------------------------------------------------------------- | 
|
|Subsidiaries                                                                        | 
|                                                                                    | 
|Amnir Recycling Industries Ltd.                                                     | 
|Graffiti Office Supplies & Paper Marketing Ltd.                                     | 
|Attar Marketing Office Supplies Ltd.                                                | 
|American Israeli Paper Mills Paper Industry (1995) Ltd.                             | 
|                                                                                    | 
|Associated Companies                                                                | 
|                                                                                    | 
|Hogla-Kimberly Ltd.                                                                 | 
|Kimberly -Clark Tuketim  Mallari Sanayi Ve Ticaret A.S. ("KCTR") (held through H-K) | 
|Mondi Business Paper Hadera Ltd.                                                    | 
|Barthelemi Holdings Ltd.**                                                          | 
|T.M.M. Integrated Recycling Industries Ltd. (direct and indirect)**                 | 
|Carmel Containers Systems Ltd.                                                      | 
|Frenkel- CD Ltd. (direct and indirect through Carmel)                               | 
|Cycle-Tec Recycling Technology Ltd.                                                 | 

---

|* |  | The
holding in voting shares is 35.11%.
|- |  | ---------------------------------------

|** |  | Until
February 2007.
|-- |  | --------------------

# D.    Property, Plants and
Equipment

The
Groups principal executive offices and manufacturing and warehouse facilities
(including associated companies) are located on approximately 87.5 acres of land in
Hadera, Israel, which is 31 miles south of Haifa, a major seaport, 28 miles north of Tel
Aviv. The Company owns 69.5 acres, out of which 18.5 acres were purchased in 2005, for the
amount of $4.4 million, and 18 acres are leased from the Israel Land Administration, an
agency of the State of Israel, under several leases. The lease periods terminate during
the period from 2007 until 2053. Some of this land is rented to associated companies,
which operate in Hadera.

The
Groups facilities in Hadera are housed in two-story plants and several adjoining
buildings. Approximately 1,200,000 square feet are utilized for manufacturing, storage and
sales and administrative offices. An additional plant owned by H-K is located in a 10-acre
plot in Afula, a city in northern Israel. AIPM is leasing from the Israel Land
Administration in Nahariya, in northern Israel, approximately 6 acres, which are rented to
an associated company. In September 2002, the Company signed an agreement with the Tel
Aviv Municipality for the extension of the lease period of a real estate lease for a plant
in Tel Aviv, that was shut down at the end of 2002, until the year 2059, in return for the
payment of $6.2 million by the Company. The Company is investigating several options for
using the land. According to the lease Agreement, the Company is obliged to utilize its
building permits until September 2009.

14



---

The
Group also owns a two-acre parcel in the industrial zone of Bnei Brak, near Tel-Aviv,
which is used for waste paper collection.

The
Group owned a warehouse containing 50,000 square feet situated on approximately 3.1 acres
in the Tel Aviv area, leased from the Israel Land Authority and rented to third party
under a long term agreement. On December 31, 2006, the Company sold its lease rights to
this land to Erledan Investments Ltd. in consideration of NIS 57 million, including
betterment taxes that apply to the buyer, so that the net worth to the Company before
betterment taxes is about NIS 43 million. As a result of this sale, the Company recorded
capital gains of some NIS 28.5 million in the fourth quarter of 2006.

H-Ks
headquarters and logistic center, which are leased under a long term lease agreement, are
located in a new modern site in Zrifin, near Tel-Aviv, covering an area of 430,550 square
feet, with 188,370 square feet of buildings.

Associated
companies rent plants and office facilities in Migdal Haemek and Caesarea and additional
warehouses and waste paper collection sites throughout Israel.

The
machinery, equipment and assets of the Company are free of any mortgage, lien, pledge or
other charge or security interest.

The
Group owns six paper machines that are used in the manufacture of various grades of paper
and board. Most of the paper production facilities of the Company and its subsidiaries are
located in Hadera where it operates five machines with a combined production capacity of
over 320,000 tons per year. The Group owns another machine in Nahariya which produces
tissue paper with production capacity of 20,000 tons per year.

In
November 2006, the Companys Board of Directors approved a total investment of
approximately $140 million in the construction project of a new machine for the
manufacture of packaging paper from cardboard and paper waste, with an output capacity of
230,000 tons per annum, at the Companys site in Hadera. Subsequent to the
construction of the new machine, planned for 2009, and along with the parallel
decommissioning of one of two machines currently operating, the Companys annual
production capacity for packaging paper will increase from 155,000 tons at the present
time, to approximately 330,000 tons per annum. The new machine is meant to answer the need
for ever-increasing demand volumes by the local market, at competitive pricing
vis-à-vis the competing importer. The Company has yet to decide how it will finance
the project and is currently analyzing various alternatives.

The
new machine is intended to meet the Companys need for ever-increasing demand volumes
by the local market, at competitive pricing vis-à-vis the competing importer. The
Company anticipates that the significant growth that is planned in the total volume of its
paper production, on the basis of the existing infrastructure, will serve to improve its
long-term profitability. The Company has yet to decide how it will finance the project and
is currently analyzing various alternatives.

The
Group also operates converting lines for personal care and household paper products in
Hadera and Nahariya.

The
Group maintains facilities for collecting, sorting and baling waste paper and board in
various locations in Israel. It also has a plant in Afula for the production of disposable
baby diapers, incontinence absorbent products and feminine hygiene products, a plant in
Migdal Haemek for the production of paperboard consumer packages and a plant in Hadera for
recycling plastic waste.

The
Company established in 2000 a new co-generation power plant, based on high-pressure steam
available from steam drying employed in paper production, for a total investment of about
$14 million. The operation of the power plant, situated in Hadera, and the Group now
enjoys an independent power generation capacity of 18MW, with generation costs
considerably lower than the cost of electricity purchased from the Israel Electricity
Company. As part of this project, the infrastructure of the main electricity supply system
was renovated and improved, utilizing modern technological innovations.

15



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The
Company is examining and promoting a project for establishing a combined cycle
co-generation plant based on natural gas at Hadera. In addition, the Company is preparing
for the conversion of its energy-generation systems, currently based on heavy fuel oil, to
natural gas, once the transportation infrastructure of natural gas to Hadera is completed.
The conversion is planned for the third quarter of 2007. This conversion is expected to
enable savings in production costs, while further improving environmental compliance. The
capacity of the new plant is expected to enable the Company to sell electricity to
external users, including the Israel Electric Company.

In
October 2004, a wholly owned subsidiary of the Company, American Israeli Paper Mills Paper
Industry (1995) Ltd., was granted by the Minister of National Infrastructure a basic
permit to generate electricity by means of power and heat systems (co-generation). In
addition, in December 2004 the project was announced as a National Infrastructure
Project.

The
permit in principle enables the Company to build a power station with a total output of
200 megawatts, with integrated cycle cogeneration, operating on natural gas, at the AIPM
site in the Hadera Industrial Zone. The said authorization is contingent upon several
conditions that have yet to be met, including meeting the production license requirements,
the demands of the Electricity Economy Law, certain milestones outlined in the
authorization and more.

In
October 2006, the National Infrastructure Committee approved the change in designation of
40,000 m(2) of land, to be used as a power station and for other uses. The approval was
empowered by the Israeli government on February 6, 2007.

Environmental
Regulation Matters

The
business license of the main production site of the Group in Hadera includes conditions
regarding sewage treatment, effluent quality, air quality and the handling of waste and
chemicals. In addition, the site has to operate according to the conditions of the Israeli
water commission regarding effluent disposal. To the best knowledge of the Company, the
site operates according to the requirements of the authorities, and in the events of
deviations, the Company acts for the repairment of the deviations, jointly with the
authorities.

In
November 2006, the Environmental Protection Ministry announced that, even though the
Company plant at Hadera has made considerable investments in sewage treatment and
environmental protection issues, an investigation may be launched against it to review
deviations from certain emission standards into the air. The Company anticipates that the
investigation will not materially impact its operations.

Certain
of the Groups manufacturing operations are subject to environmental and pollution
control laws in Israel. In order to comply with these laws, the Group planned and
acquired, during 2001, a new modern facility for the treatment of effluent using an
anaerobic treatment process. This process was installed in the Groups site in Hadera
as a pre-treatment phase in the existing system based on aerobic treatment, in order to
improve the treated effluent quality in compliance with environmental regulations.

During
the years 2000-2006 the Group invested in Hadera approximately $11.6 million in projects
intended to enable it to comply with the strict environmental regulations applicable to it
out of which: about $5 million in 2006, including a $3.5 million investment in the
conversion of the energy system to consume natural gas instead of fuel oil as described
below, and $800,000 in a project for a waste water softening facility in the treatment
facility, to serve as a basis for recycling treated waste water, as well as investments in
sewage, chemicals and waste, including systems for collection and separation of waste and
sewage incorporating tertiary treatment of treated waste water.

16



---

The
Company is preparing for the conversion of its energy-generation systems, currently based
on heavy fuel oil, to natural gas, in an investment of approximately $7million (out of
which about $3.5 million in 2006). This process will be completed with the completion of
the installation of the natural gas pipeline to Hadera , postpones due to delays that lie
outside the control of the Company, and planned for the third quarter of 2007. This
project is expected to contribute saving expense and improve the environmental compliance
since the Company will use natural gas instead of fuel oil.

In
2006 all plants at the main Hadera site successfully passed various environmental
inspections.

# ITEM 4A 
UNRESOLVED STAFF COMMENTS

None.

# ITEM 5  OPERATING AND
FINANCIAL REVIEW AND PROSPECTS

Critical Accounting
Policies and Estimates

The
Companys discussion and analysis of the financial condition and operations are based
upon the Companys consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in Israel (for information as to
the reconciliation between U.S. and Israeli GAAP, see Item 17). The preparation of these
financial statements requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities.

The
Company identified the most critical accounting principles upon which its financial status
depends. The Company determined the critical principles by considering accounting policies
that involve subjective decisions or assessments.

The
Company states its accounting policies in the notes to the consolidated financial
statements and at relevant sections in this discussion and analysis.

This
discussion and analysis should be read in conjunction with the Companys consolidated
financial statements and related notes included elsewhere in this report.

The Company identified the following
critical accounting policies:

Inventories

Inventory
is valued at the lower of cost or market, where cost is determined on the moving average
basis. The Company writes down its inventory for estimated obsolescence or unmarketable
inventory based on an analysis of the inventory aging and assumptions about future demand
and market conditions. If actual demand and/or market conditions are less favorable than
those projected by management, additional inventory write-downs may be required.

Spare
parts of the machinery and equipment that are not for current use, are presented under
fixed assets.

Allowance for doubtful
accounts

The
Company maintains allowances for doubtful accounts for estimated losses resulting from the
inability of its customers to make required payments. The Company provides an allowance
for doubtful accounts as a percentage of all specific debts doubtful of collection. The
allowances are based on the likelihood of recoverability of accounts receivable
considering the aging of the balances, the Companys historical write-off experience,
(net of recoveries), change in credit worthiness of the customers, and taking current
collection trends that are expected to continue. These estimated allowances are
periodically reviewed, and customers payment histories analyzed. Actual customer
collections could differ from the Companys estimates.

17



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Contingencies and
risks involving the business

The
Company is subject, from time to time, to various claims arising in the ordinary course of
operations. In determining whether liabilities should be recorded for pending litigation
claims, the Company assesses, based on advice of its outside legal counsel, the
allegations made and the likelihood that it will successfully defend itself.

When
the Company believes that it is probable that it will not prevail in a particular matter,
it then estimates the amount of the liability. The evaluation of the probability of
success of such claims and the determination of whether there is a necessity to include
provisions in respect thereof require judgment by the Companys legal counsel and
management.

Deferred income taxes

Deferred
taxes are determined utilizing the asset and liability method, based on the differences
between the amounts presented in the financial statements and those taken into account for
tax purposes, in accordance with the related tax laws. Valuation allowances are included
in respect of deferred tax assets when it is more likely than not that such assets will
not be realized. The Company has considered future taxable income and tax planning
strategies in assessing the need for the valuation allowance. Management evaluates the
realizability of the deferred tax assets on a current basis. If it were determined that
the Company would be able to realize the deferred tax assets in excess of its net recorded
amount, an adjustment to deferred tax assets would increase income.

Impairment in value of
Long-Lived Assets (including fixed assets and investments in associated companies)

In
February 2003, Accounting Standard No. 15 of the Israeli Accounting Standard Board
(hereafter - IASB) - Impairment of Assets, became effective. According to this
standard the Company assesses - at each balance sheet date - whether any events have
occurred or changes in circumstances have taken place, which might indicate that there has
been an impairment of non-monetary assets, mainly fixed assets and investments in
associated companies. When such indicators of impairment are present, the Company
evaluates whether the carrying value of the asset is recoverable from the cash flows
expected from that asset. See Note 2g to the Financial Statements.

The
recoverable value of an asset is determined according to the higher of the net selling
price of the asset or its value in use to the Company. The value in use is determined
according to the present value of anticipated cash flows from the continued use of the
asset, including those expected at the time of its future retirement and disposal.

When
it is not possible to assess whether an impairment provision is required for a particular
asset on its own, the need for such a provision is assessed in relation to the recoverable
value of the cash-generating unit to which that asset belongs.

Through
December 31, 2002, the Company applied the provisions for assessing and recording
impairment of assets, prescribed by the U.S. standard, FAS 121.

Discontinuance of
Adjusting Financial Statements for Inflation

The
Company draws up and presents its financial statements in Israeli currency (hereafter -
shekels or NIS), in accordance with the provisions of Israel Accounting Standard No. 12 -
Discontinuance of Adjusting Financial Statements for Inflation - of the IASB,
which establishes principles for transition to nominal reporting, commencing January 1,
2004 (hereafter - the transition date). Accordingly, amounts that relate to non-monetary
assets (including depreciation and amortization thereon), investments in associated
companies (see also below) permanent investments, and equity items, which
originate from the period that preceded the transition date, are based on the data
adjusted for the changes in the exchange rate of the dollar (based on the exchange rate of
the dollar at December 31, 2003), as previously reported. All the amounts originating from
the period after the transition date are included in the financial statements at their
nominal values.

18



---

The
financial statements of group companies which are drawn up in foreign currency, are
translated into shekels or are remeasured in shekels for the purpose of inclusion in these
financial statements, as explained in e. below.

The
sums of non-monetary assets do not necessarily reflect the realization value or an updated
economic value, but rather only the reported sums of the said assets, as stated in (1),
above. The term cost in these financial statements shall mean the cost in
reported sums.

Financial Instruments

In
August 2005, the IASB issued Israeli Accounting Standard No. 22 Financial
Instruments Disclosure and Presentation (herein after  Standard 22).
Commencing January 1, 2006, the Company applied Standard No. 22, which prescribes the
rules for presentation of financial instruments and the proper disclosure required
therefore, as follows:

|1) |  | Offset
of financial instruments
|-- |  | -------------------------------

| | Financial
assets and financial liabilities are presented on the balance sheet at their net amount,
only when the Company has a legally enforceable right to effect such set off, and subject
to the existence of an intent to settle the asset and the liability on a net basis, or to
realize the asset and settle the liability simultaneously.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2) |  | In
accordance with the transitional provisions of Standard 22, commencing           January
1, 2006, in addition to the aforesaid, the financial statements include           the
following changes:
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
balance of deferred issuance costs, which at December 31, 2005 amounted to NIS 946,000,
has been reclassified and presented as a deduction from the amount of the liabilities to
which such expenses relate. Through December 31, 2005, deferred issuance costs were
included under other assets and amortized according to the straight-line method.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
change in the amortization method of deferred issuance costs, as above, does not have a
material effect on the operating results in the reported years.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------

Revenue Recognition

In
January 2006, Accounting Standard No. 25 of the IASB - Revenue, became
effective. The standard prescribes recognition, measurement, presentation and disclosure
criteria for revenues originating from the sale of goods purchased or manufactured by the
Company.

Revenue
is measured, as detailed below, at the fair value of the consideration received or the
consideration that the Company is entitled to receive, taking into account trade discounts
and/or bulk discounts granted by the entity:

Revenue
from sale of goods is recognized when all the following conditions have been satisfied:
(a) the significant risks and rewards of ownership of the goods have been transferred to
the buyer; (b) the Company retains neither continuing managerial involvement to the degree
usually associated with ownership nor effective control over the goods sold; (c) the
amount of revenue can be measured reliably; (d) it is probable that the economic benefits
associated with the transaction will flow to the Company; and (e) the costs incurred or to
be incurred in respect of the transaction can be measured reliably.

19



---

Upon
the application of the standard, an associated company separates the financing component
embedded in revenue from sales made on credit for periods exceeding the customary credit
period in its industry (mainly 90 days), that does not bear interest at the appropriate
rate; the financing component is determined according to the amount by which the nominal
amount of consideration for the transaction exceeds the present value of future cash
payments in respect thereof, based on the customary market interest rate applicable to
credit extended under similar terms. Revenue from the financing component is recognized
over the credit period. Through December 31, 2005, the Company did not separate the
financing component in respect of sales made on credit, as above, and included within
revenue from the sale on the date of recognition of such revenue. In accordance with the
transitional provisions of the standard, on January 1, 2006 the Company recognized an
expense of NIS 1.1 million as a result of presentation in present value, resulting from
the adjustment of trade receivables in respect of such credit transactions to their
present value on the effective date of the standard, the share of the Company at the
adjustment effect as above was approximately NIS 0.5 million which is presented in these
financial statements under Cumulative effect, at beginning of year, of an accounting
change.

Share  Based
Payment

In
January, 2006, Accounting Standard No. 24 of the IASB, Share-Based Payment
became effective. The standard prescribes the recognition and measurement principles, as
well as the disclosure requirements, relating to share-based payment transactions.

Since
the Company has not granted any equity-settled awards, nor made modifications to existing
grants, subsequent to March 15, 2005, the measurement criteria of the standard do not
apply to past grants made by the Company, and its application has not had any effect on
the comparative figures included in these financial statements.

Net Income per Share

In
January 2006, Accounting Standard No. 21 of the IASB, Earnings per Share
became effective. The computation of basic net income per share is generally based on
earnings available for distribution to holders of ordinary shares, divided by the weighted
average number of ordinary shares outstanding during the period.

In
computing diluted net incomeper share, the weighted average number of shares to be
issued, assuming that all dilutive potential shares are converted into shares, is to be
added to the average number of ordinary shares used in the computation of the basic income
(loss) per share. Potential shares are taken into account, as above, only when their
effect is dilutive (reducing net income per share from continuing activities).

Comparative
net income per share figures included in these financial statements reflect a
retrospective application of the new standards computation directives.

As
to the data used in the computation of net income per share, as above - see Note 11 to
the Financial Statements.

As
for information regarding the effects of new Israeli accounting standards  see Note
1s to the Financial Statements.

Effects of Prior Year
Misstatements

In
September 2006, the SEC issued Staff Accounting Bulletin No. 108, Financial
Statements  Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements, or SAB 108. SAB 108 requires
companies to quantify the impact of all correcting misstatements, including both the
carryover and reversing effects of prior year misstatements, on the current year
financial statements. SAB 108 is effective for fiscal years ending after November 15,
2006. We initially applied the provisions of SAB 108 using the cumulative effect
transition method in our annual financial statements for the year ending December 31,
2006 in connection with our accounting treatment for various misstatements the cumulative
effect of which on our retained earnings as at December 31, 2005 totaled NIS 2,665
thousand net of tax.

General

On
March 7, 2006, T.M.M (an associated company) announced that the Israeli Securities
Authority had addressed T.M.M. with regard to an investigation the authority is conducting.
At this stage, T.M.M. is unable to estimate the impact of the investigation on the Company.
On January 4, 2007, the Company sold all its holdings in T.M.M. (See Item 4A 
History and Development of the Company above).

20



---

On
April 15, 2007, at a General Meeting the shareholders approved the appointment of
Brightman Almagor & Co as the Companys external auditors for the year 2007.
Brightman Almagor & Co will replace Kesselman & Kesselman & Co who served as
the Companys external auditors since 1954.

# A.    Operating Results

The
following is a summary of the period-to-period changes in the principal items included in
the Consolidated Statements of Income:

Amount and Percentage
Increase (Decrease)
New Israeli Shekels (in thousands)(1)

|                                                                       |  | Year ended 12/31/06
v.
year ended 12/31/05 |  | Year ended 12/31/05
v.
year ended 12/31/04 |  
|---------------------------------------------------------------------- |  | ------------------------------------------ |  | ------------------------------------------ | -
|
|Net sales                                                              |  |                                            |  | 47,648                                     |  
|Cost of sales                                                          |  |                                            |  | 35,546                                     |  
|                                                                       |  |                                            |  |                                            |  
|Gross profit                                                           |  |                                            |  | 12,102                                     |  
|Selling, administrative and general expenses                           |  |                                            |  | 4,939                                      |  
|                                                                       |  |                                            |  |                                            |  
|Income from ordinary operations                                        |  |                                            |  | 7,163                                      |  
|Financial expenses (income) - net                                      |  |                                            |  | 18,621                                     |  
|Other income                                                           |  |                                            |  | 32,861                                     |  
|Income before taxes on income                                          |  |                                            |  | 21,403                                     |  
|Taxes on income                                                        |  |                                            |  | 10,711                                     |  
|                                                                       |  |                                            |  |                                            |  
|Income from operation of the Company and the consolidated subsidiaries |  |                                            |  | 10,692                                     |  
|                                                                       |  |                                            |  |                                            |  
|Share in profits (losses) of associated companies                      |  |                                            |  | (42,616                                    | )
|                                                                       |  |                                            |  |                                            |  
|Cumulative  effect, at beginning of year of an accounting change in an |  |                                           
|associated company                                                     |  |                                            |  | (461                                       | )
|                                                                       |  |                                            |  |                                            |  
|Net income                                                             |  |                                            |  | (32,385                                    | )
|                                                                       |  |                                            |  |                                            |  
|                                                                       |  |                                           

The
statements of income for the years ended December 31, 2006, 2005 and 2004 are presented in
New Israeli Shekels as explained in note 1 to the Financial Statements.

The
number of New Israeli Shekels which were exchangeable for 1 U.S. dollar increased
(decreased) over the prior year by (-1.6%), 6.8% and (-8.2%) in 2004, 2005 and 2006,
respectively. See Note 1 to the Financial Statements attached and Item 17 Financial
Statements for the anticipated effect of adopting of accounting pronouncements that have
been issued but are not yet adopted.

---

|* | The change in selling administrative and
general expenses of NIS 3,432 was reclassified in the years 2005 and 2004.
|- | -------------------------------------------------------------------------------------------------------------------

|1 | AIPM made the transition to reporting in nominal New Israeli Shekels (NIS) in
          2004, pursuant to the directives of Standard 12 of the Financial Accounting
          Standards Board in Israel. In the past AIPMs reports were in NIS, adjusted
          to changes in the exchange rate of the US dollar against the NIS.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

21



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2006 Compared to
2005

# I.   Overview
of Results of Operations

1.   Consolidated
Data

Consolidated
sales in 2006 amounted to NIS 530.1 million, as compared with NIS 482.5 million in 2005,
representing growth of approximately 10%.

The
consolidated operating profit amounted to NIS 50.5 million in 2006, as compared with NIS
43.3 million in 2005, representing growth of approximately 17%.

Profit
after taxes and before AIPMs share in earnings of associated companies for 2006,
amounted to NIS 40.0 million, as compared with NIS 29.3 million in 2005.

2.     Net
Profit and Earnings Per Share

Net
profit in 2006 amounted to NIS 13.3 million, as compared with NIS 45.7 million in 2005.

Net
profit this year was affected by the growth in the Companys share in the losses of
the operations in Turkey (KCTR), amounting to NIS 41.9 million (see Section C7 in this
Item 5, below).

Net
profit in 2006 included a net capital gain from the sale of real estate at Atidim in the
sum of NIS 28.5 million, and non-recurring expenses (net of taxes) of NIS 18 million,
primarily on account of a provision for impairment at an associated company (in the third
quarter of the year) and the impact of the devaluation and modified tax rates in Turkey
(in the second quarter of the year- approximately NIS 8 million included in the loss of
the operations in Turkey).

Basic
earnings per share amounted to NIS 3.31 per share in 2006 ($0.81 per share), as compared
with NIS 11.43 per share in 2005 ($2.48 per share).

The
diluted earnings per share amounted to NIS 3.28 per share in 2006 ($0.77 per share), as
compared with NIS 11.35 per share in 2005 ($2.46 per share).

# II.    The
Business Environment

In
2006, the accelerated growth in the Israeli economy continued (5%), along with growing
demand in the public sector and growth in private consumption.

Although
the Second Lebanon War in the summer of 2006 led to a slowdown in economic activity
during the war. The economy, however, rapidly recovered and returned to the accelerated
growth rate that existed before the war.

The
Companys results continued to be effected by high energy prices  primarily
fuel oil, whose prices rose by an aggregate 70% in 2005 and 2006 as compared to 2004 (38%
in 2005 and 22% in 2006), while diesel prices rose by an average of 29% during the same
period.

The
impact of rising energy prices on the aggregate operating profit of the Company amounted
to approximately NIS 22 million.

At
the same time, the prices of the main raw materials utilized by the Group in their
various activities also continued to rise.

22

---

The
impact of rising raw material prices on the aggregate operating profit of the Company
amounted to approximately NIS 46 million.

The
recovery that began in Europes paper industry, which closed the gap between paper
supply and demand, was slow and has not yet fully translated into a decrease in competing
imports into Israel. As a result it has been difficult to raise selling prices primarily
those of fine paper, as warranted by the said rise in input prices.

General

The
Group dealt with the increased input prices by implementing a range of activities. These
activities included raising prices vis-à-vis the competition to the extent
possible and intensifying the efficiency measures implemented with respect to all its
expense components. The efficiency measures implemented by the Group in 2006 led to cost
savings in the amount of approximately NIS 27 million.

As
part of the said operations, the Company is initiating measures to achieve synergies
between the Groups companies, so as to allow for efficiency and cost-cutting,
including energy and raw material costs. Among other measures, this was reflected in a
fuel purchase agreement that allowed for significant savings, while capitalizing on the
Groups economies of scale. The said measures also include the anticipated savings
from the completion of the anticipated conversion to the use of natural gas at the Hadera
plant, as described below.

At
the same time, the Group continues to implement a number of cross organization plans
including the following: the talent management program for the development of the Groups
managers and the creation of a managerial reserve; the WOW Program, for enhancing the
customers perceived added value of the Companys products and improving the
loyalty premium and the price based on a differentiation of products and service; and
Kimberly Clarks global center lining program, aimed at improving production-line
efficiency (applying a methodology that creates a common basis for all factors
influencing operation of the machines, such as engineering, maintenance, technology and
operations, while continuously measuring the variance of the selected parameters,
creating a process of constant improvement in both quality and costs). These programs
have already borne the first fruits in 2006 and the Company is continues to implement the
plans at all the Groups companies in order to exploit their full potential in the
coming years.

The
Group is also currently continuing its efforts to improve selling prices, on the one
hand, while extending the efficiency measures on the other hand, in order to compensate
for the said rise in input prices.

It
is impossible to estimate the influence of the above operations on the Groups
profitability, at this stage.

As
part of the Companys efforts to cut production costs and achieve further
improvements in environmental quality, the Company is continuing to promote the project
for the establishment of a co-generation plant in Hadera, using natural gas.

The
Company has taken the initial steps to convert its energy generation facilities from the
use of fuel oil to natural gas. This process will be completed with the completion of the
natural gas pipeline to Hadera , planned for the third quarter of 2007.

In
connection therewith, the Company signed an agreement in London on July 29, 2005, with
the Tethis Sea Group, for the purchase of natural gas. The gas that will be purchased is
intended to supply the Companys requirements in the coming years, for the operation
of the existing energy co-generation plant at the Hadera plant, that will be converted
for the use of natural gas, instead of the current use of fuel oil. The overall financial
volume of the transaction totals about $35 million over the term of the agreement (5
years from the commencement of the gas flow, but no later than July 1, 2011).

The
conversion from fuel oil to gas will enable significant savings in fuel costs, estimated
at approximately $8.5 million per annum, due to the significant differences between the
current prices of fuel oil and gas, and will enhance the Groups competitiveness and
profitability.

23

---

The
exchange rate between the NIS and the US dollar was revalued by a further 8.2% in 2006,
as compared to a 6.8% devaluation in 2005.

The
inflation rate in 2006 amounted to 0%, as compared with an inflation rate of 2.4% in
2005.

# III.   Analysis
of Operations and Profitability

The
analysis set forth below is based on the consolidated data.

1.    Sales

Consolidated
sales amounted to NIS 530.1 million in 2006, as compared with NIS 482.5 million in 2005
and NIS 482.9 million in 2004.

The
growth in sales in 2006 included increases in sales in both the packaging paper and
recycling sector, as well as the office supplies sector.

The
change in sales in 2005 in comparison to 2004, originated primarily from a certain growth
in the sales of packaging paper and recycling, along with an immaterial decrease in the
office supplies sector, following the implementation of a reorganization in this sector.

2.    Cost of Sales

Cost
of sales amounted to NIS 418.7 million in 2006, representing 79.0% of sales, as compared
with NIS 383.2 million, or 79.4% of sales in 2005 and as compared with NIS 375.9 million,
or 77.9% of sales in 2004.

The
gross margin grew to 21.0% of sales in 2006, as compared with 20.6% in 2005 and 22.1% in 2004.

The principal
factors that affected the material changes in gross profitability in 2006, as compared
with 2005 consisted of a certain increase in raw material prices and an unusual rise in
energy prices (fuel oil by 22%).

The
rising prices in packaging paper and recycling and the quantitative increase in sales
 primarily in office supplies sector  together with the continuing efficiency,
resulted in an improvement in the consolidated gross margin in 2006.

The
gross margin eroded in 2005 as compared to 2004 as a result of the unusual increase in
energy prices (approximately 38%), raw material prices and other inputs. These price hikes
were not fully compensated for by an increase in selling prices, due to prevailing market
conditions.

Labor
Wages

The
labor wages in the cost of sales, in selling, general and administrative expenses ,
amounted to approximately NIS 162.2 million in 2006, as compared with NIS 149.7 million in
2005 and NIS 137.0 million in 2004.

The
increase in wages in 2006 originated mostly from an increase in personnel  primarily
at Amnir as part of the preparations for an expansion in collection volumes, in
anticipation of the establishment of the new paper manufacturing array.

3.    Selling, General and
Administrative Expenses

The
selling, general and administrative expenses (including wages) amounted to NIS 60.9
million in 2006 (11.5% of sales), as compared with NIS 55.9 million (11.6% of sales) in
2005 and NIS 52.5 million in 2004 (10.8% of sales).

24

---

The
increase in selling, general and administrative expenses originated partially from a
certain increase in labor expenses, coupled with non-recurring expenses (approximately NIS
2 million), included in the expenses this year.

4.    Operating Profit

The
operating profit amounted to NIS 50.5 million in 2006, representing growth of 17% as
compared with 2005, and comprised 9.5% , 9.0% and 11.3% of sales in 2006, 2005 and 2004
respectively.

The
increase in operating profit in 2006, in a rate of 17% as compared with 2005 originated
from the increase in sales of packaging paper and recycling, primarily on account of the
improvement in selling prices and the efficiency measures, that were partially offset by
rising energy prices, coupled with the improvement in the operating profit of the office
supplies sector as a result of efficiency measures and the reorganization that the
Company initiated in the past several years.

In
the office supplies sector, the transition to operating profit in 2006, as compared with
an operating loss in 2005, was attributed to the reorganization in the sector, accompanied
by far-reaching efficiency measures and steps to increase sales, following the decrease of
the operating loss in 2005 as compared with 2004 (NIS -0.9 million in 2005, as compared
with NIS -4.6 million in 2004).

5.    Financial Expenses

Financial
expenses amounted to NIS 31.1 million in 2006, as compared with NIS 12.5 million in 2005
and NIS 13.1 million in 2004.

The
total average of the Companys net, interest-bearing liabilities grew by an average
of approximately NIS 160 million in 2006, compared to 2006 and 2005. The increase resulted
primarily from investments in fixed assets and dividends distributed in 2006, net of
dividends received from associated companies and the positive cash flows from operating
activities.

Moreover,
the costs of hedging the Series 2 notes against a rise in the CPI has risen to 1.8% per
annum in 2006, as compared with 1.3% per annum in 2005 and resulted in an increase in
costs related to the notes.

During
2006 hedging transaction was made at a cost equal to 1.8%, and a 0.1% decrease in the CPI
led during 2006 to additional financing costs of NIS 4 million being incurred on account
of the CPI-linked notes.

In
addition to the above, the sharp revaluation in 2006 of the New Israeli Shekel against the
U.S. dollar served to increase the financial expenses on account of the surplus of
dollar-denominated assets over dollar-denominated liabilities held by the Company, as
compared with the devaluation recorded in 2005 (revaluation of 8.2% in 2006, as compared
with a devaluation of 6.8% in 2005), also resulted in an increase in financial expenses in
2006.

6.    Taxes on Income

Expenses
for taxes on income from current operations totaled approximately NIS 5.5 million in 2006,
as compared with NIS 10.2 million in 2005 and NIS 13.2 million in 2004.

The
principal factors responsible for the decrease in tax expenses from current operations in
2006 as compared with 2005, are both the decrease in the profit from current operations
before taxes this year, and the impact of the lower tax rate on current and deferred taxes
this year, in relation to last year.

Moreover,
the tax expenses in 2006 included an additional tax expense of NIS 11.2 million, primarily
on account of the betterment tax realized on the sale of real estate. A tax benefit of NIS
4.2 million was recorded in 2005 on account of the impact of the tax reforms that were
passed by the Knesset in July 2005 (gradually lowering the corporate tax rate to 25% by
2010) on the Companys deferred taxes.

25

---

In
2004, the financial statements included a tax benefit of NIS 10 million, on account of the
impact of the change in the corporate tax rate and a benefit on account of the exercise of
options by employees.

Total
tax expenses amounted to NIS 16.7 million in 2006, as compared with NIS 6.0 million in
2005 and NIS 3.2 million in 2004.

7.    Companys Share in Earnings
(Losses) of Associated Companies

The
companies whose earnings are reported under this item (according to AIPMs holdings
therein), primarily include: Mondi Hadera, Hogla-Kimberly, Carmel and T.M.M.

The
Companys share in the earnings (losses) of associated companies amounted to NIS
(26.7) million in 2006, as compared with NIS 16.4 million in 2005 and NIS 25.1 million in
2004.

The
following principal changes were recorded as the Companys share in the earnings of
the associated companies:

| |  | The
Companys share in the losses of Mondi Hadera (49.9%) in 2006, grew by NIS 2 million
in relation to last year. Last year, Mondi recorded a tax benefit of NIS 4 million (our
share consists of NIS 2 million on account of the change in the corporate tax rate;
without this benefit, no change would have been recorded in the Companys share as
compared with last year). Mondis quantitative sales increased in 2006 as a result
of greater output capacity due to the improvements to the paper machine in 2005. The
sharp rise in pulp prices in the course of the year (16%), rising energy prices (22%) and
the continuing imports from Europe at low prices, served to erode the gross margin and
harmed the operating profitability. The revaluation of the dollar and the lowering of
interest rates served to lower the financial expenses and offset the erosion in the
operating profit.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The Companys share in the net earnings of Hogla-Kimberly Israel (49.9%) increased by
NIS 9.8 million in 2006, as compared with 2005. The operating profit of Hogla-Kimberly
Israel grew from NIS 94 million to NIS 128 million. This increase is primarily attributed
to the improvement in selling prices. In the course of the year, Hogla-Kimberly continued
to improve selling prices and to expand the market share of premium products, where the
profit margins are higher. In 2006, Hogla-Kimberly also continued its far-reaching
efficiency measures, that further contributed to its profitability. This profitability was
partially offset by the continuing increase in input prices in 2006 (primarily raw
materials and energy).
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The Companys share in the losses of KCTR, a wholly-owned consolidated subsidiary of
Hogla-Kimberly (49.9%) grew by NIS 41.9 million in 2006, as compared with 2005. Over the
past two years KCTR has been establishing the organizational infrastructure in Turkey,
developing its sales and distribution network, and is continuing to upgrade the diaper
production plant producing Huggies® premium disposable diapers. In 2006, KCTR began
launching Kimberly Clarks international brands  Huggies® and Kotex®
 on the Turkish market. The launch of the brands involves significant investments in
advertising, sales promotion and listing fees for the organized retail chains. These
investments led to continued growth and an increase of 30% in quantitative sales to the
local market. However, the rising prices of raw materials on account of the sharp
devaluation in local currency in 2006, the escalating competition against local
manufacturers and the investments in launching the international brands  all led to
a significant increase in the operating loss. Furthermore, KCTR recorded an extraordinary
expenditure of approximately NIS 16 million (the Companys 49.9% share -
approximately NIS 8 million) on account of the effect of the reduction in the corporate
tax rate from 30% to 20% on the tax asset created in the past several years at KCTR and
due to the sharp 20% devaluation of the exchange rate of the Turkish lira relative to the
US dollar.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The Companys share in the net earnings of the Carmel Group (26.25%) increased by NIS
2.0 million in 2006, as compared with 2005. The change in profit is attributed to the
higher operating profit that increased from NIS 8.1 million to NIS 11.7 million. The
improvement in the operating profit originated primarily from an increase in quantities,
the rise in selling prices and the continuing efficiency measures. This improvement was
partially eroded in the course of the year as a result of the continuing rise in energy
and raw material prices. At the same time, financial expenses have decreased as a result
of the revaluation of the dollar in 2006.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

26

---

| |  | The Companys share in the losses of T.M.M. (43.08%) increased by NIS 10.1 million in
2006, as compared with 2005. The factors that led to this increase in losses included
primarily non-recurring expenses that were incurred during the year. These expenses
included a loss on account of the cumulative impact at the beginning of the year, on
account of the implementation of Standard 25, in the sum of NIS 1.1 million, a provision
for impairment on account of a long-term loan granted to a third party in the amount of
NIS 1.6 million, the cancellation of a tax asset created on account of carryover losses in
the amount of NIS 2.2 million and the impairment of two transfer stations by NIS 12.5
million. The Companys total share in these expenses amounted to approximately NIS
7.5 million (incorporated above).
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As mentioned above, the Company sold
its direct and indirect holdings in T.M.M. in early 2007.

2005 Compared to
2004

# I.    Overview of Results
of Operations

1.    Consolidated Data

Sales
amounted to NIS 482.5 million during 2005, as compared with NIS 482.9 million in 2004.

Operating
profit in 2005 amounted to NIS 47.8 million, as compared with NIS 53.9 million in 2004.

Profit
after taxes and before AIPMs share in the earnings of associated companies for
2005, amounted to NIS 29.3 million, as compared with NIS 37.7 million in 2004.

2.    Net income

Net
income amounted to NIS 45.7 million during 2005, as compared with NIS 62.7 million in
2004.

Net
income during 2005 included a tax benefit of NIS 8 million (including the Companys
share in the benefit of associated companies) on account of the impact of the tax law
reforms that were passed by the Knesset (Israeli parliament) on July 25, 2005, that serve
to gradually lower the corporate tax rate to a level of 25% by 2010.

The
net income before non-recurring items mentioned above amounted to NIS 37.7 million in
2005, as compared with NIS 48.3 million in 2004.

Earnings
per share in 2005 amounted to NIS 1,127 per NIS 1 par value ($2.45per share), as compared
with NIS 1,544 per NIS 1 par value ($3.58per share) in 2004. The return on
shareholders equity amounted to 7.9% in 2005, as compared with10.2% in 2004.

# II.    The Business
Environment

The
year 2005 was characterized by economic growth in Israel (approximately 5%), increased
demand on the part of the public sector and more moderate growth in private consumption.

The
Groups results in 2005 were significantly affected by the unusual rise in energy
prices, that began in 2004 and accelerated in 2005.

This
price increase included fuel oil and diesel prices that rose by an extraordinary average
of 38% in relation to 2004. Water and electricity prices also rose in 2005 as compared
with 2004 (by an average of 10% and 13%, respectively).

27

---

The
impact of these price increases on the Groups aggregate operating profit results
amounted to approximately NIS 40 million.

Simultaneously,
the prices of the principal raw materials used by the Group companies in their various
activities also continued to rise. The impact was an additional NIS 60 million to the
Groups costs in the aggregated operations profit, compared with 2004.

The
downturn in the European paper industry, originating from surplus supply due to the
recession, has resulted in competing imports into Israel, at low prices, which rendered it
impossible for the Group to raise prices, as warranted from the said rise in input prices.

In
view of the said market conditions and the fierce competition which the Group is facing,
and with the intention of dealing with the said rise in input prices, the Group
accelerated its efficiency programs at all its companies, intensively cutting costs across
all expense areas  at the same time maintaining the quality of products and the
market share figures.

To
cut costs, the Company is initiating measures to achieve synergy between the Group
companies, thereby allowing the Group to enjoy economies of scale, while bringing about
greater efficiency and savings in various costs, including energy and raw material costs.
These plans include among others the anticipated savings from the expected transition to
the use of natural gas at the Hadera plant, as described below.

Concurrently,
the Group is implementing the following cross-organization plans the Talent Management
plan for the development of the Groups managers and the creation of managerial
reserve, the WOW Program for enhancing the customers perceived added value of the
Companys products and improving loyalty premium and price based on differentiation
of products and service, Kimberly Clarks global Centerlining program aimed at
improving production lines (operating a methodology that creates a joint agenda for all
elements impacting operations, including: engineering, maintenance, technology and
operations, while constantly measuring the variation of selected parameters, thereby
creating a process of constant improvement in quality and efficiency).

In
addition, the Group raised the selling prices of its products, albeit only partially and
not to the extent warranted by the increase in input prices  due to the economic
conditions outlined above, the more moderate slow down in demand and the escalating
competition against both imports and local manufacturers.

These
efficiency measures, together with the partial rise in prices, rendered it possible to
significantly reduce the impact of the rising input prices on the results.

The
Group is currently continuing its efforts to improve selling prices, on the one hand,
while extending the efficiency measures on the other hand, in order to compensate for the
said increased input prices.

It
is impossible to estimate the impact of the above steps on the Groups
profitability, at this stage.

A
trend has been identified in early 2006 whereby the gap between supply and demand in the
European paper market seems to be narrowing, given the economic growth in the EU. This
trend is leading to announcements regarding increases paper prices in Europe and in the
USA.

As
part of the Companys endeavors to cut manufacturing costs and to achieve additional
environmental improvements, the Company continues to promote the energy-generation plant
project in Hadera, using natural gas.

The
Company is initially preparing for the commencement of work on the conversion of its
energy-generation systems from the use of fuel oil to natural gas, once the transportation
infrastructure of natural gas to Hadera is completed. The transition is planned for the
third quarter of 2007, subject to the arrival of the gas to Hadera.

28

---

In
this capacity, the Company signed an agreement in London on July 29, 2005, with the Thetis
Sea Group, for the purchase of natural gas. The gas that will be purchased is intended to
fulfill the Companys requirements in the coming years, for the operation of the
existing energy co-generation plant at Hadera that will be converted for the use of
natural gas, instead of the current use of fuel oil. The overall financial volume of the
transaction totals $40 million over the term of the agreement (5 years from the initial
supply of gas, but no later than July 1, 2011).

The
transition from fuel oil to natural gas will allow for significant savings, due to the
significant differences between the current price of fuel oil versus the gas price and
will serve to improve the Groups competitiveness and profitability.

The
exchange rate of the NIS compared to the USD was devaluated by 6.8% during 2005, as
compared with a revaluation of 1.6% in 2004.

The
inflation rate during 2005 amounted to 2.4%, as compared with an inflation rate of 1.2% in
2004.

# III.    Analysis of
Operations and Profitability

The
analysis set forth below is based on the consolidated data.

1.    Sales

The
consolidated sales amounted to NIS 482.5 million in 2005, as compared with NIS 482.9
million in 2004.

The
change in the turnover in 2005 originated from a certain growth in sales of packaging
paper and paper waste, along with an insignificant decrease in the sales of office
equipment sector due to the implementation of a reorganization process in this sector.

2.    Cost of Sales

The
cost of sales amounted to NIS 383.2 million in 2005, representing 79.4% of sales, as
compared with NIS 375.9 million, or 77.9% of sales in 2004.

The
gross margin amounted to 20.6% in 2005, as compared with 22.1% in 2004.

The
decrease in the gross margin originated primarily from the erosion of the gross profit
due to the increase in raw material prices (approximately 9% for paper waste), the
unusual rise in energy prices (approximately 38% for fuel oil and approximately 13% for
electricity) and water (approximately 10%). This was partially offset by a certain
quantitative growth in sales of packaging and paper waste, a certain rise in selling
prices (that failed to compensate for the said rise) and the continuing efficiency
measures across all areas of operation.

3.    Labor Wages

The
labor wages in the cost of sales, in selling expenses and in General and Administrative
expenses, amounted to NIS 149.7 million in 2005, as compared with NIS 143.5 million in
2004.

The
increase in wages is attributed to a certain rise in manpower due to the quantitative
growth, coupled with the preservation of a real level of wages, in CPI terms.

29

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4.    Selling, General and
Administrative Expenses

The
selling, general and administrative expenses (including wages) amounted to NIS 51.5
million in 2005, 10.7% of sales, as compared with NIS 53.0 million, 11.0% of sales, in
2004.

The
decrease in selling and General and administrative expenses originated from continuing
efficiency and cost-cutting measures.

5.    Operating Profit

The
operating profit amounted to NIS 47.8 million in 2005, representing 9.9% of sales, as
compared with NIS 53.9 million, or 11.2% of sales in 2004.

The
decrease in the operating profit in the paper and recycling sector in 2005 as compared
with 2004 originated primarily from the said erosion of margins, due to the sharp rise in
input prices (primarily energy, electricity and water) on the one hand, along with the
difficulty in raising prices  as warranted by the said rise in input prices due
to competing imports.

The
substantial decrease in the office supplies sector loss in 2005 as compared with 2004
resulted from the reorganization process implemented in this sector, along with extensive
efficiency measures and operations in order to increase sales.

6.    Financial Expenses

Financial
expenses amounted to NIS 12.5 million in 2005, as compared with NIS 13.1 million in 2004.

The
total average of the Companys net, interest-bearing liabilities grew by
approximately NIS 58 million, as a comparison between 2005 and 2004. The growth
originated primarily from the payment of NIS 100 million in dividends in September 2004
and NIS 50 million in September 2005, coupled with investments in fixed assets, net of
dividend received from a consolidated subsidiary (NIS 21.8 million) and net of the
positive cash flows from operating activities.

Moreover,
the cost of the transaction for hedging the Series 2 notes against a rise in the CPI has
risen to 1.3% per annum in 2005, as compared with 0.92% per annum in 2004 and resulted in
an increase in costs related to the notes.

Nevertheless,
since the Consumer Price Index (CPI) rose by an actual 2.4% in 2005, the hedging
transaction of 1.3% resulted in savings of NIS 2.7 million on additional financing costs
on account of the CPI-linked notes.

Despite
the aforesaid, the devaluation in 2005, that served to increase the financial revenues
from the Companys dollar-denominated assets, as compared with the revaluation that
took place in 2004, resulted in net financial expenses that were lower in 2005 than in
2004.

7.    Taxes on Income

Expenses
for taxes on income from current operations totaled NIS 10.2 million in 2005, as compared
with NIS 13.2 million in 2004.

The
principal factors responsible for the decrease in tax expenses in 2005 as compared with
2004 include the decrease in pre-tax earnings this year and the lower tax rate this year,
in relation to last year.

30

---

A
tax benefit of NIS 4.2 million was recorded in 2005 on account of the impact of the tax
reforms that were passed by the Knesset in July this year (gradually lowering the
corporate tax rate to 25% by 2010) on the companys deferred taxes. The financial
statements in 2004 included a tax benefit of NIS 5.8 million on account of the impact of
the change in the corporate tax rate that was passed in 2004 on the companys
deferred taxes, coupled with an additional tax benefit of NIS 4.2 million on account of
the exercise of options by employees.

The
tax expenses, including the said benefits, amounted to NIS 6.0 million in 2005, as
compared with NIS 3.2 million in 2004.

8.    Companys
Share in Earnings (losses) of Associated Companies

The
companies whose earnings are reported under this item (according to AIPMs holdings
therein), primarily include: Mondi Hadera, Hogla-Kimberly, Carmel and T.M.M.

The
Companys share in the earnings of associated companies (before non-recurring items)
amounted to NIS 12.6 million in 2005, as compared with NIS 20.7 million in 2004.

The
following principal changes were recorded in the Companys share in the (losses)
earnings of associated companies, (before non-recurring items):

| |  | The Companys share in the net earnings of Mondi Hadera (49.9%) decreased by NIS 10.1
million in 2005, as compared with 2004 (2004  gain, 2005  loss). Most of the
change in profit in 2005 as compared with 2004 originates from the decrease in operating
income between the years, as a result of the rebuild that was carried put on the paper
machine this year. The massive rebuild that was intended to improve the output of the
machine and the quality of the paper, necessitated discontinuing the manufacturing process
during the rebuild and was accompanied by a subsequent learning curve, as is normal during
such a significant project. The unusual increase in raw material, energy and water prices
also adversely affected the profitability of Mondi Hadera. The economic slowdown in Europe
and the surplus of paper led to an erosion of imported paper prices and rendered it
difficult for Mondi Hadera to raise prices, as warranted from the said price hikes 
both in local markets and especially in export markets. Mondi Hadera is nevertheless
continuing with its efforts to raise prices (in parallel to announcing higher prices in
Europe in late 2005) and is intensifying its efficiency and cost-cutting measures.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The Companys share in the net earnings of Hogla-Kimberly (49.9%) increased by NIS
2.9 million in 2005, as compared with 2004. The stronger marketing operations and the
fortification of brands, in combination with the increase in prices and effective
efficiency measures, served to compensate in 2005 for the sharp rise in input prices (raw
materials and energy) and improved the operating income. Hogla-Kimberly continues to
improve the quality of its products, while strengthening its brands, including Mollett
Hearts toilet paper, Kotex hygiene products and Nikol (complementary kitchen products).
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A
net loss of NIS 3.5 million was recorded in the second quarter of 2005 on account of
AIPMs share in a supplemental provision for doubtful debts, that was recorded by
Hogla-Kimberly on account of the debts of Club Market, that is in a stay of proceedings
and is currently  subsequent to its acquisition by Supersol  undergoing a
settlement of debts. The settlement was approved by the court, but has yet to be
finalized. The sum of the settlement is yet unknown.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The Companys share in the losses of Kimberly Clark Turkey, a wholly-owned
Hogla-Kimberly subsidiary that is consolidated in its financial statements (hereinafter:
KCTR, formerly Ovisan) (49.9%) has decreased by NIS 6.6 million in
2005, as compared with 2004. In 2005, KCTR has continued its preparation for the expansion
of operations in the Turkish market and for the introduction of Kimberly Clarks
international premium products into the Turkish market, as part of the multi-annual
program (that is being formulated in conjunction with Kimberly Clark). In this capacity,
the local management team was reinforced, to enable the realization of the said plan. KCTR
has started the introduction of the Kotex® line of feminine hygiene products in late
2005 and is expected to introduce Huggies® diapers in 2006. KCTR recorded a
significant loss in 2004, since the deployment of its distribution network on the one
hand, and fierce competition in the Turkish market, on the other hand, resulted in the
need to adjust the value of inventories to the prevailing market prices at the end of that
year.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

31

---

| |  | The Companys share in the net earnings of the Carmel Group (26.25%) decreased by NIS
2.8 million in 2005 as compared with 2004. The change in 2005 originated from a decrease
in operating profit and a rise in financial expenses (due to devaluation differentials).
The decrease in operating profit, despite the quantitative increase in sales, originated
primarily from the sharp rise in raw material prices, that was only partially offset by
the rise in selling prices (in view of the escalating competition in the corrugator
market), leading to a consequent erosion in the gross margin. In 2005, Carmel began making
investments as part of the strategic move to improve the corrugation base with the
intention of rendering the manufacturing process more efficient. At the end of this
process, the output capacity will reach 100 thousand tons. The investment will be
completed in 2006.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The Companys share in the net earnings of T.M.M. (43.08%) decreased by NIS 4.6 million
in 2005 as compared with 2004 (2004  gain, 2005  loss). T.M.M. recorded a sharp
decrease in operating profit in 2005 as compared with 2004, due to the significant rise in
transportation costs (originating from a significant average rise of 32% in diesel prices
as compared with 2004  an impact of NIS 8 million). This unusual increase in diesel
prices was not sufficiently compensated for in the selling prices, due to the fact that
most of the agreements are linked to the Consumer Price Index (CPI), that rose by only
2.4% this year. T.M.M. is intensively carrying out efficiency measures and is attempting to
modify some of the agreements, so as to reflect the extraordinary increase in diesel
prices.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | We
note that some of the customers began responding to the price changes in late 2005.
| | --------------------------------------------------------------------------------------

| |  | The Companys share in the earnings of associated companies in 2005 includes its
share in the tax benefits recorded by these companies, following the change in tax rates
(in the amount of NIS 3.9 million) amounts to NIS 16.4 million, as compared with NIS 25.1
million in 2004 (including a tax benefit of NIS 4.4 million).
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# B.   Liquidity and capital
resources

1.    Cash Flows

The
cash flows from operating activities in 2006 amounted to NIS 53.1 million, as compared
with NIS 88.6 million in 2005. The change in the cash flows from operating activities in
2006 is primarily attributed to the increase in working capital, originating mostly from
the growth in the volume of operations.

The
cash flows from operating activities in 2004 amounted to NIS 47.1 million.

The
dividend that was declared in December 2005, in the amount of NIS 50 million, was paid in
January 2006.in addition, a dividend of NIS 100 million was paid in July 2006.

2.    Financial Liabilities

The
Company believes that its existing credit lines and cash flow from operations are
sufficient for financing its working capital needs. The Company uses its cash flow from
operating activities to finance its investments and for repayment of loans and dividend
distributions to its shareholders.

32

---

Based
on the Companys balance sheet, the Company believes that it is unlikely that there
will be any difficulties to obtain credit, whether short term debt or long-term debt, to
finance anticipated investments.

On
December 21, 2003, the Company issued notes  through tender by private placement
 in the amount of NIS 200 million, to institutional investors. These notes carry an
interest rate of 5.65% per annum (a margin of 1.45% above government notes with a
comparable average maturity at the time). The principal will be repaid in seven equal
annual installments between the years 2007-2013 (average maturity of 6 years), with both
the principal and the interest being linked to the CPI. The notes are not convertible into
the Companys ordinary shares and shall not be registered for trade on a public
exchange.

The
long-term liabilities (including current maturities) of the Companies amounted to NIS
297.9 million as at December 31, 2006 as compared with NIS 267.4 million as at December
31, 2005.

The
Company uses loans from local financial institutions, mostly banks, to finance its
activities. As of December 31, 2006, these loans consisted of the following:

|1. | Short-term credit from banks  AIPM has a bank credit facility of some NIS
          360 Million. Of this, as of December 31, 2006, some NIS 242 Million were
          utilized. The Company does not have any credit limitations (i.e. 
          financial covenants) other than this. see Note 10c to the Financial Statements
          attached.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2. | Notes  see Note 4a to the Financial Statements attached.
|-- | ---------------------------------------------------------

|3. | Long Term Loans  See Note 4b to the Financial Statements attached.
|-- | -------------------------------------------------------------------

|4. | Other liabilities  see Note 4c to the Financial Statements attached. For
          information regarding financial instruments used for hedging purposes and market
          risks  see Item 11, Quantitative and Qualitative Disclosure about
          Market Risk.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
Group may incur additional tax liabilities in the event of inter-company dividend
distributions, derived from approved enterprises profits. The said dividend
distributions from investee companies is in the amount of up to approximately NIS 94
million (of which the Companys share of the additional tax is NIS 16 million, if
this dividend is distributed). No account was taken of the additional tax, since AIPM has
the ability and the intention that such earnings are to be reinvested and that no dividend
would be declared which would involve additional tax liability to the Group in the
foreseeable future.

3.    Material commitments
for Capital Expenditures

The
Company also contracted with Alstom Power Boiler Service gmbh, a manufacturer of
equipment in the energy industry, in an agreement worth approximately  1.74
million, for the purchase of the systems needed for the conversion and assistance with
their installation at the plant in Hadera. Up to December 31, 2006 the remainder of the
agreement was worth approximately  0.6 million.

# C.    Research and
development, patents and licenses, etc.

There
were no significant investments in research and development activities during the last
three years.

# D.    Trend information

For
trend information see The Business Environment section included in Item 5 above.

33

---

# E.   Off Balance sheet
Arrangements

The
Company does not have any material off balance sheet arrangements, as defined in Item 5E
of Form 20-F.

# F.    Contractual
Obligations

|In NIS in million           | Total | Less than 1 year | 1-3 years | 4-5 years | More than 5 years
|--------------------------- | ----- | ---------------- | --------- | --------- | -----------------
|                            |       |                  |           |           |                  
|Long term debt obligations* | 275.1 | 48.7             | 127.8     | 67.4      | 31.2             
|                            |       |                  |           |           |                  
|Purchase obligations**      | 158.6 | 13.7             | 123.5     | 21.4      |                 
|                            |       |                  |           |           |                  

* Including interest

** From natural gas
agreement

# ITEM 6 - DIRECTORS,
SENIOR MANAGEMENT AND EMPLOYEES

# A.    Directors and Senior
Management

The
following table sets forth certain information with respect to the directors and executive
officers of the Company:

|NAME           | DIRECTOR SINCE | AGE | POSITION                                  
|-------------- | -------------- | --- | ------------------------------------------
|              
|Directors:     |                |     |                                           
|Ronit Blum     | 2005           | 55  | Director                                  
|Nochi Dankner  | 2003           | 53  | Director                                  
|Avi Fischer    | 2004           | 51  | Director                                  
|Oren Lieder    | 2003           | 59  | Director (until May 11, 2006)             
|Ari Bronshtein | 2006           | 38  | Director (from May 11, 2006)              
|Zvi Livnat     | 2003           | 54  | Chairman of the Board since April 02, 2006
|Amir Makov     | 2005           | 73  | Director                                  
|Isaac Manor    | 2003           | 66  | Director                                  
|Amos Mar-Haim  | 1984           | 69  | Director                                  
|Adi Rozenfeld  | 2004           | 53  | Director                                  
|Avi Yehezkel   | 2003           | 49  | Director                                  

The business experience of each of
the directors is as follows:

Ms.
          Ronit Blum is Director of Association of Friends, Tel Aviv Sourasky Medical
          Center, ingaged in the fild of managing donations to the Medical Center.

Mr.
          Ari Bronshteinis Vice President of Discount Investments Corporation Ltd.
          Serves as director at various companies. Formerly served as Deputy CEO of
          Economics and Business Development of Bezeq, the Israeli Telecom Company Ltd.

Mr.
          Nochi DanknerisChairman and Chief Executive Officer of IDB Holdings
          Corporation Ltd., Chairman of IDB Development Ltd., Discount Investments
          Corporation Ltd. and of Clal Industries and Investments Ltd. He serves or
served           as Chairman and Director in public and private companies of Ganden
Group, IDB           Group and Bank Hapoalim.

34

---

Mr.
          Avi Fischer is Director and Co-CEO of Clal Industries and Investments Ltd.
          and Deputy Chairman of IDB Development Ltd, Deputy CEO of IDB Holdings
          Corporation Ltd., director of Discount Investment Corporation Ltd. and Chairman
          and director of several public and private companies of Ganden Group and IDB
          Group. Senior partner of Fischer, Behar, Chen & Co. Law Office.

Mr.
          Zvi Livnatis Chairman of the Board of the Company since April 2006, Co-CEO
          of Clal Industries and Investments Ltd., Executive Vice President of IDB
Holding           Corporation Ltd., Deputy Chairman of IDB Development Corporation Ltd.,
director           in Discount Investments Corporation Ltd., and other public and private
          companies.

Mr.
          Amir Makovis the Chairman of The Israel Institute of Petroleum & Energy
          and the Israel Export & International Cooperation Institute, Chairman of
          Polyon Plastic Industries Ltd, a member of the presidency of the Manufacturers
          Association of Israel, and a director in the following companies: ICL
          Fertilizers (Dead Sea Works, Rotem Amfert Negev), ICL Industry Products (Dead
          Sea Bromine Company, Dead Sea Periclase),and an external director in Wolfman
          Industries. Mr. Makov served as an external director of the Company between
          1996-2001.

Mr.
          Isaac Manoris a Deputy Chairman of IDB Holdings Corporation Ltd., IDB
          Development Ltd., Discount Investments Corporation Ltd. and of Clal Industries
          and Investments Ltd and a director of various publicly-traded and
privately-held           companies within the IDB Group, IDB Holdings Ltd., IDB
Development Ltd.,           Discount Investment Corporation Ltd. and Clal Industries and
Investments Ltd           ,Israel Union Bank Ltd. and others and Co-CEO and Chairman of
companies in the           David Lubinsky Group Ltd.

Mr.
Amos Mar-Haimis a member of the Israel Accounting Standards Board and a
          director of various companies; Deputy Chairman of Phoenix Investments &          Finances
Ltd, Chairman of Migdal underwriting & Promotion of Investments           Ltd.

Mr.
          Adi Rozenfeldis a businessman, consultant to companies and a
representative           of Activa Holdings BV in Israel. He is also the Honorary Consul
of Slovenia in           Israel and a director of various companies. Chairman of
Association of Friends,           Haifa University.

Mr.
          Avi Yehezkelis an external director at Bank Yahav. He served as a Knesset
          member between 1992-2003, during these years, alternately, he served as Deputy
          Minister of transportation, Chairman of the Economics Committee, Chairman of
the           Defense Budget Committee, Chairman of the Capital Market Sub-Committee,
Chairman           of the Banking Sub-Committee and member of the Finance Committee.

35

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# Senior Management
in the Company and in Subsidiaries (as of May 28, 2007)

|Name              | Age | Position                                                                                                                                                
|----------------- | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------
|                  |     |                                                                                                                                                         
|Avi Brener        | 54  | Chief Executive Officer                                                                                                                                 
|                  |     |                                                                                                                                                         
|Israel Eldar      | 62  | Corporate Controller and responsible for risks and business interruption management.                                                                    
|                  |     |                                                                                                                                                         
|Ofra Gorni        | 54  | Business Development Manager.                                                                                                                           
|                  |     |                                                                                                                                                         
|Lea Katz          | 56  | Legal counsel and Corporate Secretary .                                                                                                                 
|                  |     |                                                                                                                                                         
|Gabi Kenan        | 63  | Senior Manager                                                                                                                                          
|                  |     |                                                                                                                                                         
|Gur Ben David     | 55  | General manager of Packaging Paper and Recycling Division (as of January 01, 2007).                                                                     
|                  |     |                                                                                                                                                         
|Pinhas Rimon      | 67  | General manager of Packaging Paper and Recycling Division (until December 31, 2006). A director of subsidiaries and affiliated companies of the Company.
|                  |     |                                                                                                                                                         
|Gideon Liberman   | 57  | General Manager of Development and Infrastructure Division                                                                                              
|                  |     |                                                                                                                                                         
|Amir Moshe        | 41  | General Manager, Graffiti Office Supplies & Paper Marketing Ltd. (as of January 01, 2007).                                                              
|                  |     |                                                                                                                                                         
|Moshe Riani       | 48  | General Manager, Graffiti Office Supplies & Paper Marketing Ltd. (until December 31, 2006).                                                             
|                  |     |                                                                                                                                                         
|Uzi  Carmi        | 51  | General Manager, Amnir Recycling Industries Ltd.                                                                                                        
|                  |     |                                                                                                                                                         
|Simcha Kenigsbuch | 49  | Chief Information Officer                                                                                                                               

# Senior Management
in Affiliated Companies (as of May 28, 2007)

|Name          | Age | Position in the Company                          
|------------- | --- | -------------------------------------------------
|Arik Schor    | 51  | General Manager, Hogla-Kimberly Ltd.             
|Avner Solel   | 53  | General Manager, Mondi Business Paper Hadera Ltd.
|Doron Kempler | 57  | General Manager, Carmel Container Systems Ltd.   

# B.    Compensation

The
aggregate amount of remuneration paid to all directors and the above senior officers of
the Company (23 officers and directors) as a group for services provided by them to the
Company during 2006 was approximately NIS 19,380,980 (approximately $4,587,214). The
aggregate amount set aside for pension, retirement or similar benefits for directors and
officers as a group for services provided by them to the Company during 2006 was
approximately NIS 1,561,006 (approximately $369,469).

36

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The
aggregate amount of remuneration paid to all directors and senior officers of the Company
mentioned above, include payments paid by the Corporation and liabilities to pay taken by
it, to the 5 senior officers, as follows(1):

|      | Position                                            | Thousands NIS
|----- | --------------------------------------------------- | -------------
|      |                                                     |              
|No' 1 | Chairman of the Board of Directors (until 04/06)(2) | 5,692        
|      |                                                     |              
|No' 2 | CEO(3)                                              | 2,402        
|      |                                                     |              
|No' 3 | Division Manger                                     | 1,448        
|      |                                                     |              
|No' 4 | Vice President                                      | 1,348        
|      |                                                     |              
|No' 5 | Division Manger                                     | 1,112        
|      |                                                     |              

In
addition, the senior officers of the Company and of certain other companies in the Group,
were granted a stock option plan. For stock option plan granted to senior officers, see
Item 6.E. Share ownership below, and Note 6b of the Notes to the Consolidated Financial
Statements.

Remuneration
of Directors

The
remuneration of the directors (including the external directors) for 2006 was approved at
the 2006 general meeting of shareholders. Pursuant to regulations under the Israeli
Companies Law, each external director of the Company must receive the same annual
compensation, which must be between NIS 29,010 and NIS 47,135, plus an additional fee for
each meeting attended which must be between NIS 1,021 and NIS 1,813. The Board approved
that the remuneration of each director for the year 2006, including the external
directors, be fixed at NIS 40,000 plus an additional NIS 1,550 for each meeting attended.

---

|(1) |  | The
following, details remuneration payments paid by the Company and liabilities           to
pay taken by it, to the 5 senior officers of the Company, as reported by the
          Company at the Periodical Report published, in March 2007, following the
          Companys obligation to present that information, according to the Israeli
          Law.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | The
Chairman of the Board of Directors retired on April 2, 2006, from his           position
as Chairman of the Board of Directors after 37 years of employment in           senior
positions in the Group. The above mentioned sum of money includes           its
payment fees for 3 months and remuneration for execution of the remnant of
          remuneration according to the incentive plan approved at the General meeting on May 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, the Company paid on April 2007 the retired Chairman, according to the agreement
with him that was approved by the Board of Directors in March 2003 and at the General
meeting in July 2003, an amount of NIS 4.992 million, and an additional amount paid in April 2007 to
providence fund to cover gaps in deposits for previous
years to the retired Chairman.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | On
May 13, 2007, the Board of Directors approved the Employment Agreement and
          remuneration of Mr. Avi Brener, the CEO of the Company. The main principals of
          the Agreement are: monthly salary of NIS 95,000 (approximately $22,864) linked
          to the Israeli Consumer Price Index and a yearly bonus in the amount of between
          6-9 salaries, subject to the discretion of the Board. In addition, upon the
          termination of employment of the CEO he will receive, in addition to the
          provisions for severance payments, a retirement grant payment in an aggregate
          amount equal to one-months salary for each year in which he was employed
          by the Group (from August 1988).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

37



---

# C.    Board practices

The
directors of the Company, except for the external directors (see below), retire from
office at the Annual General Meeting of Shareholders and are eligible for re-appointment
at such Annual General Meeting.

Notwithstanding
the foregoing, if no directors were appointed at any Annual General Meeting, the directors
appointed at the previous Annual General Meeting will continue in office. Directors,
except for the external directors, may be removed from office earlier by a resolution at
an Annual General Meeting of Shareholders.

The
Articles of Association of the Company provide that any director may, by written notice,
appoint any person who is approved by the Board of Directors to be an alternate director
and to act in his place and to vote at any meeting at which he is not personally present.
The alternate director is entitled to notice of Board meetings and he will be remunerated
out of the remuneration of the director appointing him. The alternate director shall
vacate his office if and when the director appointing him vacates his office as director,
or removes him from office by written notice.

There
are no services contracts which give the current directors of the Company any benefits
upon termination of office.

# External Directors

Under
the Israeli Companies Law, the Company (as a public company) is required to have at least
two external directors as members of its Board of Directors. An external director may not
have any financial or other substantial connection with the Company and must be appointed
at the Annual General Meeting of Shareholders. The external directors are elected for a
three-year term of office that may be extended for another three years. Currently the
external directors are Ms. Blum and Mr. Makov.

For
the periods each director served in his or her respective position, see Item 6.A.Directors
and Senior Management above.

For
a description of the Termination and Employment Agreement of the Companys former
Chairman of the Board, see Item 6.B. Compensation above. Aside from Mr. Yerushalmi, none
of the Groups directors are entitled to benefits upon termination of their
employment.

# Audit Committee

Under
the Israeli Companies Law, members of the Audit Committee are to be elected from members
of the Board of the Company by the Board. The Audit Committee will be comprised of at
least three directors, including all of the external directors, but excluding: (i) the
Chairman of the Board of Directors; (ii) any director employed by the Company or who
provides services to the Company on a regular basis; or (iii) a controlling shareholder of
the Company or his relative.

The
role of the Audit Committee under the Israeli law is: (i) to examine flaws in the business
management of the Company in consultation with its auditors and to suggest appropriate
courses of action and (ii) to decide whether to approve actions or transactions which
under the Israeli Companies Law require the approval of the Audit Committee (transaction
with a related party, etc.) The Company does not have a Nominating Committee nor a
Compensation Committee.

The
role of the Audit Committee under the American law is: (i) to oversee on behalf of the
Board: (a) the integrity of the financial statements; (b) the appointment, compensation,
qualification and work of the Independent Auditors; (c) compliance with legal and
regulatory requirements applicable to the internal controls and reporting of publicly
traded companies; (d) performance of Internal Auditor and internal controls functions; and
(ii) to evaluate potential or existing deficiencies in the administration, by consulting
with the management, and make proposal to the Board; and (iii) to review matters referred
to them under the Whistleblower process of the Companys Code of Conduct
and Ethics.

38

---

The
Companys Audit Committee members are: Amos Mar-Haim, Chairman, Ronit Blum, and Amir
Makov. All members are independent directors, as that term is defined in the
American Stock Exchange listing standards.

# D.    Employees

As
of April 30, 2007, the Group had 2,950 employees in Israel, of which the Company and its
subsidiaries had 798 employees in Israel of whom 158 were engaged in the office supplies
activities, 622 in packaging paper and recycling division, and 18 were management and
clerical personnel at the Companys headquarters in Hadera. The associated companies
had 2,152 employees in Israel of whom 1,037 were engaged in the household paper activities
(in addition, KCTR had 240 employees), 321 in the printing and writing paper activities
and 794 in the corrugated board containers activities.

Some
of the employees are subject to the terms of employment of collective bargaining
agreements. The parties to such collective bargaining agreements are the Company and the
employees, through the union. The relationship between the Company and the union
is good and based on continuous dialogue.

# E.    Share ownership

In
April 2001, the Board of Directors of the Company adopted a new stock option plan under
which options to purchase a total of 194,300 shares may be granted to senior officers of
the Company and certain other companies in the Group. All of the options were granted by
July 2001. Each option is exercisable to purchase one ordinary share of NIS 0.01 par value
of the Company. The options vest in four yearly installments. The vesting period of the
first installment is two years, commencing on the date of grant, and the next three
installments vest on the third, fourth and fifth anniversary of the grant date. Each
installment is exercisable for two years from the vesting date of such installment. For
further information regarding the 2001 plan, see Note 6 of the Notes to the Consolidated
Financial Statements.

In
2006, 44,998 options were exercised under the 2001 plan and 24,303 shares were issued
following the exercise of options.

In
August 2001, the Companys Board of Directors approved a stock option plan for
employees of the Company and its subsidiaries, that expired on November 3, 2006. Under
this plan, up to 125,000 options may be granted without consideration. Each option is
exercisable to purchase one ordinary share of NIS 0.01 par value of the Company. In
November 2001, 81,455 options were granted under the 2001 employee plan. The vesting
period of the options is two years from the data of grant. Each option is exercisable
within three years from the end of the blocking period. For further information regarding
the 2001 employee plan, see Note 6 of the Notes to the Consolidated Financial Statements.

In
2006, 10,091 options were exercised under the 2001 employee plan and 6,215 shares were
issued following the exercise of options. The employees option plan expired on
November 3, 2006.

39

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# ITEM 7  MAJOR
SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

# A.   Major shareholders

The
following table sets forth, as of May 28, 2007, the number of Ordinary Shares of the
Company beneficially owned by (i) all those persons who, to the Companys knowledge,
were the beneficial owners of more than 5% of such outstanding shares, and (ii) all
officers and directors of the Company as a group:

|Name and Address:
Principal Shareholders:               |  | Amount Beneficially Owned Directly or
Indirectly* |  | Percent of Class Outstanding
|------------------------------------------------------- |  | ------------------------------------------------- |  | ----------------------------
|Clal Industries Ltd. ("Clal")                           |  |                                                   |  |                             
|3 Azrieli Center, the Triangle Tower,  Tel Aviv, Israel |  |                                                   |  | 1,531,128(1)                
|                                                        |  |                                                  
|Discount Investments Corporation Ltd. ("DIC")           |  |                                                   |  | 865,014(1)                  
|3 Azrieli Center, the Triangle Tower, Tel Aviv, Israel  |  |                                                  
|                                                        |  |                                                  
|All officers and directors as a group                   |  |                                                   |  | **                          

In
1980 DIC and Clal agreed for a period of ten years (subject to renewal for additional ten
year periods) to coordinate and pool their voting power in the Company in order to appoint
an equal number of each partys nominees to the Board of Directors of the Company,
and in order to elect their designees to the Boards Committees. They also agreed to
vote as bloc in General Meetings of the Company on the subject of dividend distributions.
This agreement has been extended to the year 2010.

---

|* |  | Beneficial
ownership is calculated in accordance with Rule 13d-3 under the Securities Exchange Act
of 1934.
|- |  | -----------------------------------------------------------------------------------------------------------

|** |  | The
officers and directors of the Company own, in the aggregate, less than 1% of the Companys
outstanding ordinary shares, except for Nochi Dankner, Isaac Manor and Zvi Livnat whose
ownership is set forth in footnote (1) below.
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(1) |  | IDB
Holding Corporation Ltd. (IDBH) holds 72.4% of the equity of and 72.69% of
the voting power in IDB Development Corporation Ltd. (IDBD), which, in turn,
holds 74.76% of the equity of and voting power in DIC and 60.52% of the equity of and
voting power in Clal. IDBH, IDBD, Clal and DIC are public companies traded on the Tel
Aviv Stock Exchange.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Since
May 19, 2003 approximately 51.7% of the outstanding share capital of IDBH, is held by a
group comprised of: (i) Ganden Investments I.D.B. Ltd. (Ganden), a private
Israeli company controlled by Nochi Dankner and his sister, Shelly Bergman, which holds
approximately 31.02% of the outstanding shares of IDBH; (ii) Manor Investments-IDB Ltd. (Manor),
a private Israeli company controlled by Isaac and Ruth Manor which holds approximately
10.34% of the outstanding shares of IDBH; and (iii) Avraham Livnat Investments (2002)
Ltd. (Livnat), a private Israeli company controlled by Avraham Livnat and Zvi
Livnat which holds approximately 10.34% of the outstanding shares of IDBH. Ganden, Manor
and Livnat, owning in the aggregate approximately 51.7% of the outstanding shares of
IDBH, entered into a Shareholders Agreement relating, among other things, to their joint
control of IDBH, the term of which is until May 19, 2023.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition: (a) Ganden Holdings Ltd., the parent company of Ganden, directly holds
approximately 7.15% of the outstanding shares of IDBH and Ganden directly holds
approximately 6.71% of the outstanding shares of IDBH ; (b) Manor Holdings B.A. Ltd., the
parent company of Manor, directly holds approximately 0.03% of the outstanding shares of
IDBH; (c) Avraham Livnat Ltd., the parent company of Livnat, directly holds approximately
0.04% of the outstanding shares of IDBH; and (d) Shelly Bergman owns, through a private
company wholly owned by her, approximately 7.23% of the outstanding shares of IDBH
(hereinafter jointly: additional holdings). It should be noted, that the
additional holdings, are not included in the shareholders agreement between Ganden, Manor
and Livnat, relating, among other things, to their joint control of IDBH.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Nochi
Dankner is Chairman and CEO of IDBH and chairman of IDBD, Clal and DIC., Isaac Manor (the
husband of Ruth Manor), and Zvi Livnat (the son of Avraham Livnat) are directors of each
of IDBH, IDBD, and DIC . Isaac Manor is also director of Clal.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

40



---

Since
May 23, 2005, beneficial ownership percentages for Clal and DIC increased by 5.14% and
2.9%, respectively, as compared to the percentages as indicated in the chart above.

The
Company estimates that as of May 30, 2007, 10.56 % of its outstanding ordinary shares were
held in the United States by 851 record holders.

All
ordinary shares of the Company have equal voting rights. The Companys major
shareholders who beneficially own 5% or more of the Companys ordinary shares
outstanding do not have a voting rights different from other holders of ordinary shares.

# B.    Related Party
Transactions

The
information is included in the Companys attached Consolidated Financial Statements.
For loans to associated companies see Note 2 to the attached financial statements. For a
capital note to an associated company, see Note 4c to the attached financial statements.
For transactions and balances with related parties see Note 13 to the attached Financial
Statements.

For
further information see also Note 9e and 9d to the Financial Statements attached.

# C.    Interests of Experts
and Counsel

Not
applicable to annual reports.

# ITEM 8 - FINANCIAL
INFORMATION

# A.    Consolidated
Statements and Other Financial Information

See
the financial statements included in Item 17.

# B.    Export Sales

The amount
of export sales represents approximately 9% out of the total sales volume of the Company.

# C.    Legal Proceedings

In
September 2006, a petition was filed against H-K, an affiliated company (49.9%), for
approval of a class action. According to the petition H-K has reduced the number of units
of diapers in a package of its Titulim® brand and thus misled the public
according to the Israeli Consumer Protection Act. The plaintiff estimated the scope of the
class action to be NIS 47 million. On June 18, 2007, court approved plaintiffs
abandonment from the petition for the approval of a class action, and also ordered the
dismissal of the plaintiffs personal action, with no expenses order.

In
December 2006, a petition was filed against H-K, an affiliated company (49.9%), for the
approval of a class action. According to the petition, 3.5 years ago, H-K has reduced the
quantity of paper in the toilet packages of its Kleenex® Premium brand and
thus misled the public according to the Israeli Consumer Protection Act. The plaintiff
estimates the scope of the class action to be approximately NIS 43 million.  On June 26, 2007, the court approved
plaintiffs abandonment from the petition for the approval of a class action, a
payment of expenses to the plaintiff in the amount of NIS 10,000 and also ordered the
dismissal of the plaintiffs personal action, with no expenses order.

41

---

In
January 2007, a petition was filed against H-K, an affiliated company (49.9%), for the
approval of a class action. According to the petition, 3.5 years ago H-K reduced the
quantity of wipes in the baby wipes packages of its Titulim® Premium brand
and thus misled the public according to the Israeli Consumer Protection Act. The plaintiff
estimated the scope of the class action to be approximately NIS 28 million. H-K rejects
the claims and intends to defend itself against the action. At this early stage H-K is not
able to assess the chances of the class action and its influences.

In
November 2006, the Environmental Protection Ministry announced that even though the
Company plant at Hadera has made considerable investments in sewage treatment and
environmental protection issues, an investigation against the Company is required in
connection with its plant at Hadera to review deviations from certain emission standards
concerning air. The company anticipates that the investigation will not materially impact
its operations.

On
March 7, 2006, T.M.M., an associated company announced that the Israeli Securities
Authority had addressed T.M.M. with regard to an investigation the authority is conducting.
At this stage, T.M.M. is unable to estimate the impact of this investigation on the company.
On February 04, 2007, the Company sold all its holdings in T.M.M.

# D.    Dividend Policy

During
2006, the Company did not have a defined policy for distributing dividends.

# E.    Significant Changes

On
January 4, 2007, the Company entered into an Agreement with CGEA, according to which, the
Company sold to CGEA its holdings in Barthelemi, and the rest of its holdings in T.M.M. for
the total amount of $ 27 million. This transaction was consummated on February 13, 2007,
from which date the Company is no longer a shareholder in T.M.M.

42

---

# ITEM 9  THE OFFER AND
LISTING

# A.    Offer and Listing
Details

The
following table sets forth the high and low market prices of the Companys ordinary
shares on the American Stock Exchange and the Tel Aviv Stock Exchange for the five most
recent full fiscal years:

|              |  | American Stock Exchange |       | Tel Aviv Stock Exchange | 
|------------- |  | ----------------------- | ----- | ----------------------- | 
|
|
|Calendar Year |  |                         |       |                         | 
|2006          |  |                         | 52.12 |                         | 
|2005          |  |                         | 57.98 |                         | 
|2004          |  |                         | 60.73 |                         | 
|2003          |  |                         | 54.66 |                         | 
|2002          |  |                         | 40.50 |                         | 

The
following table sets forth the high and low market prices of the Companys ordinary
shares on the American Stock Exchange and the Tel Aviv Stock Exchange for each fiscal
quarter for the two most recent fiscal years and the first quarter of 2007:

|                          |  | American Stock Exchange |       | Tel Aviv Stock Exchange | 
|------------------------- |  | ----------------------- | ----- | ----------------------- | 
|
|
|June 30 (through June 25) |  |                         | 61.46 |                         | 
|March 31                  |  |                         | 49.84 |                         | 
|                         
|
|
|March 31                  |  |                         | 49.23 |                         | 
|June 30                   |  |                         | 52.12 |                         | 
|September 30              |  |                         | 46.67 |                         | 
|December 31               |  |                         | 48.55 |                         | 

---

|(1) |  | Share
prices have been converted from New Israeli Shekels (NIS) to U.S. Dollars           at
the representative rate of exchange, as reported by the Bank of Israel, on           the
dates when such high or low prices in NIS were recorded.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

43

---

|2005 Quarter Ended |  | High |       | Low |  | High  |  | Low |        | High |  | Low    | 
|------------------ |  | ---- | ----- | --- |  | ----- |  | --- | ------ | ---- |  | ------ | 
|
|March 31           |  |      | 57.98 |     |  | 48.25 |  |     | 246.90 |      |  | 214.80 | 
|June 30            |  |      | 52.00 |     |  | 42.13 |  |     | 227.60 |      |  | 187.50 | 
|September 30       |  |      | 45.73 |     |  | 40.50 |  |     | 207.90 |      |  | 183.80 | 
|December 31        |  |      | 44.00 |     |  | 37.50 |  |     | 200.20 |      |  | 176.90 | 

The
following table sets forth the high and low market prices of the Companys ordinary
shares on the American Stock Exchange and the Tel Aviv Stock Exchange for each month of
the most recent six months:

|              |  | American Stock Exchange |       | Tel Aviv Stock Exchange | 
|------------- |  | ----------------------- | ----- | ----------------------- | 
|
|
|May 2007      |  |                         | 67.50 |                         | 
|April 2007    |  |                         | 56.75 |                         | 
|March 2007    |  |                         | 48.00 |                         | 
|February 2007 |  |                         | 49.84 |                         | 
|January 2007  |  |                         | 45.76 |                         | 

---

|(1) |  | Share
prices have been converted from New Israeli Shekels (NIS) to U.S. Dollars           at
the representative rate of exchange, as reported by the Bank of Israel, on           the
dates when such high or low prices in NIS were recorded.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# B.    Markets

The
Companys ordinary shares are listed on the American Stock Exchange. The trading
symbol for the ordinary shares is AIP. The ordinary shares are also listed on the Tel Aviv
Stock Exchange.

# ITEM 10  ADDITIONAL
INFORMATION

# A.    Share Capital

Not
applicable to Annual Reports.

# B.    Memorandum and
Articles of Association

The
Company was registered under Israeli law on February 10, 1951 and its registration number
with the Israeli registrar of companies is 52-001838-3.

44

---

The
Memorandum of Association and Articles of Association are attached as Exhibits 1.1and 1.2
to this Annual Report.

Objects of the Company

As
indicated in Article 5 of the Companys Articles, the Company may, at any time,
engage in any branch or kind of business in which it is, expressly or by implication,
authorized to engage in accordance with the Articles. The Company may also cease to engage
in such businesses, whether or not it has commenced to engage in such branch or kind of
business.

Directors
Personal Interest

The Israeli
Companies Law requires that a director and an officer of a company disclose to the Company
any personal interest that he may have and all related material information, in connection
with any existing or proposed transaction by the Company. The disclosure is required to be
made promptly and in any event no later than the date of meeting of the board of directors
in which the transaction is first discussed.

If
the transaction is an extraordinary transaction, the procedure of approval is as described
below. Under Israeli law, an extraordinary transaction is a transaction other than in the
ordinary course of business, otherwise than on market terms or that is likely to have a
material impact on the Companys profitability, assets or liabilities.

Subject
to the restrictions of the Israeli Companies Law, a director is entitled to participate in
the deliberations and vote with regard to the approval of transactions in which he has a
personal interest. A director is not entitled to participate and vote with regard to the
approval of an extraordinary transaction in which he has a personal interest, the approval
of indemnity, exemption or insurance of the directors or the approval of the
directors compensation. If a majority of the directors have a personal interest in a
certain decision, they may participate and vote but the issue must be approved also by the
audit committee and by the shareholders. If the controlling shareholder has a personal
interest in an extraordinary transaction, the issue must be approved also by the audit
committee and the shareholders.

Any
power of the Company which has not been conferred by law or by the Articles to any other
body, may be exercised by the Board. The management of the Company is guided by the Board.

Powers and Function of
Directors

The
Board shall formulate the policies of the Company and shall supervise the performance of
the office and actions of the General Manager, including inter alia examination of the
financial position of the Company and determination of the credit framework which the
Company may receive. Without derogating from any power vested in the Board in accordance
with the Articles, the Board may, from time to time, at its discretion, decide upon the
issuance of a series of debentures, including capital notes or undertakings, including
debentures, capital notes or undertakings which can be converted into shares, and also the
terms thereof, and mortgage of the property of the Company, in whole or in part, at
present or in future, by floating or fixed charge. Debentures, capital notes, undertakings
or other securities, as aforesaid, may be issued either at a discount or at a premium or
in any other manner, whether with deferred rights or special rights and/or preferred
rights and/or other rights, all the aforesaid as the Board may, at its discretion,
determine. Compensation to directors is subordinate to an approval of the Audit committee,
the Board of Directors and the General meeting of the Shareholders. There are no
provisions in the Companys Articles for the retirement of directors under an age
limit.

45

---

Except
for special cases as detailed in the Articles and subject to the provisions of the Israeli
Companies Law, the Board may delegate its powers to the General Manager, to an officer of
the Company or to any other person or to the Board committees. Delegation of the powers of
the Board may be with regard to a specific matter or for a particular period, at the
discretion of the Board.

The
directors need not be shareholders of the Company in order to qualify as directors.

The Shares Rights
and Restrictions

All
of the Companys shares are ordinary shares. Every ordinary share in the capital of
the Company is of equal rights, for all intents and purposes, to every other ordinary
share, including the right to dividends, to bonus shares and to participation in the
surplus assets of the Company upon liquidation, proportionately to the par value of each
share, without taking into consideration any premium paid in respect thereof, all the
aforesaid subject to the provisions of the Articles.

Each
of the ordinary shares entitles the holder thereof to participate at and to one vote at
Annual General Meetings of the Company. As described in Item 6C, all directors, except
external directors, stand for election each year at the Annual General Meeting.

Subject
to the provisions of the Israeli Companies Law, the Board may resolve upon the
distribution of a dividend. When deciding on the distribution of a dividend, the Board may
decide that the dividend shall be paid, in whole or in part, in cash or by way of the
distribution of assets in specie, including securities or bonus shares, or in any other
manner at the discretion of the Board.

Dividends
on the Companys ordinary shares may be paid only out of retained earnings, as
defined in the Israeli Companies Law, as of the end of the most recent fiscal year or
profits accrued over a period of two years, whichever is higher.

The
Company may, by resolution adopted at an Annual General Meeting by an ordinary majority,
decrease the capital of the Company and of any reserve fund from redemption of capital.
For the execution of any resolution as aforesaid, the Board may, at its discretion,
resolve any issues, which may arise in connection therewith.

In
case of winding up of the Company, the liquidator may determine the proper value of the
assets available for distribution and determine how the distribution among the
shareholders will be carried out.

The
liability of the shareholders is limited to the payment of par value of their ordinary
shares.

Under
the Israeli Companies Law, each shareholder has a duty to act in good faith in exercising
his rights and fulfilling his obligations toward the Company and other shareholders and to
refrain from abusing his power in the Company.

In
addition, each shareholder has the general duty to refrain from depriving other
shareholders of their rights.

Furthermore,
any controlling shareholder, who knows that it possesses the power to determine the
outcome of a shareholder vote and any shareholder that, pursuant to the provisions of the
Articles, has the power to appoint or to prevent the appointment of an officer in the
Company or any other power toward the Company is under a duty to act in fairness toward
the Company. The Israeli Companies Law does not describe the substance of this duty of
fairness. These various shareholder duties may restrict the ability of a shareholder to
act in what the shareholder perceives to be its own best interests.

46

---

Modification of Rights
of Shares

If
the share capital is divided into different classes, the Company may by resolution adopted
at a General Meeting by a special majority of 60% of the votes of shareholders (in person or by proxy)
 voting at the General Meeting (except if the terms of the issuance of the
shares of such class otherwise provide) annul, convert, expand, supplement, restrict,
amend or otherwise modify the rights of a class of shares of the Company, provided that
the consent, in writing, of all the shareholders of such class thereto shall be received
or that the resolution shall have been approved by a General Meeting of the shareholders
of such class by special majority, or in the event that it was otherwise provided in the
terms of the issuance of a particular class of the shares of the Company, as may have been
provided in the terms of issuance of such class, provided that the quorum at the class
meeting shall be the presence, in person or by proxy, at the opening of the meeting of at
least two shareholders who own at least twenty five percent (25%) of the number of the
issued shares of such class.

The
rights conferred upon the shareholders or owners of a class of shares, whether issued with
ordinary rights or with preference rights or with other special rights, shall not be
deemed to have been converted, restricted, prejudiced or altered in any other manner by
the creation or issuance of additional shares of any class, whether of the same degree or
in a degree different or preferable to them, nor shall they be deemed to have been
converted, restricted, prejudiced or altered in any other manner by a change of the rights
linked to any other class of shares, all the aforesaid unless otherwise expressly provided
in the terms of the issuance of such shares.

Shareholders Meeting

The
Company shall hold an Annual General Meeting each year not later than fifteen months after
the previous Annual Meeting, at such time and place as may be determined by the Board. Any
other General Meeting is referred to as a Special Meeting.

A
notice of a General Meeting shall be published in at least two widely distributed daily
newspapers published in Hebrew. The notice shall be published at least twenty-one days
prior to the convocation of the meeting. In addition the Company provides a notice of the
meeting and related proxy statement in English to the holders of its Ordinary Shares
listed on the records of the Companys registrar and stock transfer agent in the
United States.

Apart
from the notices as to the General Meeting as above, according to its articles and the
Israeli Companies Law the Company is not required to give any notice as to the General
Meeting, either to the registered shareholders or to shareholders who are not registered,
subject to provisions of the Companies Law and/or any other applicable law. The notice as
to a General Meeting is required to detail the place, the day and the hour at which the
meeting will be held and to include the agenda as well as a summary of the proposed
resolutions and any other details required by law.

The
Board of Directors of the Company shall convene a Special Meeting as may be decided by the
Board, and shall also convene a special meeting at the demand of any two directors or one
quarter of the directors in office or one or more shareholders who hold at least five
percent of the issued capital and one percent of the voting rights, or one or more
shareholders who hold at least five percent of the voting rights.

If
the Board receives a demand for the convocation of a Special Meeting as aforesaid, the
Board shall within twenty one days of receipt of the demand convene the meeting for a date
fixed in the notice as to the Special Meeting, provided that the date for convocation
shall not be later than thirty five days from the date of publication of the notice, all
the aforesaid subject to the provisions of the Companies Law.

47

---

In
the resolution of the Board to convene a meeting, the Board may, at its discretion and
subject to the provisions of the law, fix the manner in which the items on the agenda will
be determined and notice given to the shareholders entitled to participate at the meeting.

Each
shareholder holding at least ten percent (10%) of the issued capital and one percent (1%)
of the voting rights, or each shareholder holding at least ten percent (10%) of the voting
rights is entitled to request the Board to include in the agenda any issue, provided that
this issue is suitable to be discussed in a General Meeting.

No
business shall be transacted at any General Meeting unless a quorum is present at the time
the meeting proceeds to business. A quorum shall be constituted when two shareholders,
holding collectively at least twenty five percent (25%) of the voting rights, are present
in person or by proxy within half an hour from the time appointed for commencement of the
meeting, unless otherwise determined in the Articles.

If
a quorum is not present within half an hour, the meeting shall stand adjourned for seven
days, to the same day of the week at the same time and place, without need for
notification to the shareholders, or to such other day, time and place as the Board may by
notice to the shareholders appoint.

If
a quorum is not present as aforesaid at the adjourned meeting, the meeting shall be
canceled.

Voting and Adopting
Resolutions at General Meetings

A
shareholder who wishes to vote at a General Meeting shall prove to the Company his
ownership of his shares. The Board may issue directives and procedures relating to the
proof of ownership of shares of the Company.

A
shareholder is entitled to vote at a General Meeting or class meeting, in person, or by
proxy or by proxy card. A voting proxy need not be a shareholder of the Company.

The
above shall also apply to any person entitled to shares, provided that at least forty
eight hours before the time for the meeting or the adjourned meeting, as the case may be,
at which he proposes to vote, he shall satisfy the Board of his right to vote such shares
unless the Company shall have previously recognized his right to vote the shares at such
meeting.

The
instrument appointing a proxy (hereinafter Proxy Appointment) shall be in
writing signed by the principal, or if the principal is a corporation the proxy
appointment shall be in writing and signed by authorized signatories of the corporation.
The Board is entitled to demand that prior to the holding of the meeting, there shall be
produced to the Company a confirmation in writing of the authority of signatories to bind
the corporation to the satisfaction of the Board. The Board may also issue provisions and
procedures relating to such matters.

The
Proxy Appointment or an office copy to the satisfaction of the Board shall be deposited at
the registered office or at such other place or places, in or outside of Israel, as may
from time to time be determined by the Board, either generally or in respect of a specific
meeting, at least forty eight hours prior to the commencement of the meeting or the
adjourned meeting, as the case may be, at which the proxy proposes to vote on the strength
of such Proxy Appointment.

A
voting proxy is entitled to participate in the proceedings at the General Meeting and to
be elected as chairman of the meeting in the same manner as the appointing shareholder,
unless the Proxy Appointment otherwise provides. The Proxy Appointment shall be in form
usual in Israel or any other form which may be approved by the Board.

According
to an amendment in the Israeli Companies Law , a shareholder is also entitled, in certain
issues, to vote by a proxy card.

48

---

Each
ordinary share entitles the holder thereof to participate at a General Meeting of the
Company and to one vote at a poll.

Right of Non-Israeli
Shareholders to Vote

There
is no limitation on the right of non-resident or foreign owners of any class of the
Companys securities to hold or to vote according to the rights vested in such
securities.

Change of Control

Under
the Articles, the approval of merger as provided in the Israeli Companies Law, is subject
to a simple majority at the General Meeting or class meeting, as the case may be, all the
aforesaid subject to the applicable provisions of any law. It is also subject to the
approval of the boards of the merging companies.

For
purposes of shareholders approval, unless a court rules otherwise, the merger will
not be deemed approved if a majority of the shares held by shareholders voting at the
general meeting, other than the shareholders who are also shareholders in the other
merging company whose shares are held by the other merging company, or by any person who
holds 25% or more of the shares or the right to appoint 25% or more of the directors in
the other merging company, vote against the merger. Upon the request of a creditor of
either party to the proposed merger, a court may delay or prevent the merger if it
concludes that there exists a reasonable concern that as a result of the merger, the
surviving company will be unable to satisfy the obligations of any of the parties to the
merger. In addition, a merger may not be completed unless at least 30 days have passed
from the data that the merger was approved at the general meeting of all the merging
companies and at least 50 days have passed from the time that a proposal of the merger has
been filed with the Israeli Registrar of companies.

The
Israeli Companies Law also provides that an acquisition of shares of 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% shareholder of the Company and there is no existing 25% or more shareholder
in the Company. If there is no existing 45% or greater shareholder in the Company, the
Companies Law provides that an acquisition of shares of a public company must be made by
means of a tender offer if as a result of the acquisition the purchaser would become a 45%
shareholder of the Company.

If
following any acquisition of shares, the acquirer will hold 90% or more of the
Companys shares, the acquisition may not be made other than through a tender offer
to acquire all of the shares of such class. If more than 95% of the outstanding shares are
tendered in the tender offer, all the shares that the acquirer offered to purchase will be
sold to it. However, the remaining minority shareholders may seek to alter the
consideration by court order.

Under
the Israeli Securities Act 1968, any major shareholder who is the beneficial owner of more
then 5% of the Companys equity capital or voting securities is required to report
this fact and any change in his holding to the Israeli Securities Authority.

# C.    Material Contracts

| |  |  | In
May 2007, the Company entered into an agreement with East Mediterranean Gas Company (EMG)
for the purchase of natural gas from Egypt. The Agreement describes the principles for
the negotiations toward the conclusion of a Detailed Agreement for the purchase of
natural gas, that will be purchased in order to fulfill the Companys requirements
after the conversion of its energy generation facilities from the use of fuel oil to
natural gas, that will enable significant savings in fuel costs and further improvement
in air quality. In July 2005, AIPM signed an agreement for the purchase of natural gas
with Thetis Sea Group to provide its requirements in natural gas until mid 2011 for the
currently operating facility in its Hadera site. The new agreement with EMG provides for
the continued availability of gas, for the following 15 years. In addition, the agreement
allows AIPM, within a limited timetable, to increase the contracted quantities to serve
the needs of the new power plant which is being planned by AIPM. The estimated annual
purchase from EMG will range from $10 million up to $50 million, according to the
quantities acquired and the prevailing prices. Bank and corporate guarantees, of an order
of one year purchase, will be provided by AIPM, when signing the Detailed Agreement.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

49

---

| |  |  | In
February 2007, AIPM finalized the sale of all its direct and indirect holdings in T.M.M. to
CGEA in an Agreement signed on January 04, 2007 (through a complete tender offer) (by
agreement with CGEA for the sale of its holdings in Barthelemi) for a total amount of
approximately $27 million, so that AIPM has absolutely ceased to be a shareholder in
T.M.M. For further details, please see the chapter on History and Development of the
Company.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | In
the beginning of 2006, companies in the Group signed a three year agreement with Delek,
for the purchase of fuel and oil for current use, in an aggregated amount of NIS 60
million per year for all the companies in the Group. This agreement will replace former
agreements in similar amounts.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | On
July 29, 2005 the Company signed an agreement in London, with the Thetis Sea Group, for
the purchase of natural gas. The gas that will be purchased is intended to fulfill the
Companys requirements in the coming years, for the operation of the existing energy
co-generation plant at Hadera that will be converted for the use of natural gas, instead
of the current use of fuel oil. The overall financial volume of the transaction totals
$40 million over the term of the agreement (5 years from the initial supply of gas, but
no later than July 1, 2011).
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# D.    Exchange Controls

Foreign
Exchange Regulations

There
are no Israeli governmental laws, decrees or regulations that restrict or that affect the
export or import of capital, including but not limited to, foreign exchange controls on
remittance of dividends on the ordinary shares or on the conduct of the Groups
operations, except as otherwise set forth in the paragraph below regarding taxation.

# E.    Taxation

The
following information is regarding the Israeli laws only.

Investors
are advised to consult their tax advisors with respect to the tax consequences of their
purchases, ownership and sales of ordinary shares, including the consequences under
applicable state and local law and federal estate and gift tax law, and the application of
foreign laws or the effect of nonresident status on United States taxation. This tax
summary does not address all of the tax consequences to the investors of purchasing,
owning or disposing of the ordinary shares.

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

50

---

Shortly
after the 2003 Tax Reform, the Israeli Parliament approved on July 25, 2005 an additional
income tax reform legislation (the 2006 Tax Reform) pursuant to the
recommendations of a committee appointed by the Israeli Minister of Finance, which
incorporated additional fundamental changes in Israeli tax law. Inter alia, The 2006 Tax
Reform includes a gradual reduction of income tax rates for both individuals and
corporations over the years through 2010, and outlined a path towards uniformity in the
taxation of interest, dividend and capital gains derived from securities. Most of the
amendments to the tax law are effective as of January 1, 2006, subject to certain
exceptions. Transition rules apply in certain circumstances.

Various
issues related to the effective date of 2003 Tax Reform and the 2006 Tax Reform remain
unclear in view of the legislative language utilized and the lack of authoritative
interpretations at this stage. The analysis below is therefore based on our current
understanding of the new legislation.

Income Taxes on
Dividends Distributed by the Company to Non-Israeli Residents

Subject
to the provisions of applicable tax treaties, dividend distributions from regular profits
(non-approved enterprise) by the Company to a non-resident shareholder are generally
subject to withholding tax of 20%. The portion of dividends paid out of profits earned
under an Approved Enterprise tax status of the Company is subject to withholding tax at
the rate of 15% (in excess of the corporate tax paid by the Company when the dividend is
paid of these profits  25% tax).

Generally,
under the Tax Treaty Between the Government of the United States of America and the
Government of the State of Israel with Respect to Taxes on Income (US Treaty)
the maximum rate of withholding tax on dividends paid to a shareholder who is a resident
of the United States (as defined in the US Treaty) will be 25%. Due to the fact that a tax
rate of 25% is higher than the maximum Israeli tax rate on dividends pursuant to the 2006
Tax Reform, the maximum tax rate should be 20%. . However, when a U.S. tax resident
corporation is the recipient of the dividend, the rate on a dividend out of regular
(non-Approved Enterprise) profits may be reduced to 12.5% under the treaty, where the
following conditions are met:

|(a) | the recipient corporation owns at least 10% of the outstanding voting rights of
          the Company for all of the period preceding the dividend during the
          Companys current and prior taxable year; and
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) | generally not more than 25% of the gross income of the paying corporation for
          its prior tax year consists of certain interest and dividend income.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------

Otherwise,
the usual rates apply.

In
addition, If an Individual shareholder is considered a principal shareholder
at any time during the 12-month period preceding such sale, i.e., such shareholder holds
directly or indirectly, including with others, at least 10% of any means of control in the
company, the tax rate on the dividend (not source from Approved Enterprise income) will be
25%. The withholding tax by the Company on such dividend would remain 20%.

United
States individual citizens and residents and U.S. corporations generally will be required
to include in their gross income the full amount of dividends received from the Company
with respect to the ordinary shares owned by them, including the amount withheld as
Israeli income tax. Subject to the limitations and conditions provided in the Internal
Revenue Code of 1986, as amended (the Code), such persons may be eligible to
claim a credit for such withheld amounts against their United States federal income tax
liability. As an alternative, the persons enumerated above (provided such persons, in the
case of individual taxpayers, itemize their deductions) may elect to deduct such withheld
tax from their gross income in determining taxable income (subject to applicable
limitations on the deductions claimed by individuals). However, such a credit or deduction
may be limited for U.S. alternative minimum tax purposes, depending on the taxpayers
specific circumstances.

Dividend
payments on the Ordinary Shares will not be eligible for a dividends received deduction
generally allowed to United States corporations under the Code.

51

---

Income Taxes on
Dividends Distributed by the Company to Israeli Residents

The
distribution of dividend income to Israeli residents will generally be subject to income
tax at a rate of 20% for individuals and will be exempt from income tax for corporations.
The portion of dividends paid out of profits earned under an Approved Enterprise tax
status of the Company, to both individuals and corporations, is subject to withholding tax
at the rate of 15% (in excess of the corporate tax paid by the Company when the dividend
is paid of these profits  25% tax).

In
addition, If an Individual Israeli shareholder is considered a principal
shareholder at any time during the 12-month period preceding such sale, i.e., such
shareholder holds directly or indirectly, including with others, at least 10% of any means
of control in the Company, the tax rate on the dividend (not source from Approved
Enterprise income) will be 25%. The withholding tax by the Company on such dividend would
remain 20%.

# Tax on Capital Gains of
Shareholders - General

Israeli
law imposes a capital gains tax on the sale of capital assets by an Israeli resident and
on the sale of capital assets located in Israel or the sale of direct or indirect rights
to assets located in Israel. The Israeli Tax Ordinance distinguishes between Real
Gain and Inflationary Surplus. Real Gain is the excess of the total
capital gain over Inflationary Surplus computed on the basis of the increase in the
Israeli CPI between the date of purchase and the date of sale. The Real Gain accrued at
the sale of an asset purchased on or after January 1, 2003 is generally taxed at a 20%
rate for individuals and 25% for corporations. Inflationary Surplus, that accrued after
December 31, 1993, is exempt from tax.

In
July 2005 the Israeli Parliament approved a Reform in the Israeli taxation law, which
among other decreases the corporate tax gradually from 31% in 2006 to 25% in 2010.

Pursuant
to the 2006 Tax Reform the current applicable corporate tax rate in 2007 is to be
gradually reduced from 29% to 25%, in the following manner: the tax rate for 2007 will be
 29%, , in 2008  27%, in 2009  26%, in 2010 and onwards  25%. The
maximum tax rate for individuals is 48% and shall also be gradually reduced to 44% in 2010
and onwards. These rates are subject to the provisions of any applicable bilateral double
taxation treaty. Israeli law generally imposes a capital gains tax on the sale of
securities and any other capital assets.

# Capital gains Israeli
Individuals

The
shareholder will generally be subject to tax at 20% rate on realized real capital gain
accrued from January 1, 2003 and thereafter. To the extent that the shareholder claims a
deduction of financing expenses, the gain will be subject to tax at a rate of 25% (until
otherwise stipulated in bylaws that may be published in the future).

If
such shareholder is considered a principal shareholder at any time during the
12-month period preceding such sale, i.e., such shareholder holds directly or indirectly,
including with others, at least 10% of any means of control in the Company, the tax rate
will be 25%.

The
tax basis of shares acquired prior to January 1, 2003 will be determined in accordance
with the average closing share price in the three trading days preceding January 1, 2003.
However, a taxpayer may elect the actual adjusted cost of the shares as the tax basis
provided he can provide sufficient proof of such adjusted cost.

It
should be noted hat different taxation rules may apply to shareholders who purchased their
shares prior to the listing on the Tel Aviv Stock Exchange. They should consult with their
tax advisors for the precise treatment upon sale.

52

---

# Capital gains Israeli
Corporations

It
should be noted that different taxation rules may apply to shareholders who purchased
their shares prior to the listing on the Tel Aviv Stock Exchange. They should consult with
their tax advisors for the precise treatment upon sale.

Corporations
which are subject to the Inflationary Adjustments Law

The
shareholder will be subject to tax at the corporate tax rate on realized real capital
gain (currently 29% in 2007).

# Corporations which are
not subject to the Inflationary Adjustments Law

Generally,
the shareholder will be subject to tax at the corporate tax rate of 25% on realized real
capital gains.

# Capital gains  non-Israeli
residents (Individuals and Corporations)

Non-Israeli residents
are generally exempt from capital gains tax on any gains derived from the sale of shares
publicly traded on the Tel Aviv Stock Exchange provided, however, that such capital gains
are not derived from a permanent establishment in Israel, that such shareholders are not
subject to the Inflationary Adjustment Law and that such shareholders did not acquire
their shares prior to an initial public offering. In addition, non-Israeli companies will
not be entitled to such exemption if an Israeli resident (i) has a controlling interest of
25% or more in such non-Israeli company, or (ii) is the beneficiary or is entitled to 25%
or more of the revenues or profits of such non-Israeli company, whether directly or
indirectly.

It
should be noted hat different taxation rules may apply to shareholders who purchased their
shares prior to the listing on the Tel Aviv Stock Exchange. They should consult with their
tax advisors for the precise treatment upon sale.

Notwithstanding
the foregoing with respect to both Israeli and non-Israeli residents, dealers (both
individuals and corporation) in securities in Israel are generally taxed at regular tax
rates applicable to business income.

The
U.S. Israeli Tax Treaty exempts U.S. residents who hold an interest of less than 10% an
Israeli company, and who held an interest of less than 10% during the 12 months prior to a
sale of their shares, from Israeli capital gains tax in connection with such sale. Certain
other tax treaties to which Israel is a party also grant exemptions from Israeli capital
gains taxes.

# F.    Dividends
and Paying Agents

Not
applicable to Annual Reports.

# G.    Statement
by Expert

Not
applicable to Annual Reports.

# H.    Documents on display

A
copy of each document (or a translation thereof to the extent not in English) concerning
the Company that is referred to in this Annual Report on Form 20-F, is available for
public view at our principal executive offices at American Israeli Paper Mills Ltd., 1
Meizer Street Industrial Zone, Hadera 38100, Israel. We are subject to the information
requirements of the Securities Exchange Act of 1934, as amended. In accordance with these
requirements, we file reports and other information with the Securities and Exchange
Commission (the SEC).

Copies
of this Annual Report and the exhibits hereto may be inspected and copied at the SECs
Public Reference Room at 100 F Street, NE, Washington, D.C. 20549 at proposed rates. The public may obtain information on
the operation of the SECs Public Reference Room by calling the SEC in the United
States at 1-800-SEC-0330.

Our
reports and other information can also be inspected on EDGAR available on the SECs
website at www.sec.gov.

53

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# ITEM 11  QUANTITATIVE
AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Due
to its operations, the Company is exposed to market risks, consisting primarily of changes
in interest rates  on both short and long-term loans, changes in exchange rates and
changes in raw material and energy prices. These changes in interest rates effect the
Companys financial results.

The
Companys Board of Directors determines the policy according to which financial
instruments are employed and defines the objectives to be attained, taking into account
the Groups linkage balance sheet and the impact of changes in various currencies and
in the Consumer Price Index on the Companys cash flows and on its financial
statements.

AIPM
conducts calculations of the its exposure every month and examines the compliance with the
policy determined by the Board of Directors.

Furthermore,
limited use is made of derivative financial instruments, which the Company employs for
hedging the cash flows, originating from the existing assets and liabilities.

Such
transactions are conducted primarily through currency options and forward transactions
opposite Israeli banking institutions. The Company therefore believes that the inherent
credit risk of these transactions is slight.

As
of December 31, 2006 AIPM owns CPI-linked long-term loans (notes) in the total sum of
about NIS 226 million. The interest on such loans is not higher than the market interest
rate. In the event that the inflation rate shall rise significantly, a loss may be
recorded in AIPMs financial statements, due to the surplus of CPI-linked
liabilities.

In
order to hedge this exposure, AIPM has entered into forward transactions, in December 2006
and January 2007 for hedging NIS 220 million against a rise in the CPI until December
2007. These transactions serve to replace hedging transactions of NIS 230 million that
terminated in late 2005.

Through
our normal operations, we are exposed to market risks mainly to the changes in the
Consumer Price Index, which our notes are linked to. We manage our exposure to these
market risks through our regular financing activities and, when deemed appropriate, we
hedge these risks through the use of derivative financial instruments. We use the term
hedge to mean a strategy designed to manage risks of volatility movements on certain
liabilities. The gains or losses on derivative instruments are expected to offset the
losses or gains on these liabilities. We use derivative financial instruments as risk
hedging tools and not for trading or speculative purposes. Our risk management objective
is to minimize the effect of volatility on our financial results exposed to these risks
and appropriately hedging them with forward contracts.

|                    | Maturity
|------------------- | --------
|
|                   
|Series 1 Debentures | 6,841   
|                   
|Series 2 Debentures | 29,518  
|                   

# Credit Risks

The
Companys and its subsidiaries cash and cash equivalents and the short-term
deposits as of December 31, 2006 are deposited mainly with major Israeli banks. The
Company and its subsidiaries consider the credit risks in respect of these balances to be
immaterial.

Most
of these companies sales are made in Israel, to a large number of customers. The
exposure to credit risks relating to trade receivables is limited due to the relatively
large number of customers. The Group performs ongoing credit evaluations of its customers
to determine the required amount of allowance for doubtful accounts. The Company believes
that an appropriate allowance for doubtful debts is included in the financial statements.

Fair Value of
Financial Instruments

The
fair value of the financial instruments included in working capital of the Group is
usually identical or close to their carrying value. The fair value of loans and other
liabilities also approximates the carrying value, since they bear interest at rates close
to the prevailing market rates, except as described below.

54



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Sensitivity
Analysis Tables for Sensitive Instruments, According to Changes in Market Elements

All
other Companys market risk sensitive instruments are instruments entered into for purposes other than trading proposes.

|Sensitivity to Interest Rates               | 
|------------------------------------------- | 
|
|
|
|Series 1 Debentures                         | 
|Series 2 Debentures                         | 
|Other liability                             | 
|Long-term loans and capital notes - granted | 

The
fair value of the loans is based on a calculation of the present value of the cash flows,
according to the generally-accepted interest rate on loans with similar characteristics
(5% in 2006).

Regarding
the terms of the debentures and other liability  See Note 4 to the Financial
Statements.

Regarding
the terms of the long-term loans and capital notes granted - See Note 2 to the Financial
Statements.

|Sensitivity to Consumer Price Index | 
|----------------------------------- | 
|
|
|
|NIS-CPI forward transaction         | 

55

---

See Note 12a to the
Financial Statements.

|Sensitivity to US Dollar Exchange Rate | 
|-------------------------------------- | 
|
|
|
|Other accounts receivable              | 
|Capital note                           | 
|Accounts payable                       | 

Other
accounts receivable reflect primarily short-term customer debts.

Capital
note  See Note 2b to the Financial Statements.

Accounts
payable reflect primarily short-term liabilities to suppliers.

56

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Quantitative
Information Regarding Market Risk

The following
are the balance-sheet components by linkage bases at December 31, 2006:

|In NIS Millions                                                |  | Unlinked |  | CPI-linked |   | In foreign
currency, or
linked thereto
(primarily US$) |        | Non-monetary
items |  | Total | 
|-------------------------------------------------------------- |  | -------- |  | ---------- | - | ------------------------------------------------------ | ------ | ------------------ |  | ----- | 
|Assets                                                         |  |          |  |            |   |                                                        |        |                    |  |       | 
|Cash and cash equivalents                                      |  |          |  | 5.0        |   |                                                        |        |                    |  | 8.6   | 
|Other accounts receivable                                      |  |          |  | 243.1      |   |                                                        | 0.2    |                    |  | 59.8  | 
|Inventories                                                    |  |          |  |            |   |                                                        |        |                    |  |       | 
|Investments in associated companies                            |  |          |  | 63.7       |   |                                                        |        |                    |  | 6.3   | 
|Deferred taxes on income                                       |  |          |  |            |   |                                                        |        |                    |  |       | 
|Fixed assets, net                                              |  |          |  |            |   |                                                        |        |                    |  |       | 
|                                                               |  |          |  |            |   |                                                        |        |                    |  |      
|Total assets                                                   |  |          |  | 311.8      |   |                                                        | 0.2    |                    |  | 74.7  | 
|                                                               |  |          |  |            |   |                                                        |        |                    |  |      
|                                                               |  |         
|Liabilities                                                    |  |         
|credit from banks                                              |  |          |  | 203.0      |   |                                                        |        |                    |  |       | 
|Accounts payable                                               |  |          |  | 191.5      |   |                                                        |        |                    |  | 8.4   | 
|Deferred taxes on income                                       |  |          |  |            |   |                                                        |        |                    |  |       | 
|Notes (bonds) - including current maturities                   |  |          |  |            |   |                                                        | 226.4  |                    |  |       | 
|Long term loans                                                |  |          |  | 38.7       |   |                                                        |        |                    |  |       | 
|Other liabilities - including current maturities               |  |          |  | 32.8       |   |                                                        |        |                    |  |       | 
|Shareholders' equity, funds and retained earnings              |  |          |  |            |   |                                                        |        |                    |  |       | 
|                                                               |  |          |  |            |   |                                                        |        |                    |  |      
|Total liabilities and equity                                   |  |          |  | 466.0      |   |                                                        | 226.4  |                    |  | 8.4   | 
|                                                               |  |          |  |            |   |                                                        |        |                    |  |      
|                                                               |  |         
|Surplus financial assets (liabilities) as at December 31, 2006 |  |          |  | (154.2     | ) |                                                        | (226.2 | )                  |  | 66.3  | 

# ITEM 12  DESCRIPTION OF
SECURITIES OTHER THAN EQUITY SECURITIES

Not
applicable to Annual Reports.

# ITEM 13  DEFAULTS,
DIVIDEND ARREARAGES AND DELINQUENCIES

None.

# ITEM 14  MATERIAL
MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

None.

57



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# ITEM 15T CONTROLS AND
PROCEDURES

# (a) Disclosure
controls and procedures

Our
Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of
our disclosure, controls and procedures (as defined in the U.S. Securities Exchange Rule
13a  15(e) and 15d  15(e)) have concluded that as of the end of the period
covered by this Form 20-F, our disclosure controls and procedures were effective to ensure
that material information required to be disclosed in the reports that we file and furnish
under the Exchange Act as recorded, processed and summarized and reported within the time
periods specified in the Securities and Exchange Commissions rules and regulations.

# (b) Managements
Report on Internal Control over Financial Reporting

Our
management is responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and
15d-15(f). Internal control over financial reporting is a process 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. Because of its inherent limitations, internal control over
financial reporting may not prevent or detect material misstatements. Also, projection 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 and procedures may deteriorate.

Under
the supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we conducted an evaluation of the
effectiveness of our internal control over financial reporting as of December 31,
2006 based on the framework in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.

As
permitted, we have excluded from our evaluation the affiliated companies: T.M.M.
Integrated Recycling Industries Ltd, Barthelemi Holdings Ltd, Frenkel C.D. Limited, Carmel
Container Systems Limited, Cycle-Tec Recycling Technology Ltd, and Hogla- Kimberly Lt d.
(H-K) (which together, not including H-K, are referred to as the excluded
companies), which are included in our 2006 Consolidated Financial Statements. The
aggregate Companys investments in the excluded companies represented 5% of
consolidated total assets and the aggregate Companys share in net income of the
excluded companies represented 11% of consolidated net income (loss) for the year ended
December 31, 2006. Hogla- Kimberly Ltd. has a significant influence on 2006
Consolidated Financial Statements; however, H-K had her evaluation separately, as part of
Kimberly Clark Ltd. (parent company) 2006 evaluation.

Our
managements assessment of the effectiveness of the Companys internal control
over financial reporting concluded that, as of December 31, 2006, the Companys
internal control over financial reporting was effective.

(c) This
annual report on Form 20-f does not include an attestation report of our independent registered public
accounting firm regarding managements assessment of the Companys internal
control over financial reporting. Managements report was not subject to audit by our
independent registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission, which permit us to defer obtaining such report until
our fiscal year ending December 31, 2007.

# (d) Changes in Internal
Control Over Financial Reporting.

There
were no changes in our internal control over financial reporting that occurred during the
year ended December 31, 2006 that have materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.

58



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# ITEM 16C.      PRINCIPAL
ACCOUNTANT FEES AND SERVICES

The
Audit Committee maintains a policy of approving and recommending only those services to be
performed by the Companys external auditors which are permitted under the
Sarbanes-Oxley Act and the applicable rules of the SEC relating to auditors
independence, and which are otherwise consistent with and will encourage, and are
remunerated at levels that accord with, the basic principles of auditor independence. The
practice of the Audit Committee is to receive from the Companys management, a list
of all services, including audit, audit-related, tax and other services, proposed to be
provided during the current fiscal year to the Company and its subsidiaries by Kesselman
& Kesselman, an affiliate of PricewaterhouseCoopers. After reviewing and considering
the services proposed to be provided during the current fiscal year and, where appropriate
in order better to understand their nature, discussing them with management, the Audit
Committee pre-approves such of the proposed services, with a specific pre-approved budget,
as it considers appropriate in accordance with the above principles. Additional services
from Kesselman & Kesselman and any increase in budgeted amounts will similarly be
pre-approved during the year by the Audit Committee on a case-by-case basis.

All
audit-related and non-audit-related services performed by Kesselman & Kesselman during
2006 were reported to, and the services proposed to be provided by them during 2006 were
pre-approved by the Audit Committee, in accordance with the procedures outlined above.

The
following table provides information regarding fees we paid to Kesselman & Kesselman
for all services, including audit services, for the years ended December 31, 2006 and
2005, respectively.

|                   |  | U.S. $ in thousands | 
|------------------ |  | ------------------- | 
|
|Audit Fees         |  |                     | 
|Audit Related Fees |  |                     | 
|                   |  |                     | 
|Total              |  |                     | 
|                   |  |                     | 

|* |  | Consulting
 fees regarding the establishment of processes pursuant of Section 404 of the
Sarbanes Oxley Act.
|- |  | ------------------------------------------------------------------------------------------------------------

Audit
Fees are the aggregate fees billed for the audit of our annual financial
statements. This category also includes services that generally the independent
accountant provides, such as statutory audits, consents and assistance with and review of
documents filed with the SEC.

Audit-Related
Fees are the aggregate fees billed for assurance and related services that are
reasonably related to the performance of the audit and are not reported under Audit Fees.
These fees include mainly accounting consultations regarding the accounting treatment of
matters that occur in the regular course of business, implications of new accounting
pronouncements and other accounting issues that occur from time to time.

Tax
Fees are the aggregate fees billed for professional services rendered for tax
compliance, tax advice, other than in connection with the audit. Tax compliance involves
preparation of original and amended tax returns, tax planning and tax advice.

# Item 16D.   Exemptions
from the Listing Standards for Audit Committees

Not
applicable.

# Item 16E.    Purchases
of Equity Securities by the Issuer and Affiliated Purchasers

Neither
the Company nor any affiliated purchaser purchased any of the Companys equity
securities during 2006.

59

---

# PART III

# ITEM 17  FINANCIAL
STATEMENTS

See
Item 19 below for Consolidated Financial Statements filed as a part of this Annual Report.

The Company
prepares its financial statements in accordance with Israeli GAAP. The effect of the
material differences between Israeli GAAP and U.S. GAAP, as it relates to the Company, are
described below:

# a.    The functional
currency of the Company

Through
December 31, 1993, the financial statements of the Company, presented in NIS values
adjusted for the changes in the general purchasing power of the Israeli currency based on
the changes in the exchange rate of the dollar were also used for the purposes of
reporting in conformity with U.S. GAAP applicable to entities operating in
hyper-inflationary economic environments, as prescribed by Statement No. 52 of the
Financial Accounting Standards Board of the United States (FASB). Since the inflation rate
in Israel has decreased considerably, the Company decided that, commencing in 1994, it
would implement the rules relating to economies no longer considered hyper-inflationary,
for reporting purposes, in accordance with U.S. GAAP.

Under
those rules:

| | 1)
                     The functional currency of the Company (the currency in which most
income is derived and most expenses are incurred) is the New Israeli Shekel (NIS);
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2)
 The opening balances for 1994 are the balances presented in the Companys
                    balance sheet at December 31, 1993;
| | -------------------------------------------------------------------------------------------------------------------------------------

| | 3)
Transactions performed
from January 1, 1994 are presented on the basis of their                     original
amounts in Israeli currency.
| | --------------------------------------------------------------------------------------------------------------------------------------------

The
term Re-measured NIS signifies the currency used for FASB 52 purposes, as
described above.

As
to the effect of application of these rules  see (h) below.

As
to the discontinuance of the adjustment of the financial statements under Israeli GAAP,
to the exchange rate of the dollar as from January 2004, see Note 1b to the Financial
Statements.

# b.    Deferred income taxes

Under
Israeli GAAP, no deferred taxes have been provided through December 31, 2004 in respect of
certain long-lived (more than 20 years) assets, such as buildings and land. Under U.S.
GAAP, in accordance with the provisions of FAS 109, income taxes are to be provided for
any assets that have a different basis for financial reporting and income tax purposes.
Following the adoption of Israeli Standard No. 19 in 2005, except for land that originated
from business combinations consummated prior to January 1, 2005, these differences no
longer exist.

In
addition, for U.S. GAAP purposes deferred taxes are to be provided for with respect to
un-remitted earnings of investee companies. Under Israeli GAAP due to the Companys
policy to hold its investments in investee companies, and not to realize them, these
temporary differences are considered differences permanent in duration for which deferred
taxes are not provided for.

60



---

Through
1999, as long as the main investments of the Company were subsidiaries which were
controlled by the Company, the Company did not provide for deferred taxes also for U.S.
GAAP reporting purposes, since those differences were deemed to be not taxable due to the
tax free inter-company dividend distribution law in Israel and tax planning on its behalf,
accordingly.

As
from 2000, due to changes in certain of the Companys investments from subsidiaries
to associated companies, deferred taxes were provided for any portion that arose from
investee companies sources other than pre-1993 undistributed earnings (taking into account
the Companys tax strategy).

As
to the effect of application of this treatment, see (h) below.

# c.    Stock based
compensation

Under Israeli
GAAP, and up until December 31, 2005 no compensation expenses were recorded in respect of employee
stock options. Commencing January 1, 2006, the company applies Israel Accounting Standard
No. 24 of the IASB, Share-Based Payment (hereafter - Standard 24), which
prescribes the recognition and measurement principles, as well as the disclosure
requirements, relating to share-based payment transactions.

However,
since the company has not granted any equity-settled awards, nor made modifications to
existing grants, subsequent to March 15, 2005, the transition date for as prescribed in
the Israeli standard, the measurement criteria of the standard do not apply to past grants
made by the company, and its application has not had any effect on the measurements of the
stock based compensation expenses.

Under Israeli GAAP, prior to the
adoption of Standard 24, there were no compensation expenses recorded in respect of share based payments.
However, upon exercise, the tax benefit is credited to shareholders equity.  The U.S. GAAP adjustment of
NIS (2,414) in 2006 and NIS (401) in 2005 to shareholders' equity is required to reverse the credit to equity upon exercise.

For
U.S. GAAP purposes, prior to January 1, 2006 the Company accounted for employee stock
based compensation under the intrinsic value model in accordance with Accounting
Principles Board Opinion No. 25 Accounting for Stock Issued to Employees
(APB 25) and related interpretations. In accordance with FAS 123 
Accounting for Stock-Based Compensation (FAS 123), the Company
disclosed pro forma data assuming the Company had accounted for employee stock option
grants using the fair value-based method defined in FAS 123.

In
December 2004, the Financial Accounting Standards Board (FASB) issued the
revised Statement of Financial Accounting Standards (FAS) No. 123, Share-Based
Payment (FAS 123R), which addresses the accounting for share-based payment
transactions in which the Company obtains employee services in exchange for (a) equity
instruments of the Company or (b) liabilities that are based on the fair value of the
Companys equity instruments or that may be settled by the issuance of such equity
instruments. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107)
regarding the SECs interpretation of FAS 123R.

FAS
123R eliminates the ability to account for employee share-based payment transactions using
APB 25 -, and requires instead that such transactions be accounted for using the
grant-date fair value based method. This Statement applies to all awards granted or
modified after the Statements effective date. In addition, compensation cost for the
unvested portion of previously granted awards that remain outstanding on the
Statements effective date shall be recognized on or after the effective date, as the
related services are rendered, based on the awards grant-date fair value as
previously calculated for the pro-forma disclosure under FAS 123.

Compensation
expense for outstanding awards for which the requisite service had not been rendered as of
the effective date will be recognized over the remaining service period using the
compensation cost calculated for pro-forma disclosure purposes under FAS 123, taking into
account the forecasted forfeiture rate.

The
Company adopted FAS 123R, as of January 1, 2006, using the modified prospective
application transition method, as permitted by FAS 123R. Under such transition method, the
Companys financial statements for periods prior to the effective date of FAS 123R
(January 1, 2006) have not been restated. The adoption of FAS 123R resulted in a net gain
representing the cumulative effect of a change in accounting principle in an amount of
approximately NIS 0.2 million net of tax, which reflects the net cumulative impact of
estimating future forfeiture in the determination of period expense, rather that recording
forfeitures when they occur as previously required.

61

---

The
fair value of stock options granted with service conditions, was determined using the
Black-Scholes option pricing model, which is consistent with the Companys valuation
techniques previously utilized for options in footnote disclosures required under FAS 123
and FAS 148. Such value is recognized as an expense over the service period, net of
estimated forfeitures, using the accelerated method of amortization under FAS 123R.

The
estimation of stock awards that will ultimately vest requires significant judgment, and to
the extent actual results or updated estimates differ from the Companys current
estimates, such amounts will be recorded as a cumulative adjustment in the period those
estimates are revised. The Company considers many factors when estimating expected
forfeitures, including types of awards, employee class, and historical experience. Actual
results, and future changes in estimates, may differ substantially from the Companys
current estimates.

As
of December 31, 2006 all options are fully vested.

The
following table illustrates the effect on net income and EPS assuming the Company had
applied the fair value recognition provisions of FAS 123 to its stock based employee
compensation for the years presented prior to the adoption of FAS 123R:

|                                                                                   |  | Year ended December 31 | 
|---------------------------------------------------------------------------------- |  | ---------------------- | 
|
|
|Net income, as reported under U.S. GAAP                                            |  |                        | 
|Add (deduct):                                                                      |  |                       
|stock based employee compensation expense (reversal), included in reported  net    |  |                       
|income, net of related tax effect                                                  |  |                        | 
|Deduct:                                                                            |  |                       
|stock based employee compensation expense -determined under fair value  method for |  |                        | 
|all awards, net of related tax effect                                              |  |                        | 
|                                                                                   |  |                        | 
|                                                                                   |  |                       
|Pro forma net income -under U.S. GAAP                                              |  |                        | 
|                                                                                   |  |                        | 
|                                                                                   |  |                       
|Earnings per share - under U.S. GAAP:                                              |  |                       
|Basic - as reported                                                                |  |                        | 
|Basic - pro forma                                                                  |  |                        | 
|Diluted - as reported                                                              |  |                        | 
|Diluted - pro forma                                                                |  |                        | 

62

---

A
summary of the status of the Companys plans as of December 31, 2006, 2005 and 2004
, and changes during the years ended on those dates, is presented below:

|                                   |  | 2006 |  | 2005    |   | 2004 |       
|---------------------------------- |  | ---- |  | ------- | - | ---- | ------
|
|Options outstanding at             | 
|beginning of year                  |  |      |  | 127,571 |   |      | 114.03
|                                   |  |     
|Changes during the year:           |  |     
|Exercised                          |  |      |  | (55,090 | ) |      | 94.01 
|Forfeited                          |  |      |  | (37,056 | ) |      | 102.06
|                                   |  |      |  |         |   |      |       
|Options outstanding at end of year |  |      |  | 35,425  |   |      | 122.21
|                                   |  |      |  |         |   |      |       
|Options exercisable at             |  |     
|year-end                           |  |      |  | *35,425 |   |      | 127.35
|                                   |  |      |  |         |   |      |       

|* |  | Represents the number of options fully vested as of December 31, 2006. Based upon the
Companys share market value as of December 31, 2006, this reflects potentially
11,113 shares regarding the options exercisable at year-end.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
following table summarizes information about options outstanding at December 31, 2006.

|Options outstanding and exercisable | 
|----------------------------------- | 
|
|
|106.44                              | 
|132.09                              | 
|                                    | 
|                                    | 
|                                    | 

# d.    Earnings per share (EPS)

Israeli
GAAP relating to computation of EPS was changed as of January 1, 2006 with retroactive
effect. As to the provisions of the new standard see note 1r to the financial statements
attached.

The
EPS computation according to U.S. GAAP presented below is in accordance with FAS 128.

As
applicable to the Company, after the implementation of the new Israeli standard No. 21
there are no material GAAP differences with regard to the computation of the basic EPS
however there is a difference in the computation of the diluted EPS as follows:.

The
computation of the diluted EPS under US GAAP requires that the unamortized compensation
expenses related to employee stock options will be included in the total amount of the
assumed proceeds used in applying the treasury stock method, while under Israeli GAAP
this amounts is not taken into account.

As
to the effect of application of U.S. GAAP, see (h) below.

63



---

Following
are data relating to the weighted average number of shares for the purpose of computing
basic and diluted earnings per share under U.S. GAAP:

|                                                                     | 2006 |  | 2005 |           | 2004 | 
|-------------------------------------------------------------------- | ---- |  | ---- | --------- | ---- | 
|Weighted average number of shares used in the computation of basic   |      |  |      |           |      | 
|earnings per share                                                   |      |  |      | 4,025,181 |      | 
|Net additional shares from the assumed exercise of employee stock    |      | 
|options                                                              |      |  |      | 30,447    |      | 
|                                                                     |      |  |      |           |      | 
|Weighted average number of shares used in the computation of diluted |      | 
|earnings per share                                                   |      |  |      | 4,055,628 |      | 
|                                                                     |      |  |      |           |      | 

|e. | Investment in marketable equity securities accounted for by the equity method
          (associated companies)  Carmel Container Systems (Carmel) and
          T.M.M. Integrated Recycling Industries Ltd (T.M.M.)
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Carmel

Under
Israeli GAAP, an investment in an associated company is tested for impairment under the
provisions of Israeli Standard No. 15 of the Israeli Accountant Standard Board -
Impairment of Assets (see note 1h to the financial statements). Based on the
provisions of this Standard, and as explained in note 2f to the financial statements, the
Company determined that the recoverable value of the investment in Carmel exceeds its
carrying value (based, among other, on its Discounted Cash Flows), and accordingly, the
investment was not written down.

Under
U.S. GAAP (APB 18 - The Equity Method of Accounting for Investments in Common
Stock), SEC Staff Accounting Bulletin (SAB) No. 59 (Accounting for Non current
Marketable Equity Securities) and EITF 03-1 (The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments), a decline in value of investment
in an associated company which is other than temporary was recognized as a realized loss
in 2003, establishing a new carrying value for the investment. Factors considered in
determining that a decline is other than temporary included, among other, the length of
time and the extent to which the market value has been less than the carrying value of the
investment. The relevant market value for determining the impairment loss is the market
value at December 31, 2003.

Therefore,
although according to the Israeli GAAP the recoverable value of this investment exceeds
its carrying value (see above) under U.S. GAAP and SEC rules described above, the decline
in the market value of Carmel shares was the significant factor in determining other than
temporary decline. Accordingly, for U.S.GAAP reporting, since the decline in the market
value of Carmel was long and extensive, the Company reduced the carrying value of this
investment to its market value as of December 31, 2003 and recorded an impairment loss
amounting NIS 16,986,000.

Under
US GAAP- Since there is no goodwill or non amortizable assets, the impairment was
attributed only to Carmels fixed assets; therefore the Company amortizes the
impairment at the rates applicable to Carmels fixed assets. The amortization of the
impairment, as above, resulted in an increase in the share in profits of the associated
company amounting to NIS 1,699 thousands in the years 2006, 2005 and 2004.

# T.M.M.

Under
Israeli GAAP, an investment in an associated company is tested for impairment under the
provisions of Israeli Standard No. 15 of the Israeli Accountant Standard Board -
Impairment of Assets (see note 1h to the financial statements). Until December
31, 2005 based on the provisions of this Standard, a the Company determined that the
recoverable value of the investment in T.M.M. based on an outside appraiser exceeds its
carrying value (based, among other, on its Discounted Cash Flows), and accordingly, the
investment was not written down.

64



---

As
a result of the implementation of Accounting Standard No. 15, T.M.M recorded a loss of NIS
12.5 million from the impairment of fixed assets in the third quarter of 2006, based on
the estimate of an external assessor.The Companys share in this loss
(43.08%) amounts to NIS 5.4 million.This sum appears as part of the Companys
share in the earnings (losses) of associated companies for that year.

At
the beginning of 2007 the Company sold its holdings in T.M.M. in consideration of a sum
approximately similar to the book value, after taking into account the impairment, which
was done during 2006.

Under
U.S. GAAP (APB 18 - The Equity Method of Accounting for Investments in Common Stock),
SEC Staff Accounting Bulletin (SAB) No. 59 (Accounting for Non-current
Marketable Equity Securities), and  EITF 03-1 (The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments), a decline in value of investment
in an associated company which is other than temporary was recognized as a realized loss
in 2005, establishing a new carrying value for the investment. Factors considered in
determining that a decline is other than temporary included, mainly, the length of time
and the extent to which the market value has been less than the carrying value of the
investment. The relevant market value for determining the impairment loss is the market
value at December 31, 2005.

Therefore,
although according to the Israeli GAAP the recoverable value of this investment exceeded
its carrying value (see above) under U.S. GAAP and SEC rules described above, the decline
in the market value of T.M.M. shares was the significant factor in determining other than
temporary decline. Accordingly, for U.S.GAAP reporting, since the decline in the market
value of T.M.M. was long and extensive, the Company reduced the carrying value of this
investment to its market value as of December 31, 2005 and recorded an impairment loss
amounting NIS 10,000,000.

The
losses of T.M.M. and Barthelemi for the year 2006 under U.S. GAAP including impairment in
value of fixed assets and goodwill, amount to NIS 21.6 million. The Companys share
in this impairment charged approximately NIS 8.7 million. Due to the impairment recorded
in the Companys books in 2005 the Companys share in the operating results of
those investment for 2006 was determined, based on their actual results, net of the
impairment, already reflected in 2005. As a result under U.S. GAAP the book value of T.M.M.
is similar to the value under Israeli GAAP, as mentioned above.

|f. | Reclassification
of deferred charges
|-- | ------------------------------------

Under
Israeli GAAP, in accordance with a new Israeli Standard No. 22, commencing January 1, 2006
see also note 1o to the financial statements:

The
balance of deferred debt issuance costs, which at December 31, 2005 amounted to NIS 946
thousands, is reclassified and presented as a deduction from the amount of the liabilities
to which such expenses relate.  Under U.S. GAAP deferred charges
should be classified as other assets, see h.3. below.  The reclassifications have no impact on net income
as both costs are accreted/amortized to the income statement over the term of the debt.

|g. | Leasehold
rights from the Israel Land Administration Authority (ILAA)
|-- | ---------------------------------------------------------------------

Under
Israeli GAAP, land lease rights from the ILAA are accounted for as fixed assets, and not
depreciated.

Under
US GAAP, in accordance with SFAS 13 Accounting for Leases, leases involving
real estate can be accounted for as capital lease only when (a) the lease transfers
ownership of the property to the lessee by the end of the lease term or (b) the lease
contains a bargain purchase option. Since none of the above-mentioned terms is met,
leasehold rights are accounted for as an operating lease. The leasehold rights are
amortized over the period of the initial option and if applccable the renewal option
period (See j below).

65



---

|h. | The
effect of applying U.S. GAAP on the consolidated financial statements is           as
follows:
|-- | --------------------------------------------------------------------------------------------------

1)          Consolidated
statement of income figures:

|                                                                                                       | Year ended December 31 | 
|------------------------------------------------------------------------------------------------------ | ---------------------- | 
|
|
|Net income, as reported  according to Israeli GAAP                                                     |                        | 
|Effect of treatment of the following items in accordance with U.S. GAAP:                               |                        | 
|Functional currency, see a above                                                                       |                        | 
|Deferred income taxes - net, see b above                                                               |                        | 
|Reconciliation resulting from the Companys share in the adjustments of the associated companies.      |                        | 
|Other than temporary impairment of an investment in associated companies, see e above                  |                        | 
|Amortization of other than temporary impairment of an investment in an associated company, see e above |                        | 
|Amortization of leasehold rights from the ILAA, see g above                                            |                        | 
|Applying FAS 123R in respect of employee stock options, see c above:                                   |                        | 
|Gross amount                                                                                           |                        | 
|Deferred taxes                                                                                         |                        | 
|Applying APB 25 in respect of employee stock options, see c above:                                     |                        | 
|Gross amount                                                                                           |                        | 
|Deferred taxes                                                                                         |                        | 
|Cumulative effect at beginning of period, net of tax of NIS 127*,  see c above                         |                        | 
|                                                                                                       |                        | 
|Net income under U.S. GAAP                                                                             |                        | 
|                                                                                                       |                        | 
|Earnings per share, see d above:                                                                       |                        | 
|Basic                                                                                                  |                        | 
|                                                                                                       |                        | 
|Diluted                                                                                                |                        | 
|                                                                                                       |                        | 
|                                                                                                       |                        | 

*As a result
of the adoption of FAS 123R, see (c) above.

2)       
          Shareholders equity:

|                                                                                                 | December 31 | 
|------------------------------------------------------------------------------------------------ | ----------- | 
|
|
|Shareholders' equity according to Israeli GAAP                                                   |             | 
|Effect of treatment of the following items in accordance with US GAAP:                           |             | 
|Functional currency                                                                              |             | 
|Amortization of leasehold rights                                                                 |             | 
|Investments in associated companies                                                              |             | 
|Other then temporary impairment of an investment in an associated companies, net of amortization |             | 
|Elimination of exercise options into shares                                                      |             | 
|Cumulative effect, at beginning of year of SAB 108, net of tax                                   |             | 
|Deferred income taxes                                                                            |             | 
|                                                                                                 |             | 
|Shareholders' equity under US GAAP                                                               |             | 
|                                                                                                 |             | 
|                                                                                                 |             | 

66



---

3)       
          Consolidated balance sheet figures:

|                                     | D e c e m b e r   3 1 | 
|------------------------------------ | --------------------- | 
|
|
|
|
|Assets                               | Israeli GAAP          | 
|                                    
|Inventories                          |                       | 
|                                     |                       | 
|Investment in associated companies   |                       | 
|                                     |                       | 
|Fixed assets - net                   |                       | 
|                                     |                       | 
|Deferred charges                     |                       | 
|                                     |                       | 
|Liabilities and shareholders' equity |                       | 
|                                    
|Deferred taxes - net                 |                       | 
|                                     |                       | 
|Notes                                |                       | 
|                                     |                       | 
|Shareholders' equity**               |                       | 
|                                     |                       | 
|                                     |                       | 

---

|** |  | 2006
retained earnings are net of an adjustment of NIS (2,665) thousands, net of tax, related
to the adoption of SAB 108 (See j below).
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------

|i. | Statement
of cash flows
|-- | -----------------------

The
Company presents its cash flow information, under Israeli GAAP net of the effects of
inflation.

The
information to be included under US GAAP for the years ended December 31, 2004, 2005 and
2006 is presented below:

|                                          | 2006 |  | 2005 |         | 2004 | 
|----------------------------------------- | ---- |  | ---- | ------- | ---- | 
|
|
|Net cash provided by operating activities |      |  |      | 64,521  |      | 
|Net cash used in investing activities     |      |  |      | (50,410 | )    | 
|Net cash used in financing activities     |      |  |      | (8,808  | )    | 
|                                          |      |  |      |         |      | 
|Increase (decrease) in cash and cash      |      | 
|Equivalents                               |      |  |      | 5,303   |      | 
|Balance of cash and cash equivalents      |      | 
|at beginning of year                      |      |  |      | 8,318   |      | 
|                                          |      |  |      |         |      | 
|Balance of cash and cash equivalents      |      | 
|at end of year                            |      |  |      | 13,621  |      | 
|                                          |      |  |      |         |      | 

Under
Israeli GAAP, cash flows relating to investments in, and proceeds from the sale of,
marketable securities classified as a current investment are presented as
investing activities in the statements of cash flows, while under U.S. GAAP, these
securities should be classified as operating activities.

67



---

|j. | Adoption of SAB 108 Accounting for the Effects of Prior year
          Misstatements when Quantifying Misstatements in current year financial
          statements
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

In
September 2006, the U.S. Securities and Exchange Commission (SEC) issued Staff Accounting
Bulletin No. 108, Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements (SAB
108). SAB 108 addresses the diversity in practice of quantifying financial statement
misstatements resulting in the potential build up of improper amounts on the balance
sheet. SAB 108 provides interpretive guidance on how the effects of the carryover or
reversal of prior year misstatements should be considered in quantifying a current year
misstatement. The SEC staff believes that registrants should quantify errors using both a
balance sheet and an income statement approach and evaluate whether either approach
results in quantifying a misstatement that, when all relevant quantitative and qualitative
factors are considered, is material. SAB 108 is effective for companies with fiscal years
ending after November 15, 2006 and SAB 108 allows a one-time transitional cumulative
effect adjustment to beginning retained earnings, in the first year of adoption, for
errors that were not previously deemed material, but are material under the guidance in
SAB 108.

Additionally,
the use of the cumulative effect transition method requires detailed disclosure of the
nature and amount of each individual error being corrected through the cumulative
adjustment and how and when it arose. The Company has adopted SAB No. 108. The adoption of
SAB No. 108 had an effect of NIS 2,665 thousand, net of tax, on the consolidated retained earnings due
to the GAAP differences related to the leases from the Israeli administration, see note g
above.

k.    
          Recently issued accounting pronouncements in the Untied States:

1.    
          SFAS 155 - Accounting for certain Hybrid Financial Instruments, an amendment
          of FASB statements No.133 and 140

In
February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No.
155, Accounting for Certain Hybrid Financial Instruments - an Amendment of FASB
Statements No. 133 and 140 (SFAS No. 155). SFAS No. 155 allows financial
instruments that contain an embedded derivative and that otherwise would require
bifurcation to be accounted for as a whole on a fair value basis, at the holders
election. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133
and SFAS No. 140. This statement is effective for all financial instruments acquired or
issued in fiscal years beginning after September 15, 2006 (January 1, 2007 for the
Company). The adoption of SFAS No. 155 is not expected to have a material impact on the
Companys consolidated financial condition or results of operations.

2.    
          FIN 48  Accounting for uncertainty in Income Taxes, an interpretation
          of SFAS No. 109

In
July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), Accounting for
Uncertainty in Income Taxes, an Interpretation of SFAS No. 109". FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprises financial
statements in accordance with SFAS No. 109, Accounting for Income Taxes, by
prescribing a recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a tax
return. Under FIN 48, the financial statement effects of a tax position should initially
be recognized when it is more likely than not, based on the technical merits, that the
position would be sustained upon examination. A tax position that meets the
more-likely-than-not recognition threshold should initially and subsequently be measured
as the largest amount of tax benefit that has a greater than fifty percent likelihood of
being realized upon ultimate settlement with a taxing authority. The cumulative effect,
if any, of applying the provisions of FIN 48 will be reported as an adjustment to the
opening balance of

68



---

retained earnings in the period
adopted. FIN 48 also requires additional disclosures about unrecognized tax benefits
associated with uncertain income tax positions and a reconciliation of the change in the
unrecognized benefit. In addition, FIN 48 requires interest to be recognized on the full
amount of deferred benefits for uncertain tax positions. An income tax penalty is
recognized as expense when the tax position does not meet the minimum statutory threshold
to avoid the imposition of a penalty. The Company is currently evaluating the impact that
the adoption of FIN 48 will have on its consolidated financial position and results of
operations.

3.     SFAS 157
Accounting for fair value Measurement

In September
2006, the FASB issued SFAS No. 157 (SFAS 157), Fair Value
Measurements, which defines fair value, establishes a framework for measuring fair
value under generally accepted accounting principles (GAAP), and expands disclosures about
fair value measurements. This Statement applies in conjunction with other accounting
pronouncements that require or permit fair value measurements. This Statement shall be
effective for financial statements issued for fiscal years beginning after November 15,
2007. The Company is currently evaluating the impact that the adoption of SFAS No. 157
will have on its consolidated financial position and results of operations.

4.    
          SFAS 159  Accounting for the Fair Value Option For Financial Assets and
          Financial Liabilities

In
February 2007, the FASB issued SFAS No. 159 (SFAS 159), The Fair Value
Option for Financial Assets and Financial Liabilities, to permit all entities to
choose, at specified election dates, to measure eligible financial instruments at fair
value. An entity shall report unrealized gains and losses on items for which the fair
value option has been elected in earnings at each subsequent reporting date, and recognize
upfront costs and fees related to those items in earnings as incurred and not deferred.
SFAS No. 159 applies to fiscal years beginning after November 15, 2007 (January 1, 2008
for the Company), with early adoption permitted for an entity that has also elected to
apply the provisions of SFAS No. 157, Fair Value Measurements. An entity is prohibited
from retrospectively applying SFAS No. 159, unless it chooses early adoption. SFAS No. 159
also applies to eligible items existing at November 15, 2007 (or early adoption date). The
Company is currently evaluating the impact that the adoption of SFAS No. 159 will have on
its consolidated financial position and results of operations.

5.EITF
06-03 Accounting for Presentation of Taxes Collected from           Customers and
remitted toGovernmental Authorities

In
June 2006, the Emerging Issues Task Force, reached a consensus on Issue No. 06-03,
How Taxes Collected from Customers and Remitted to Governmental Authorities Should
be Presented in the Income Statement (That Is, Gross versus Net Presentation)". EITF
06-03 relates to any tax assessed by a governmental authority that is directly imposed on
a revenue-producing transaction. EITF 06-03 states that the presentation of the taxes,
either on a gross or net basis, is an accounting policy decision that should be disclosed
pursuant to Accounting Principles Board Opinion No. 22, Disclosure of Accounting
Policies, if those amounts are significant. EITF 06-03 should be applied to
financial reports for interim and annual reporting periods beginning after December 15,
2006 (as of January 1, 2007 for the Company). The Companys policy is to recognize
revenue net of VAT, accordingly. The Company does not expect that the adoption of EITF
06-03 will have a material effect on its financial position and results of operations.

69



---

# Schedule 
Valuation and Qualifying Accounts

# Three Years Ended
December 31, 2006

# (NIS in thousands)

|Column A                         |                                | Column B |                                            | Column C |            | Column D |                          | Column E | 
|-------------------------------- | ------------------------------ | -------- | ------------------------------------------ | -------- | ---------- | -------- | ------------------------ | -------- | 
|
|                                 | Balance at beginning of period |          | (reductions)
Additions
charged to expenses |          | Deductions |          | Balance at
end of period |         
|Allowance for doubtful accounts: |                                |          |                                            |          |            |          |                          |          | 
|                                
|Year ended December 31, 2006     |                                |          |                                            | 16,914   |            |          | (123                     | )        | 
|                                 |                                |          |                                            |          |            |          |                          |         
|Year ended December 31, 2005     |                                |          |                                            | 16,148   |            |          | 840                      |          | 
|                                 |                                |          |                                            |          |            |          |                          |         
|Year ended December 31, 2004     |                                |          |                                            | 13,696   |            |          | 3,102                    |          | 
|                                 |                                |          |                                            |          |            |          |                          |         

70



---

# ITEM 19 - EXHIBITS

(a)     The
following financial statements and supporting documents are filed with this
          report:

|(i) |  | Consolidated Audited Financial Statements of the Company for the year ended
                    December 31, 2006 (including Reports of Independent Registered Public Accounting
                    Firms).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(ii) |  | Financial Statements of Mondi Business Paper Hadera Ltd. for the year ended
                    December 31, 2006.
|---- |  | ------------------------------------------------------------------------------------------------------------------

|(iii) |  | Financial
Statements of Hogla-Kimberly Ltd. for the year ended December 31,           2006.
|----- |  | -------------------------------------------------------------------------------------------

|(iv) |  | Report of Independent Registered Public Accounting Firms on Schedule on
                    Valuation and Qualifying Accounts.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------

|(v) |  | Report of Independent Registered Public Accounting Firms on reconciliation to
                    U.S. GAAP.
|--- |  | ------------------------------------------------------------------------------------------------------------

|(vi) |  | Report of Independent Registered Public Accounting Firms for affiliated companies.
|---- |  | ----------------------------------------------------------------------------------

(b)    
          Exhibits:

| | 1.1* |  | Memorandum
of Association
| | ---- |  | -------------------------

| | 1.2** |  | Articles
of Association Voting Agreement dated February 5, 1980 by and among Clal Industries Ltd.,
PEC Israel Economic Corporation and Discount Bank Investment Corporation
Ltd.
| | ----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.1*** |  | Voting Agreement dated February 5, 1980 by and among Clal Industries Ltd., PEC Israel
Economic Corporation and Discount Bank Investment Corporation Ltd.
| | ------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------

| | 31.1 |  | Certification
of Chief Executive Officer pursuant to 17 CFR 240.13a-14(a), as adopted pursuant to §302
of the Sarbanes-Oxley Act.
| | ---- |  | ---------------------------------------------------------------------------------------------------------------------------------

| | 31.2 |  | Certification
of Chief Financial Officer pursuant to 17 CFR 240.13a-14(a), as adopted pursuant to §302
of the Sarbanes-Oxley Act.
| | ---- |  | ---------------------------------------------------------------------------------------------------------------------------------

| | 32.1 |  | Certification
of Chief Executive Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of
the Sarbanes-Oxley Act.
| | ---- |  | ----------------------------------------------------------------------------------------------------------------------------

| | 32.2 |  | Certification
of Chief Financial Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of
the Sarbanes-Oxley.
| | ---- |  | ------------------------------------------------------------------------------------------------------------------------

|* |  | Previously filed as an exhibit to the Companys Annual Report on Form 20-F for the
year ended December 31, 1987, file No. 1-4212, and incorporated by reference herein.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

|** |  | Previously filed as an exhibit to the Companys Annual Report on Form 20-F for the
year ended December 31, 2005, filed with the SEC in June 2006 and incorporated by
reference herein.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|*** |  | Incorporated by reference to the exhibit number 3.1 in the Companys form 20-F for
the year ended December 31, 1987.
|--- |  | --------------------------------------------------------------------------------------------------------------------

71



---

# SIGNATURES

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

| |                                      |                           
| | ------------------------------------ | --------------------------
| |                                      |                           
| | AMERICAN ISRAELI PAPER MILLS LIMITED
|
|
| | By:                                  | /s/ Lea Katz              
| |                                      |                           
| |                                      | Name: Lea Katz            
| |                                      | Title: Corporate Secretary

Dated: June 28, 2007

72



---

Item 19(a)(i)

# AMERICAN ISRAELI PAPER
MILLS LIMITED

2006 CONSOLIDATED
FINANCIAL STATEMENTS

TABLE OF CONTENTS

|                                              | Page 
|--------------------------------------------- | -----
|REPORT OF INDEPENDENT REGISTERED PUBLIC       |      
|ACCOUNTING FIRM                               | 2    
|                                             
|CONSOLIDATED FINANCIAL STATEMENTS:           
|Balance sheets                                | 3-4  
|Statements of income                          | 5    
|Statements of changes in shareholders' equity | 6    
|Statements of cash flows                      | 7-9  
|Notes to financial statements                 | 10-46
|                                             
|SCHEDULE - DETAILS OF SUBSIDIARIES AND       
|ASSOCIATED COMPANIES                          | 47   

_________________

__________________________________

_________________



---



2



---

# AMERICAN ISRAELI PAPER
MILLS LIMITED

CONSOLIDATED BALANCE
SHEETS

|                                    | December 31 | 
|----------------------------------- | ----------- | 
|
|
|
|CURRENT ASSETS:                     |             | 
|Cash and cash equivalents           |             | 
|Marketable securities               |             | 
|                                    |             | 
|Accounts receivable:                |             | 
|Trade                               |             | 
|Other                               |             | 
|Inventories                         |             | 
|                                    |             | 
|T o t a l  current assets           |             | 
|                                    |             | 
|INVESTMENTS AND LONG-TERM           |             | 
|RECEIVABLES:                        |             | 
|Investments in associated companies |             | 
|Deferred income taxes               |             | 
|                                    |             | 
|                                    |             | 
|                                    |             | 
|FIXED ASSETS:                       |             | 
|Cost                                |             | 
|L e s s - accumulated depreciation  |             | 
|                                    |             | 
|                                    |             | 
|                                    |             | 
|DEFERRED CHARGES,                   |             | 
|net of accumulated amortization     |             | 
|                                    |             | 
|Total assets                        |             | 
|                                    |             | 

|/s/ Zvi Livnat                                    |                                    
|------------------------------------------------- | -----------------------------------
|_____________________________________Zvi Livnat   | )Chairman of the)Board of Directors
|                                                 
|/s/ Avi Brener                                    |                                    
|_____________________________________Avi Brener   | ))Chief Executive Officer          
|                                                 
|                                                 
|/s/ Israel Eldar                                  |                                    
|_____________________________________Israel Eldar | ))Controller                       

Date of approval of the financial
statements: 7 March 2007

# The accompanying notes
are an integral part of the financial statements

3



---

|                                                          | December 31 | 
|--------------------------------------------------------- | ----------- | 
|
|
|
|CURRENT LIABILITIES:                                      |             | 
|Credit from banks and others                              |             | 
|Current maturities of long-term notes and long-term loans |             | 
|Accounts payable and accruals:                            |             | 
|Trade                                                     |             | 
|Dividend payable                                          |             | 
|Other                                                     |             | 
|                                                          |             | 
|T o t a l  current liabilities                            |             | 
|                                                          |             | 
|LONG-TERM LIABILITIES:                                    |             | 
|Deferred income taxes                                     |             | 
|Loans and other liabilities                               |             | 
|(net of current maturities):                              |             | 
|Loans from banks                                          |             | 
|Notes                                                     |             | 
|Other liabilities                                         |             | 
|                                                          |             | 
|T o t a l  long-term liabilities                          |             | 
|                                                          |             | 
|COMMITMENTS AND CONTINGENT LIABILITIES                    |             | 
|T o t a l  liabilities                                    |             | 
|                                                          |             | 
|SHAREHOLDERS' EQUITY:                                     |             | 
|Share capital (ordinary shares of NIS 0.01 par value:     |             | 
|authorized - 20,000,000 shares; issued and paid:          |             | 
|December 31, 2006 and 2005 - 4,032,723 and                |             | 
|4,002,205 shares, respectively)                           |             | 
|Capital surplus                                           |             | 
|Capital surplus resulting from tax benefit on exercise    |             | 
|of employee options                                       |             | 
|Differences from translation of foreign currency          |             | 
|financial statements of associated companies              |             | 
|Retained earnings                                         |             | 
|                                                          |             | 
|                                                          |             | 
|                                                          |             | 
|T o t a l  liabilities and shareholders' equity           |             | 
|                                                          |             | 

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

4



---

# AMERICAN ISRAELI PAPER
MILLS LTD.

CONSOLIDATED STATEMENTS
OF INCOME

|                                                                      | Note              |  | 2006    |  | 2005 |  | 2004      |  
|--------------------------------------------------------------------- | ----------------- |  | ------- |  | ---- |  | --------- | -
|
|SALES                                                                 |                   |  | 10e; 14 |  |      |  | 530,109   |  
|COST OF SALES                                                         |                   |  | 10f     |  |      |  | 418,725   |  
|                                                                      |                   |  |         |  |      |  |          
|GROSS PROFIT                                                          |                   |  |         |  |      |  | 111,384   |  
|                                                                      |                   |  |         |  |      |  |          
|SELLING, MARKETING, ADMINISTRATIVE                                    |                   | 
|AND GENERAL EXPENSES:                                                 |                   |  | 10g     |  |      |  |           |  
|Selling and marketing                                                 |                   |  |         |  |      |  | 31,366    |  
|Administrative and general                                            |                   |  |         |  |      |  | 29,517    |  
|                                                                      |                   |  |         |  |      |  |          
|                                                                      |                   |  |         |  |      |  | 60,883    |  
|                                                                      |                   |  |         |  |      |  |          
|INCOME FROM ORDINARY OPERATIONS                                       |                   |  |         |  |      |  | 50,501    |  
|FINANCIAL EXPENSES - net                                              |                   |  | 10h     |  |      |  | 31,111    |  
|OTHER INCOME (EXPENSES) - net                                         |                   |  | 10i     |  |      |  | 37,305    |  
|                                                                      |                   |  |         |  |      |  |          
|INCOME BEFORE TAXES ON INCOME                                         |                   |  |         |  |      |  | 56,695    |  
|TAXES ON INCOME (EXPENSES) - net                                      |                   |  | 7       |  |      |  | 16,720    |  
|                                                                      |                   |  |         |  |      |  |          
|INCOME FROM OPERATIONS OF THE                                         |                   | 
|COMPANY AND ITS SUBSIDIARIES                                          |                   |  |         |  |      |  | 39,993    |  
|SHARE IN PROFITS (LOSSES) OF ASSOCIATED                               |                   | 
|COMPANIES - net                                                       |                   |  | 2       |  |      |  | (26,202   | )
|                                                                      |                   |  |         |  |      |  |          
|INCOME BEFORE CUMULATIVE EFFECT,                                      |                   |  |         |  |      |  |           |  
|AT BEGINNING OF YEAR, OF AN ACCOUNTING                                |                   |  |         |  |      |  |           |  
|CHANGE IN ASSOCIATED COMPANIES                                        |                   |  |         |  |      |  | 13,791    |  
|CUMULATIVE EFFECT, AT BEGINNING OF                                    |                   | 
|YEAR, OF AN ACCOUNTING CHANGE IN AN ASSOCIATED COMPANY                |                   |  | 1k      |  |      |  | (461      | )
|                                                                      |                   |  |         |  |      |  |          
|NET INCOME FOR THE YEAR                                               |                   |  |         |  |      |  | 13,330    |  
|                                                                      |                   |  |         |  |      |  |          
|                                                                      |                   | 
|                                                                      | (See Note 1b) NIS | 
|                                                                      |                   |  |        
|EARNINGS PER SHARE:                                                   |                   |  | 1r;11   |  |      |  |           |  
|Primary:                                                              |                   | 
|Before cumulative effect of a change in accounting policy             |                   |  |         |  |      |  | 3.42      |  
|Cumulative effect, at beginning of year, of a change in               |                   | 
|accounting policy at loss of an associated  company                   |                   |  |         |  |      |  | (0.11     | )
|                                                                      |                   |  |         |  |      |  |          
|Net income per share                                                  |                   |  |         |  |      |  | 3.31      |  
|                                                                      |                   |  |         |  |      |  |          
|Fully diluted:                                                        |                   | 
|Before cumulative effect of a change in accounting policy             |                   |  |         |  |      |  | 3.39      |  
|Cumulative effect, at beginning of year, of a change in               |                   | 
|accounting policy at loss of an associated  company                   |                   |  |         |  |      |  | (0.11     | )
|                                                                      |                   |  |         |  |      |  |          
|Net income per share                                                  |                   |  |         |  |      |  | 3.28      |  
|                                                                      |                   |  |         |  |      |  |          
|Number of shares used to compute the primary earnings per share       |                   |  |         |  |      |  | 4,025,181 |  
|                                                                      |                   |  |         |  |      |  |          
|Number of shares used to compute the fully diluted earnings per share |                   |  |         |  |      |  | 4,058,610 |  
|                                                                      |                   |  |         |  |      |  |          

* Reclassified

** As a result of implementing
retroactively the change of accounting policy

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

5



---

# AMERICAN ISRAELI PAPER
MILLS LIMITED

STATEMENTS OF CHANGES
IN SHAREHOLDERS EQUITY

|                                                     | Share
capital |  | Capital
surpluses |         | Capital surplus
resulting from
tax benefit on
exercise of
employee options |  | Differences from
currency
translation
resulting from
financial
statements of
associated companies |  | Retained
earnings |       | Total | 
|---------------------------------------------------- | ------------- |  | ----------------- | ------- | -------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------- |  | ----------------- | ----- | ----- | 
|
|BALANCE AT JANUARY 1, 2004                           |               |  |                   | 125,257 |                                                                            |  | 90,060                                                                                            |  |                   |       |       | 
|CHANGES IN 2004:                                     |               | 
|Net income                                           |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|Dividend paid                                        |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|Exercise of employee options into shares             |               |  |                   | *       |                                                                            |  |                                                                                                   |  |                   |       |       | 
|Differences from currency translation resulting from |               | 
|financial statements of associated companies         |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|                                                     |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|BALANCE AT DECEMBER 31, 2004                         |               |  |                   | 125,257 |                                                                            |  | 90,060                                                                                            |  |                   |       |       | 
|CHANGES IN 2005:                                     |               | 
|Net income                                           |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|Dividend paid ***                                    |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|Exercise of employee options into shares             |               |  |                   | *       |                                                                            |  |                                                                                                   |  |                   | 401   |       | 
|Differences from currency translation resulting from |               | 
|financial statements of associated companies         |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|                                                     |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|BALANCE AT DECEMBER 31, 2005                         |               |  |                   | 125,257 |                                                                            |  | 90,060                                                                                            |  |                   | 401   |       | 
|                                                     |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|                                                     |               | 
|CHANGES IN 2006:                                     |               | 
|Net income                                           |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|Dividend paid                                        |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|Exercise of employee options into shares             |               |  |                   | *       |                                                                            |  |                                                                                                   |  |                   | 2,013 |       | 
|Differences from currency translation resulting from |               | 
|financial statements of associated companies         |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|                                                     |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 
|BALANCE AT DECEMBER 31, 2006                         |               |  |                   | 125,257 |                                                                            |  | 90,060                                                                                            |  |                   | 2,414 |       | 
|                                                     |               |  |                   |         |                                                                            |  |                                                                                                   |  |                   |       |       | 

* Represents an amount less than NIS
1,000.

** See note 2c.

*** Includes a dividend, declared in December
2005 and paid in January 2006, amounting to approximately NIS 50 million.

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

6



---

(Continued)  1

# AMERICAN ISRAELI PAPER
MILLS LIMITED

CONSOLIDATED STATEMENTS
OF CASH FLOWS

|                                                              | 2006 |  | 2005 |          | 2004 | 
|------------------------------------------------------------- | ---- |  | ---- | -------- | ---- | 
|
|CASH FLOWS FROM OPERATING ACTIVITIES:                         |      |  |      |          |      | 
|Net income for the year                                       |      |  |      | 13,330   |      | 
|Adjustments to reconcile net income to                        |      | 
|net cash provided by operating activities (A)                 |      |  |      | 39,775   |      | 
|                                                              |      |  |      |          |      | 
|Net cash provided by operating activities                     |      |  |      | 53,105   |      | 
|                                                              |      |  |      |          |      | 
|CASH FLOWS FROM INVESTING ACTIVITIES:                         |      | 
|Purchase of fixed assets                                      |      |  |      | (53,107  | )    | 
|Deposit and Marketable securities                             |      |  |      | 11,582   |      | 
|                                                              |      | 
|Associated companies:                                         |      | 
|Granting of loans                                             |      |  |      |          |      | 
|Collection of loans                                           |      |  |      | 2,112    |      | 
|Proceeds from sale of subsidiary consolidated in the past (B) |      |  |      |          |      | 
|                                                              |      |  |     
|Proceeds from sale of fixed assets                            |      |  |      | 419      |      | 
|                                                              |      |  |      |          |      | 
|Net cash used in investing activities                         |      |  |      | (38,994  | )    | 
|                                                              |      |  |      |          |      | 
|                                                              |      |  |     
|                                                              |      | 
|CASH FLOWS FROM FINANCING ACTIVITIES:                         |      | 
|                                                              |      |  |     
|Receipt of long-term loans from others                        |      |  |      | 40,000   |      | 
|Repayment of long-term loans from banks                       |      |  |      | (1,277   | )    | 
|Redemption of notes                                           |      |  |      | (6,913   | )    | 
|Dividend paid                                                 |      |  |      | (150,450 | )    | 
|Short-term credit from banks - net                            |      |  |      | 109,832  |      | 
|                                                              |      |  |      |          |      | 
|Net cash used in financing activities                         |      |  |      | (8,808   | )    | 
|                                                              |      |  |      |          |      | 
|INCREASE (DECREASE) IN CASH AND                               |      | 
|CASH EQUIVALENTS                                              |      |  |      | 5,303    |      | 
|                                                              |      | 
|BALANCE OF CASH AND CASH EQUIVALENTS AT                       |      | 
|BEGINNING OF YEAR                                             |      |  |      | 8,318    |      | 
|                                                              |      |  |      |          |      | 
|BALANCE OF CASH AND CASH EQUIVALENTS AT                       |      | 
|END OF YEAR                                                   |      |  |      | 13,621   |      | 
|                                                              |      |  |      |          |      | 
|                                                              |      |  |     

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

7



---

(Continued)  2

# AMERICAN ISRAELI PAPER
MILLS LIMITED

CONSOLIDATED STATEMENTS
OF CASH FLOWS

|                                                              | 2006 |  | 2005 |         | 2004 | 
|------------------------------------------------------------- | ---- |  | ---- | ------- | ---- | 
|
|(A) Adjustments to reconcile net income to net cash provided  |      |  |      |         |      | 
|by operating activities:                                      |      | 
|Income and expenses not involving cash flows:                 |      | 
|Share in losses (profits) of associated companies - net       |      |  |      | 26,663  |      | 
|Dividend received from associated company                     |      |  |      | 19,616  |      | 
|Depreciation and amortization                                 |      |  |      | 31,957  |      | 
|Deferred income taxes - net                                   |      |  |      | (5,755  | )    | 
|Capital losses (gains) on:                                    |      | 
|Sale of fixed assets - net                                    |      |  |      | (28,823 | )    | 
|Sale of subsidiary consolidated in the past (B)               |      |  |      |         |      | 
|Losses (gains) on short-term deposits and investments         |      |  |      | (166    | )    | 
|Linkage and exchange differences (erosion) on principal of    |      | 
|long-term loans from banks - net                              |      |  |      |         |      | 
|Linkage differences (erosion) on principal of notes           |      |  |      | (415    | )    | 
|Linkage differences (erosion) on principal of long-term loans |      | 
|granted to associated companies                               |      |  |      | 178     |      | 
|                                                              |      |  |      |         |      | 
|                                                              |      |  |      | 43,255  |      | 
|                                                              |      |  |      |         |      | 
|                                                              |      | 
|Changes in operating asset and liability items:               |      | 
|Increase in trade receivables                                 |      |  |      | (17,641 | )    | 
|Increase in other receivables                                 |      | 
|(excluding deferred income taxes)                             |      |  |      | (1,661  | )    | 
|Decrease (increase) in inventories                            |      |  |      | 1,890   |      | 
|Increase in trade payables                                    |      |  |      | 5,761   |      | 
|Increase (decrease) in other payables and accruals            |      |  |      | 8,171   |      | 
|                                                              |      |  |      |         |      | 
|                                                              |      |  |      | (3,480  | )    | 
|                                                              |      |  |      |         |      | 
|                                                              |      |  |      | 39,775  |      | 
|                                                              |      |  |      |         |      | 
|Supplementary disclosure of cash flow information             |      | 
|Payments in cash during the year:                             |      | 
|Income taxes paid                                             |      |  |      | 23,877  |      | 
|                                                              |      |  |      |         |      | 
|Interest paid                                                 |      |  |      | 23,714  |      | 
|                                                              |      |  |      |         |      | 

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

8



---

(Concluded)  3

# AMERICAN ISRAELI PAPER
MILLS LIMITED

CONSOLIDATED STATEMENTS
OF CASH FLOWS

|                                                                 | 2005 | 
|---------------------------------------------------------------- | ---- | 
|
|(B)   Proceeds from sale of subsidiary consolidated in the past- |      | 
|see also note 10h:                                               |      | 
|Assets and liabilities of the subsidiary consolidated in the     |      | 
|past at the date of its sale:                                    |      | 
|Working capital (excluding cash and cash equivalents)            |      | 
|Fixed assets                                                     |      | 
|Long-term liabilities                                            |      | 
|                                                                 |      | 
|Capital gain from the sale                                       |      | 
|                                                                 |      | 

|(C) | Information on activities not involving cash flows:
|--- | ---------------------------------------------------

|1) |  | Dividend
declared by the Company in December 2005, in the amount of           approximately NIS 50
million, was paid in January 2006.
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------

|2) |  | Dividend
declared by an associated company in December 2005 that the           Companys
share in this dividend amounts to NIS 2,650,000 was paid during           2006.
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3) |  | In
2004, equipment, which the Company had found to be unsuitable for its use,           was
retired. The retirement was made against the cancellation of the loan made
          available by the supplier in respect of said equipment. The retirement amounted
          to NIS 1,079,000.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4) |  | In
December 2006 a land was sold in consideration of approximately NIS 40           million,
net of tax, betterment levy and other accompanying selling cost. This amount was transferred to a trustee at the date of the           transaction
execution and received during January 2007 see note 10i.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

9



---

AMERICAN ISRAELI PAPER
MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

# NOTE 1 
SIGNIFICANT ACCOUNTING POLICIES

| | The
financial statements are drawn up in conformity with accounting principles generally
accepted in Israel and in accordance with the Israeli Securities (Preparation of Annual
Financial Statements) Regulations, 1993.The Companys financial statements
are presented separately from these consolidated financial statements. The significant
accounting policies, which, except for the changes in the accounting policy concerning
revenue recognition, in an associated company, and after taking into consideration, by
way of retrospective application, the change in accounting policy concerning the
computation of net income per share, resulting from the first-time application, in
2006, of new accounting standards of the Israel Accounting Standards Board (hereafter -
the IASB) and first-time application of clarification no. 7 in 2005,  were applied on a consistent basis, as follows:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to the adoption of International Financial Reporting Standards (IFRS), which is to be
carried out in reporting periods commencing on January 1, 2008 and thereafter, see
s. below.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. |  | General:
| | -- |  | --------

| | 1) |  | Activities
of the Group
| | -- |  | -----------------------

| | American
Israeli Paper Mills Limited and its subsidiaries (hereafter  the Company) are
engaged in the production and sale of paper packaging, in paper recycling activities and
in the marketing of office supplies. The Company also has holdings in associated
companies that are engaged in the production and sale of paper and paper products
including the handling of solid waste (the Company and its investee companies  hereafter
the Group). Most of the Groups sales are made on the local (Israeli) market.
For segment information, see note 14.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) |  | Use
of estimates in the preparation of financial statements
| | -- |  | -----------------------------------------------------------

| | The
preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and liabilities at
the dates of the financial statements and the reported amounts of revenues and expenses
during the reporting years. Actual results could differ from those estimates.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) |  | Definitions:
| | -- |  | ------------

| | Subsidiaries
 companies over which the Company has control and over 50% of the ownership, the
financial statements of which have been consolidated with the financial statements of the
Company.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Associated
companies  investee companies, which are not subsidiaries, over whose financial and
operational policy the Company exerts material influence, the investment in which is
presented by the equity method. Material influence is deemed to exist when the percentage
of holding in said company is 20% or more, unless there are circumstances that contradict
this assumption.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Interested
parties  as defined in the Israeli Securities (Preparation of Annual Financial
Statements) Regulations, 1993.
| | -------------------------------------------------------------------------------------------------------------------------

10



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | b. |  | Basis
of presentation of the financial statements
| | -- |  | -------------------------------------------------

| | The
Company draws up and presents its financial statements in Israeli currency (hereafter -
shekels or NIS). in accordance with the provisions of Israel Accounting Standard No. 12
 Discontinuance of Adjusting Financial Statements for Inflation  of
the IASB, which establishes principles for transition to nominal reporting, commencing
January 1, 2004 (hereafter - the transition date). Accordingly, amounts that
relate to non-monetary assets (including depreciation and amortization thereon),
investments in associated companies (see also below) permanent investments,
and equity items, which originate from the period that preceded the transition date, are
based on the data adjusted for the changes in the exchange rate of the dollar (based on
the exchange rate of the dollar at December 31, 2003), as previously reported. All the
amounts originating from the period after the transition date are included in the
financial statements at their nominal values. The financial statements of group companies
which are drawn up in foreign currency, are translated into shekels or are remeasured in
shekels for the purpose of inclusion in these financial statements, as explained in e.
below.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
sums of non-monetary assets do not necessarily reflect the realization value or an
updated economic value, but rather only the reported sums of the said assets, as stated
in (1), above. The term cost in these financial statements shall mean the
cost in reported sums.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | 1) |  | The
consolidated financial statements include the accounts of the Company and
               its subsidiaries. A list of the main subsidiaries is presented in a
               schedule to the financial statements.
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) |  | Intercompany
transactions and balances, as well as profits on intercompany sales                that
have not yet been realized outside the Group, have been eliminated.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. |  | Inventories
| | -- |  | -----------

| | Raw
materials and supplies, finished goods, purchased products and maintenance and sundry
materials (including spare parts) are valued at the lower of cost or market (net of
processing costs and after deduction of a provision for obsolescence, where appropriate);
cost is determined on the moving average basis. Spare parts of the machinery and
equipment that are not for current use, are presented under fixed assets.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. |  | Investments
in associated companies:
| | -- |  | ------------------------------------

| | 1) |  | The
investments in these companies are accounted for by the equity method.
               According to this method, the Company records, in its statement of income,
its                share in the profits and losses of these companies that were created
after                acquisition, and, in its statement of changes in shareholders equity,
its                share in changes in capital surpluses (mostly translation differences
relating                to their investments in subsidiaries that present their financial
statements in                foreign currency) that were created after acquisition.
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) |  | Profits
on intercompany sales, not yet realized outside the Group, have                been
eliminated according to the percentage of the Companys holding in
               such companies.
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

11



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | 3) |  | The
Company reviews  at each balance sheet date                whether
any events have occurred or changes in circumstances have taken place,
               which might indicate that there has been an impairment of its investments
in                associated companies  see h. below.
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) |  | The
excess of cost of the investment in associated companies over the equity in
               net assets at time of acquisition (excess of cost of investment)
or                the excess of equity in net assets of associated companies at time of
               acquisition over the cost of their acquisition (negative excess of
cost of                investment) represent the amounts attributed to specific
assets upon                acquisition, at fair value. The excess of cost of investment
and the negative                excess of cost of investment are presented at their net
amount and are amortized                over the remaining useful life of the assets. The
average rate of amortization                is 10%.
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5) |  | In
accordance with the provisions of Standard No. 20 (As Amended), which is
               applied by the group companies since January 1, 2006, as of that
date,                amortization of goodwill at associated company, which until then
was included                under share in profits (losses) of associated companies,
was                discontinued. The amounts of amortization of goodwill, included under share in profits (losses) of
associated                companies, as above, for the years ended December 31,
2005 and 2004                are NIS 4 million and NIS 4 million, respectively.
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | f. |  | Marketable
securities
| | -- |  | ---------------------

| | These
securities are stated at market prices.
| | ---------------------------------------------

| | The
changes in value of the above securities are carried to financial income or expense.
| | ----------------------------------------------------------------------------------------

| | g. |  | Fixed
assets:
| | -- |  | -------------

| | 1) |  | Fixed
assets are stated at cost, net of related investment grants.
| | -- |  | ------------------------------------------------------------------

| | 2) |  | Fixed
assets of own manufacture are stated at cost, based on the direct costs
               with the addition of an appropriate portion of indirect production costs.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) |  | Borrowing
costs in respect of credit applied to finance the construction of                fixed
assets - during the period until construction is completed - are
               charged to the cost of such assets.
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) |  | The
assets are depreciated by the straight-line method on the basis of their
               estimated useful life, as follows:
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------

|                               | Years
|------------------------------ | -----
|Buildings                      |      
|Machinery and equipment        |      
|Vehicles                       |      
|Office furniture and equipment |      

12



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | 5) |  | As
to the change in the accounting treatment of property, plant and equipment,
               commencing January 1, 2007, resulting from the application of Israel
               Accounting Standard No. 27 of the IASB, Property, Plant and
               Equipment - see s(3) below.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6) |  | As
to the change in the accounting treatment of investment property, commencing
               January 1, 2007, resulting from the application of Israel Accounting
               Standard No. 16 of the IASB, Investment Property -
see s(5) below.
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | h. |  | Impairment
of assets
| | -- |  | --------------------

| | The
Company assesses  at each balance sheet date  whether any events have
occurred or changes in circumstances have taken place, which might indicate that there
has been an impairment of non-monetary assets, mainly fixed assets and investments in
associated companies. When such indicators of impairment are present, the Company
evaluates whether the carrying value of the asset is recoverable from the cash flows
expected from that asset. See note 2g.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
recoverable value of an asset is determined according to the higher of the net selling
price of the asset or its value in use to the Company. The value in use is determined
according to the present value of anticipated cash flows from the continued use of the
asset, including those expected at the time of its future retirement and disposal.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | When
it is not possible to assess whether an impairment provision is required for a particular
asset on its own, the need for such a provision is assessed in relation to the
recoverable value of the cash-generating unit to which that asset belongs.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
item represents notes issuance costs, which are amortized over the period of the notes
(see note 4a).
| | ---------------------------------------------------------------------------------------------------------

| | As
to the change from January 1, 2006 in the method of presenting and amortizing these
charges  see o(2) below.
| | ----------------------------------------------------------------------------------------------------------------

| | j. |  | Deferred
income taxes:
| | -- |  | ----------------------

| | 1) |  | Commencing
January 1, 2005, the Company applies the IASBs Accounting                Standard
No. 19  Taxes on Income that prescribes the
               accounting treatment (recognition criteria, measurement, presentation and
               disclosure) required for taxes on income.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
the most part, the provisions of this standard are the same as the accounting principles
that the Company applied prior to implementing the new standard.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) |  | In
accordance with the standard and with prior years policy, the Company
               recognizes deferred taxes in respect of temporary differences between the
               amounts of assets and liabilities as reported in the consolidated
financial                statements and those taken into account for tax purposes; the
standard requires                that full recognition be given to deferred taxes in
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

13



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE
1  SIGNIFICANT ACCOUNTING POLICIES(continued):

| | respect
of all taxable temporary differences, except for the temporary difference resulting from
the initial recognition of goodwill and the temporary difference resulting from the
initial recognition of an asset or a liability that has no effect on the profit or loss,
whether for accounting or tax purposes, at that time (unless the temporary difference
results from the initial recognition of a business combination).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Deferred
tax assets are recognized for all temporary differences that are tax deductible, up to
the amount of the differences that are expected to be utilized in the future, against
taxable income. As to the main types of differences, in respect of which deferred taxes
have been included  see note 7f.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) |  | Deferred
tax balances are computed at the tax rates expected to be in effect at                the
time the deferred tax asset is utilized or the deferred tax liability is
               settled, based on the tax rates and the tax laws enacted, or substantively
               enacted, by the balance sheet date.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) |  | The
current taxes, as well as the changes in the deferred tax balances, are
               included in the tax expenses or income in the reporting period.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5) |  | Taxes
that would apply in the event of disposal of investments in subsidiaries
               and associated companies have not been taken into account in computing the
               deferred taxes, as it is the Companys policy to hold these
investments,                not to realize them.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6) |  | The
Group may incur an additional tax liability in the event of an intercompany
               dividend distribution derived from approved enterprises profits
                see note 7a. No account was taken of this additional tax,
since it                is the Groups policy not to cause distribution of
dividends, which would                involve an additional tax liability to the Group in
the foreseeable future.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 7) |  | In
April 2005, the IASB issued Clarification No. 7  Accounting
               Treatment of the Tax Benefits, in Respect of Capital Instruments Granted
to                Employees, For Which No Compensation was Recognized. The
provisions of                this clarification apply to such tax benefits, which have
not been allowed as a                deduction through December 31, 2004. The
clarification stipulates that,                commencing on January 1, 2005, the tax
benefit derived by the Company from                the exercise of options granted to
employees is to be carried to                shareholders equity, in the period in
which the benefit to the employees                is allowed as a deduction for tax
purposes. Formerly, the aforesaid tax saving                was credited to the statement
of income, as part of the taxes on income item.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | k. |  | Revenue
recognition
| | -- |  | -------------------

| | Commencing
January 1, 2006, the company applies Israel Accounting Standard No. 25 of the
IASB  Revenue, which prescribes recognition, measurement, presentation
and disclosure criteria for revenues originating from the sale of goods purchased or
manufactured by the company.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenue
is measured, as detailed below, at the fair value of the consideration received or the
consideration that the company is entitled to receive, taking into account trade
discounts and/or bulk discounts granted by the entity:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

14



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | Revenue
from sale of goods is recognized when all the following conditions have been satisfied:
(a) the significant risks and rewards of ownership of the goods have been transferred to
the buyer; (b) the company retains neither continuing managerial involvement to the
degree usually associated with ownership nor effective control over the goods sold; (c)
the amount of revenue can be measured reliably; (d) it is probable that the economic
benefits associated with the transaction will flow to the company; and (e) the costs
incurred or to be incurred in respect of the transaction can be measured reliably.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Upon
the application of the standard, an associated company separates the financing component
embedded in revenue from sales made on credit for periods exceeding the customary credit
period in its industry (mainly 90 days), that does not bear interest at the appropriate
rate; the financing component is determined according to the amount by which the nominal
amount of consideration for the transaction exceeds the present value of future cash
payments in respect thereof, based on the customary market interest rate applicable to
credit extended under similar terms. Revenue from the financing component is recognized
over the credit period. Through December 31, 2005, the company did not separate the
financing component in respect of sales made on credit, as above, and included within
revenue from the sale on the date of recognition of such revenue. In accordance with the
transitional provisions of the standard, on January 1, 2006 the company recognized
an expense of NIS 1.1 million as a result of presentation in present value,
resulting from the adjustment of trade receivables in respect of such credit transactions
to their present value on the effective date of the standard, the share of the company at
the adjustment effect as above was approximately NIS 0.5 million which is presented in
these financial statements under Cumulative effect, at beginning of year, of an
accounting change.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | l. |  | Shipping and handling costs
| | -- |  | ---------------------------

| | Shipping
and handling costs are classified as a component of selling and marketing expenses.
| | --------------------------------------------------------------------------------------------

| | m. |  | Allowance for doubtful accounts
| | -- |  | -------------------------------

| | The
allowance is determined mainly in respect of specific debts doubtful of collection (see
note 12b).
| | ------------------------------------------------------------------------------------------------------

| | n. |  | Derivate
financial instruments
| | -- |  | ------------------------------

| | Gains
and losses on derivatives that are hedging existing assets or liabilities are recognized
in income commensurate with the results from those assets or liabilities.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o. |  | Financial
instruments
| | -- |  | ---------------------

| | Commencing
January 1, 2006, the Company applies Israel Accounting Standard No. 22 of the IASB
 Financial Instruments: Disclosure and Presentation (hereafter -
Standard 22), which prescribes the rules for presentation of financial instruments and
the proper disclosure required therefore, as follows:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

15



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | 1) |  | Offset
of financial instruments
| | -- |  | -------------------------------

| | Financial
assets and financial liabilities are presented on the balance sheet at their net amount,
only when the Company has a legally enforceable right to effect such set off, and subject
to the existence of intent to settle the asset and the liability on a net basis, or to
realize the asset and settle the liability simultaneously.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) |  | In
accordance with the transitional provisions of Standard 22, commencing
               January 1, 2006, in addition to the aforesaid, the financial
statements                include the following changes:
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
balance of deferred issuance costs, which at December 31, 2005 amounted to NIS 946
thousands, has been reclassified and presented as a deduction from the amount of the
liabilities to which such expenses relate. Through December 31, 2005, deferred
issuance costs were included under other assets and amortized according to the
straight-line method.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
change in the amortization method of deferred issuance costs, as above, do not have a
material effect on the operating results in the reported years.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | p. |  | Share-based
payment
| | -- |  | -------------------

| | Commencing
January 1, 2006, the company applies Israel Accounting Standard No. 24 of the
IASB, Share-Based Payment (hereafter - Standard 24), which prescribes
the recognition and measurement principles, as well as the disclosure requirements,
relating to share-based payment transactions.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Since
the company has not granted any equity-settled awards, nor made modifications to existing
grants, subsequent to March 15, 2005, the measurement criteria of the standard do
not apply to past grants made by the company, and its application has not had any effect
on the comparative figures included in these financial statements.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | q. |  | Cash
equivalents
| | -- |  | ----------------

| | The
Company considers all highly liquid investments, which include short-term bank deposits
that are not restricted as to withdrawal or use, the period to maturity of which did not
exceed three months at time of deposit, to be cash equivalents.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | r. |  | Net
income per share
| | -- |  | --------------------

| | Commencing
January 1, 2006, the company applies the provisions of Israel Accounting Standard No. 21
of the IASB, Earnings per Share. The computation of basic net income per
share is generally based on earnings available for distribution to holders of ordinary
shares, divided by the weighted average number of ordinary shares outstanding during the
period.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
computing diluted net income per share, the weighted average number of shares to be
issued, assuming that all dilutive potential shares are converted into shares, is to be
added to the average number of ordinary shares used in the computation of the basic
income (loss) per share. Potential shares are taken into account, as above, only when
their effect is dilutive (reducing net income per share from continuing activities).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

16



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | Comparative
net income per share figures included in these financial statements reflect a
retrospective application of the new standards computation directives.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to the data used in the computation of net income per share, as above - see note
 11
| | ---------------------------------------------------------------------------------------

| | s. |  | Recently
issued accounting pronouncements inIsrael
| | -- |  | --------------------------------------------------

| | 1) |  | Israel
Accounting Standard No. 29  Adoption of International
          Reporting Financial Standards (IFRS)"
| | -- |  | --------------------------------------------------------------------------------------------------------------

| | In
July 2006, the Israel Accounting Standards Board issued Israel Accounting Standard No. 29
 Adoption of International Reporting Financial Standards (IFRS) (hereafter -
Standard 29). Standard 29 stipulates that companies, which are subject to the Securities
Law, 1968 and are required to report pursuant to regulations issued thereunder,
shall draw up their financial statements under International Financial Reporting
Standards (IFRS) with effect from reporting periods commencing on January 1, 2008 (i.e. commencing the financial statements for the first quarter of 2008). Pursuant to the
provisions of Standard 29, such companies and other companies may elect early adoption of
the Standard, and prepare their financial statements under IFRS, commencing with the
financial statements that are published subsequent to July 31, 2006.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard prescribes that companies, which currently do not draw up their financial
statements under IFRS, and are required or elect, as stated above, to prepare their
financial statements for the first time under IFRS, shall apply the provisions specified
in International Financial Reporting Standard No. 1 (IFRS 1) -
First-Time Adoption of International Financial Reporting Standards in making
the transition. IFRS 1, which deals with first-time transition to reporting under IFRS,
provides that, in the first annual financial statements that are drawn up under IFRS
(including the interim financial statements for that year), all the latest IFRS standards
in effect at the end of the reporting year in which the company reports under IFRS for
the first time, shall be applied retrospectively (with the exception of certain
exemptions and prohibitions, as referred to below). IFRS 1 specifies two groups of
exceptions to the principle of retrospective application: (1) exemptions from
mandatory retrospective application with regard to certain topics, while providing the
option to utilize all or part of those exemptions, and (2) prohibitions concerning
mandatory retrospective application with regard to defined topics. Pursuant to the
provisions of IFRS 1, the first financial statements drawn up under IFRS shall
include at least one years comparative data. Accordingly, a company that draws up
its financial statements under IFRS for the first time for periods commencing after
January 1, 2008, and elects to present comparative data for one year only, shall be
required, pursuant to IFRS 1, to prepare an opening balance sheet as of January 1,
2007, which shall be drawn up under IFRS. In preparing this opening balance sheet, all
the latest IFRS standards, as referred to above, with regard to recognition,
non-recognition, classification and measurement of all the companys assets,
liabilities and shareholders equity items, shall be applied. IFRS 1 also
establishes certain disclosure requirements that apply to the annual financial statements
that are drawn up for the first time under IFRS. Pursuant to these disclosure
requirements, companies applying IFRS for the first time are required to explain what
effect the transition from the previous generally accepted accounting principles to IFRS
has had on the reported financial position, operating results and cash flows. Also,
companies are required to include notes providing reconciliations of the data reported
under the previous accounting principles, to the data reported under IFRS, in respect
of their shareholders equity and statements of income (loss) as of certain dates
and for certain prior periods.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

17



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | In
addition, Standard 29 requires companies, which draw up their financial statements under
IFRS for the first time for periods commencing after January 1, 2008, to disclose, in a
note to their financial statements for 2007, the balance sheet data as of December 31,
2007 and income statement data for the year ended December 31, 2007, as they would
appear after applying IFRS recognition, measurement and presentation rules.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | IFRS
differ from general accounting principles accepted in Israel and, accordingly, financial
statements drawn up under IFRS might reflect a financial position, operating results and
cash flows that are significantly different from those presented in these financial
statements. Application of IFRS requires a proper arrangement from the company, including
making certain decisions relating to the manner of determining assets and liabilities at
the transition date and with regard to setting an accounting policy for various topics.
The company is currently assessing the implications of the transition to reporting under
IFRS, including the date for first-time adoption of IFRS by the company. At this stage,
the company is unable to estimate the effect that the adoption of IFRS will have on its
financial statements.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) |  | Israel
Accounting Standard No. 26  Inventory
| | -- |  | -----------------------------------------------

| | In
August 2006, the IASB issued Israel Accounting Standard No. 26 - Inventory,
which is based on International Accounting Standard No. 2. This standard prescribes the
accounting treatment of inventory and provides guidelines for determining the cost of
inventory and its subsequent recognition as an expense, including recognition and
treatment of any write-down to net realizable value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard specifies the costs that are to be taken into account in determining the cost of
inventory and the costs that may not be included in the cost of inventory, and requires
that fixed production overheads be allocated based on the normal capacity of the
production facilities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
determining the cost of inventory, the standard requires specific identification of the
cost of certain items that are not ordinarily interchangeable and of goods and services
that have been produced and segregated for specific projects. In other instances, the
standard prescribes the exclusive use of the first-in, first-out (FIFO)
method or the weighted average method.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard also stipulates that the financing element in purchases of inventory on credit
must be accounted for separately, whenever the actual arrangement includes a financing
element. For instance, the difference between the purchase price on normal credit terms
and the actual amount paid is to be recognized as interest expense over the financing
period.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
standard shall be applicable to financial statements for periods commencing on or after
January 1, 2007. The standard is to be applied retrospectively, unless it is
impracticable to determine the specific effects in a given period. At this stage the
Company is examining the possible effect of the standard on its financial statements.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

18



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | 3) |  | Israel
Accounting Standard No. 27  Property, Plant and Equipment
| | -- |  | -------------------------------------------------------------------

| | In
September 2006, the IASB issued Israel Accounting Standard No. 27 - Property,
Plant and Equipment, which is based on International Accounting Standard No. 16.
This standard prescribes the accounting treatment for property, plant and equipment. The
standard stipulates provisions for the recognition of an item of property, plant and
equipment as an asset, the initial measurement of its cost, the measurement subsequent to
initial recognition, as well as provisions regarding depreciation and derecognition of an
item of property, plant and equipment.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the standard, an item of property, plant and equipment that qualifies for recognition
as an asset is to be measured at cost upon its initial recognition. The standard
determines that the cost of an item of property, plant and equipment includes its
purchase price (including import duties and non-refundable purchase taxes, after
deducting trade discounts and rebates), costs directly attributable to bringing the asset
to the location and condition necessary for it to be capable of operating in the manner
intended by management, as well as the initial estimate of the present value of the costs
of dismantling and removing the item and restoring the site on which it is located (if
the entity is obligated to do so). According to the standard, the cost of an item of
property, plant and equipment is the cash price equivalent at the recognition date.
Accordingly, if payment
is deferred beyond normal credit terms, the difference between the cash price equivalent
and the total payment is recognized as interest over the period of credit.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Subsequent
to the date of initial recognition, the standard allows for a choice between the cost
method and the revaluation method as an accounting policy, which must be applied to all
the items within a given class of property, plant and equipment. Under the cost method,
an item of property, plant and equipment shall be carried at its cost, less any
accumulated depreciation and any accumulated impairment losses. Under the revaluation
method, an item of property, plant and equipment whose fair value can be measured
reliably shall be carried at a revalued amount, being its fair value at the date of the
revaluation less any subsequent accumulated depreciation and subsequent accumulated
impairment losses.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | An
increase in the carrying amount of an item of property, plant and equipment, resulting
from a revaluation, is to be credited directly to equity under the heading of Revaluation
surplus. However, such increase shall be recognized in profit or loss to the extent
that it reverses a revaluation decrease of the same asset previously recognized in profit
or loss.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
the other hand, a decrease in the carrying amount of an item of property, plant and
equipment, resulting from a revaluation, is to be recognized in profit or loss. However,
the decrease shall be debited directly to equity under the heading of Revaluation
surplus, to the extent of any credit balance existing in the revaluation surplus in
respect of that asset.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard discusses the definition of a depreciable amount of an item of property, plant
and equipment, its residual value and the period and method of depreciation. The standard
stipulates that, for the purpose of depreciating property, plant and equipment, the
amount initially recognized in respect of an item of property, plant and equipment should
be allocated to its significant parts, and each such part should be depreciated
separately. Nevertheless, different parts of an item of property, plant and equipment,
with the same useful life and depreciation method, may be grouped for the purpose of
depreciation.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

19



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | According to the provisions of the standard, the residual value, the useful
life and the depreciation method of an asset should be reviewed at least at each fiscal
year-end; if there has been a change in the expected pattern of consumption of the future
economic benefits embodied in the asset, the depreciation method shall be changed to
reflect the changed pattern. Such a change shall be accounted for as a change in an
accounting estimate.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard is to be applied to financial statements for periods commencing on or after
January 1, 2007, by way of retrospective application, with two exceptions. First, for a
company that, upon the adoption of the standard, chooses the revaluation method as its
accounting policy, the difference between the revalued amount of the asset and its
carrying amount as of January 1, 2007 shall represent the revaluation surplus as of
the said date. Second, if the initial cost of the asset does not include any removal and
disposal costs, specific transitional provisions stipulated in the standard should be
applied.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is currently examining the effect of the application of the standard on the
financial statements.
| | -------------------------------------------------------------------------------------------------------------

| | Recently,
the IASB issued standard proposal No. 28  correction of transitional provisions
stipulated in standard No. 27 and adjusting them to the IFRS1.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) |  | Israeli
Accounting Standard No. 23  Accounting Treatment Applied to
Transactions between an Entity and its Controlling Shareholder.
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------

| | In
December 2006, the IASB issued Accounting Standard No. 23  Accounting
Treatment Applied to Transactions between an Entity and its Controlling Shareholder.

The
standard, which does not obligate entities that are not subject to the Securities Law,
1968, provides that assets and liabilities, in respect of which a transaction was carried
out between an entity and its controlling shareholder, shall be measured at the date of
transaction at their fair value, and the difference between fair value and the
consideration set in the transaction shall be carried to shareholders equity. Those
provisions replace the requirements of the Securities Regulations (Presentation of
Transactions between an Entity and its Controlling Shareholder in Financial Statements),
1996, whereunder, assets transferred as above would be measured at their carrying amount
in the transferors accounts, while the difference between this value and the
consideration set in those transactions is carried to shareholders equity.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the provisions of the standard, in case the difference between fair value and the
consideration arises from a benefit granted by the controlling shareholder to the entity
controlled thereby, the said difference shall be credited to capital surplus within the
entitys shareholders equity; while in case the said difference arises from a
benefit granted by the entity to its controlling shareholder, such difference shall be
carried to the entitys retained earnings.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, the difference between the fair value of the asset and its carrying amount in
the transferors accounts shall be recognized as a gain or loss in the transferors
accounts. Under the standard, differences as above, arising in the financial statements
of an entity as a result of a transaction with its controlling shareholder, and carried
to retained earnings or capital surplus, shall constitute, from the controlling
shareholders point of view , an owners withdrawal or an owners investment,
respectively, and shall be presented accordingly in the financial statements of the
controlling shareholder.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

20



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE
1  SIGNIFICANT ACCOUNTING POLICIES(continued):

| | The
standard includes specific provisions pertaining to assets transfers, assuming
liabilities, indemnification and waiver and the grant or receipt of loans. The standard
also sets a hierarchy for the measurement of fair value and includes disclosure
requirements as to the nature and scope of transactions between an entity and its
controlling shareholder, occurring during the reported period, as well as to the effect
of these transactions on the entitys income or loss for the reported period and its
financial position.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard shall apply to all transactions taking place between an entity and its
controlling shareholder, except for a business combination under common control, that
would be carried out subsequent to January 1, 2007. In addition, the standard would apply
to a loan granted to a controlling shareholder or received therefrom, prior to the
abovementioned effective date of the standard; the standard would apply to such a loan
commencing the standards effective date.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | At
this stage the Company is examining the possible effect of the standard on its financial
statements.
| | -------------------------------------------------------------------------------------------------------

| | 5) |  | Israel
Accounting Standard No. 16  Investment Property
| | -- |  | ---------------------------------------------------------

| | In
February 2007, the IASB issued Israel Accounting Standard No. 16 - Investment
Property, which is based on International Accounting Standard No. 40. This
standard prescribes the accounting treatment applicable to investment property. The
standard sets provisions for the recognition, measurement and disclosure required for
investment property in the financial statements.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the standard, investment property is property held to earn rentals or for capital
appreciation or both, rather than for: (a) use in the production or supply of goods or
services or for administrative purposes; or (b) sale in the ordinary course of business.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard stipulates that investment property, which qualifies as an asset, is to be
measured at cost upon its initial recognition. According to the standard, the cost of an
investment property comprises its purchase price and other directly attributable
expenditures (such as fees for legal services, transfer taxes and other transaction
costs).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Subsequent
to the date of initial recognition, the standard allows a choice between the cost model
and the fair value model as an accounting policy, which must be applied to all investment
property items of the entity. According to the standard, transition from one model to the
other is only allowed if such transition results in a more appropriate presentation in
the financial statements. The standard states that this is not highly likely to be the
case when transition is from the fair value model to the cost model.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the cost model, the entity shall account for investment property in accordance with the
cost model specified in Standard 27 - Property, Plant and Equipment,
pursuant to which the investment property is to be carried at depreciated cost (net of
accumulated impairment losses).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

21



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | According
to the fair value model, subsequent to initial recognition, the entity shall measure all
of its investment property at fair value as of the balance sheet date. Gains or losses
resulting from changes in fair value are carried to the statement of income (loss) in the
period in which they arise. In exceptional cases, when fair value cannot be reliably
determinable for certain investment property items, and the entity has elected the fair
value model as an accounting policy for its investment property, such specific items
shall be accounted for using the cost model, despite the application of the fair value
model to the other investment property items.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard includes extensive disclosure requirements, including, inter alia, disclosure as
to the fair value of the investment property, if the company has opted for the cost
model.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
standard shall be applicable to financial statements for periods commencing on January 1,
2007 or thereafter. Election of the fair value model would require the adjustment of the
opening balance of retained earnings for the period in which the standard is first
adopted.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | At
this stage, the Company is examining the effect of the application of the standard on the
financial statements.
| | ------------------------------------------------------------------------------------------------------------------

22



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

# NOTE 2  INVESTMENTS
IN ASSOCIATED COMPANIES:

| | a. |  | The
Company has a number of investments in associated companies, which are held
          either directly or through investee companies. The financial statements of
          significant associated companies (Mondy Business Paper Hadera Ltd.           formerly
Neusiedler Hadera Paper Ltd, NHP  and Hogla-Kimberly Ltd.) are           attached
to these financial statements.
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. |  | Composed
as follows:
| | -- |  | --------------------

|                                                               | December 31
|-------------------------------------------------------------- | -----------
|
|
|Shares:                                                        |            
|Cost                                                           |            
|Excess of cost of investment - net                             |            
|L e s s - accumulated amortization                             |            
|Gain on issuance of shares of an associated                    |            
|company to a third party                                       |            
|Differences from translation of foreign currency               |            
|financial statements                                           |            
|Share in profits (after deduction of losses) accumulated since |            
|acquisition                                                    |            
|                                                               |            
|                                                               |            
|Long-term loans and capital notes *                            |            
|                                                               |            
|                                                               |            
|                                                               |            

| | * |  | Classified
by linkage terms and rate of interest, the total amounts of the loans and capital notes
are as follows:
| | - |  | ------------------------------------------------------------------------------------------------------------------

|                                 | Weighted average
interest rate at
December 31, |      | December 31
|-------------------------------- | ---------------------------------------------- | ---- | -----------
|
|
|In dollars                       |                                                |      |            
|Unlinked loans and capital notes |                                                | 4.8% |            
|                                 |                                                |      |            
|                                 |                                                |      |            
|                                 |                                                |      |            

| | As
of December 31, 2006, the repayment dates of the balance of the loans and capital
notes have not yet been determined.
| | ------------------------------------------------------------------------------------------------------------------------

23



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 2  INVESTMENTS IN
ASSOCIATED COMPANIES (continued):

| | c. |  | The
changes in the investments during 2006 are as follows:
| | -- |  | ----------------------------------------------------------

|                                                               | NIS in thousands
|-------------------------------------------------------------- | ----------------
|Balance at the beginning of the year                           |                 
|                                                               |                 
|Changes during the year:                                       |                 
|Share in losses of associated companies - net                  |                 
|Dividend from associated companies                             |                 
|Adjustments resulting from translation of foreign currency     |                 
|financial statements                                           |                 
|Increase in balance of long-term loans and capital notes - net |                 
|                                                               |                 
|Balance at end of year                                         |                 
|                                                               |                 

| | * |  | In
the first quarter of the year, the balance of negative goodwill as of January 1, 2006
amounted NIS 1,062 thousands, was written off against retained earnings. In these
financial statements this reporting entry was cancelled since the amount represented a
negative excess of cost of investment.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. |  | Mondy
Business Paper Hadera Ltd.(hereafter - Mondy Hadera; formerly            Neusiedler
Hadera Paper Ltd.  NHP):
| | -- |  | --------------------------------------------------------------------------------------------------------------------

| | Mondy
Hadera is held to the extent of 49.9% by the Company and also by Mondi Business Paper LTD
(hereafter  MBP), under an agreement dated November 21, 1999. According to
said agreement, Mondy Hadera purchased the Groups activities in the field of
printing and writing paper, and issued to MBP 50.1% of its shares. As part of the said
agreement, Neusiedler was granted an option to sell to the Company its holdings in Mondy
Hadera, at a price that is 20% lower than the value (as defined in the agreement). The
understanding between the parties is that the option would only be exercised under
prolonged, extraordinary circumstances that preclude the operation of Mondy Hadera in
Israel. The Company believes that the likelihood of such circumstances is very remote.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. |  | Hogla-Kimberly
Ltd. (hereafter  Hogla-Kimberly)
| | -- |  | ------------------------------------------------

| | Hogla-Kimberly
is held to the extent of 49.9% by the Company and to the extent of 50.1% by Kimberly
Clark Corporation (hereafter- KC).
| | --------------------------------------------------------------------------------------------------------------------------------------

| | f. |  | Investment
in Carmel Container Systems Limited(hereafter  Carmel)
| | -- |  | ------------------------------------------------------------------

| | Carmel
Container Systems is held to the extent of 26.25% by the Company.
| | ------------------------------------------------------------------------

| | In
November 2004, Carmels board of directors decided to take measures to withdraw
Carmels shares from trade on the AMEX Stock Exchange in the United
States and also to deregister with the SEC. Accordingly, trade in Carmels shares on
the AMEX was suspended from November 30, 2004 and in July 2005 the process of
deregistering the shares from being traded and with the SEC was finalized.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

24



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 2  INVESTMENTS IN
ASSOCIATED COMPANIES (continued):

| | g. |  | Investment
in T.M.M Integrated Recycling Industries Ltd.(hereafter  T.M.M.)
| | -- |  | ----------------------------------------------------------------------------

| | As
of December 31, 2006, the Companys share in T.M.M. (directly and through
another associated company) is 43.08%
| | ------------------------------------------------------------------------------------------------------------------

| | T.M.M.
announced in March 2006 that the Securities Authority was conducting an unspecified
investigation in its matter.  T.M.M. possesses no information regarding the
investigation.  To date, the Companys management cannot estimate the impact of
the above matter, if any, on the Company and on its financial statements.  As a result of
the implementation of Accounting Standard No. 15, T.M.M. recorded a loss of NIS 12.5 million
from the impairment of fixed assets in the third quarter of 2006, based on the estimate
of an external assessor. The Companys share in this loss (43.08%) amounts to NIS
5.4 million.  This sum appears as part of the Companys share in the earnings
(losses) of associated companies this year.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
January 4, 2007, the Company entered into an agreement with Veolia Israel CGEA Ltd.
(hereinafter: CGEA), whereby it will sell to CGEA its holdings in Barthelemi,
along with its remaining holdings in T.M.M.  Pursuant to the agreement, CGEA has
acquired all of the Companys holdings in Barthelemi.  CGEA also acquired all
of the Companys holdings in T.M.M., as part of a complete tender offer and starting
February 2007, the Company is no longer a shareholder in T.M.M.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
sale of the holdings in T.M.M. was made in consideration of a sum approximately similar to the book value,
after taking into account, the impairment as mention above.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

25



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

# NOTE 3  FIXED
ASSETS:

| | a. |  | Composition
of assets and the accumulated depreciation thereon, grouped by           major
classifications, and changes  therein during 2006, are as follows:
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|                               |  | Cost |  | Accumulated depreciation |  |  | Depreciated balance
December 31 |  
|------------------------------ |  | ---- |  | ------------------------ |  |  | ------------------------------- | -
|
|
|Land and buildings thereon     |  |      |  | 228,822                  |  |  | 414                             |  
|                               |  |     
|Machinery and equipment        |  |      |  | 689,398                  |  |  | 12,838                          |  
|                               |  |     
|Vehicles                       |  |      |  | 31,096                   |  |  | 5,205                           |  
|                               |  |     
|Office furniture and equipment |  |     
|(including computers)          |  |      |  | 70,166                   |  |  | 1,045                           |  
|                               |  |     
|Payments on account of         |  |     
|machinery and equipment, net   |  |      |  | 15,167                   |  |  | 34,162                          |  
|                               |  |     
|Spare parts - not current, net |  |      |  | 23,262                   |  |  | (557                            | )
|                               |  |      |  |                          |  |  |                                 |  
|                               |  |      |  | 1,057,911                |  |  | 53,107                          |  
|                               |  |      |  |                          |  |  |                                 |  

26



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

# NOTE 3  FIXED
ASSETS(continued):

| | b. |  | The
item is net of investment grants in respect of investments in approved
          enterprises (see notes 7a and 9a).
| | -- |  | -------------------------------------------------------------------------------------------------------------------------

| | c. |  | The
Companys real estate is partly owned and partly leased  to the
extent of NIS 43.8 million, in respect of which lease fees of
approximately NIS 25.8 million have been capitalized. The leasehold rights are
for 49 year periods ending in the years 2008 to 2059, with options to extend
for an additional 49 years.
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. |  | As
of December 31, 2006 and 2005, the cost of fixed assets includes borrowing
          costs of NIS 1,007,000 capitalized to the cost of machinery and equipment.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. |  | Depreciation
expenses amounted to NIS 31,957,000 NIS 31,444,000 and           NIS 28,472,000,
for the years ended December 31, 2006, 2005 and 2004,           respectively.
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | f. |  | As
to pledges on assets  see note 9a.
| | -- |  | --------------------------------------

| | g. |  | As
to the change in accounting treatment of property, plant and equipment, which
          will take effect commencing January 1, 2007, as a result of applying Accounting
          Standard No. 27, Property, Plant and Equipment of the IASB  see
note 1s (3).
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | h. |  | As
to the change in accounting treatment of investment property, commencing           January 1,
2007, as a result of applying Accounting Standard No. 16           Investment
Property of the IASB  see note 1s (5).
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 4  NOTES AND
OTHER LONG-TERM LIABILITIES:

| | a. |  | Notes
| | -- |  | -----

| | The
item represents two series of notes issued to institutional investors as follows:
| | -------------------------------------------------------------------------------------

|                          | December 31 | 
|------------------------- | ----------- | 
|
|
|
|Balance                   |             | 
|Less - current maturities |             | 
|                          |             | 
|                          |             | 
|                          |             | 

| | 1) |  | Series
I  May 1992
| | -- |  | -------------------

| | The
balance of the notes as of December 31, 2005 is redeemable in four installments, due
in June of each of the years 2006-2009, each installment amounting to 6.66% of the
original par value of the notes, which is NIS 102,202,000, in December 2006 terms;
the unpaid balance of the notes bears annual interest of 3.8%, payable annually each
June. The notes  principal and interest  are linked to the Israeli CPI of
February 1992.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

27



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

# NOTE 4  NOTES AND
OTHER LONG-TERM LIABILITIES:

| | 2) |  | Series
II  December 2003
| | -- |  | -------------------------

| | The
balance of the notes as of December 31, 2005 is redeemable in 7 equal, annual
installments due in December of each of the years 2007-2013; the unpaid balance of the
notes bears annual interest of 5.65%, payable annually each December. The notes principal
and interest  are linked to the Israeli CPI of November 2003.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) |  | As
to the change from January 2006 in the presentation of deferred issuance           costs
 see note 1i above.
| | -- |  | ----------------------------------------------------------------------------------------------------------------

| | b. |  | Long-Term
Loans
| | -- |  | ---------------

| | The
section refers to two long-term loans that were received from banks, as detailed below:
| | -------------------------------------------------------------------------------------------

|                          | December 31, 2006
NIS Thousands | 
|------------------------- | ------------------------------- | 
|Loan 1                    |                                 | 
|Loan 2                    |                                 | 
|Less - current maturities |                                 | 
|                          |                                 | 
|                          |                                 | 
|                          |                                 | 

| | 1) |  | Loan
1
| | -- |  | ------

| | In
July 2006, the Company assumed a loan of NIS 15 million.The outstanding balance as
at December 31, 2006, is scheduled for repayment in 21 quarterly installments through to
January 2012, each in the sum of NIS 0.7 million.The outstanding balance of the
loan carries a variable rate of interest, linked to the Prime lending rate.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) |  | Loan
2
| | -- |  | ------

| | In
July 2006, the Company assumed a loan of NIS 25 million.  The outstanding balance as
at December 31, 2006, is scheduled for repayment in 31 quarterly installments
through to July 2014, each in the sum of NIS 1.0 million including principal and interest component on the outstanding balance of principal.  The outstanding balance
of the loan carries a variable rate of interest, linked to the Prime lending rate.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. |  | Other
liability:
| | -- |  | ----------------

| | The
capital note from an associated company is unlinked and interest free. No repayment date
has been fixed, but the associated company does not intend to demand the repayment of the
capital note before January 1, 2008.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

28



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

# NOTE 5  EMPLOYEE
RIGHTS UPON RETIREMENT:

| | a. |  | Israeli
labor laws and agreements require the Company and its subsidiaries to           pay
severance pay to employees dismissed or leaving their employ under certain
          circumstances, computed on the basis of the number of years of service, or a
          pension upon retirement.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | To
cover the liability for employee rights upon retirement, pursuant to labor agreements in
force and based on salary components that, in managements opinion, create
entitlement to severance pay, deposits are made by the Company and its subsidiaries with
various provident funds (including pension funds) or insurance policies for the benefit
of the employees.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
severance pay and pension liability and the amounts funded as above are not reflected in
the financial statements, as the pension and severance pay risks have been irrevocably
transferred to the pension funds and the insurance companies, as allowed by the Severance
Pay Law.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. |  | The
expenses relating to employee rights upon retirement, which reflect the           amounts
that were deposited during the reported years with provident funds,           pension
funds and various insurance policies, are NIS 8,849,000           NIS 8,710,000,and
NIS 8,368,000 in 2006, 2005, and 2004, respectively.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 6  SHAREHOLDERS EQUITY:

| | a. |  | Share
capital
| | -- |  | -------------

| | Composed
of ordinary registered shares of NIS 0.01 par value, as follows:
| | -------------------------------------------------------------------------

|                 | December 31 | 
|---------------- | ----------- | 
|
|
|Number of shares |             | 
|                 |             | 
|Amount in NIS    |             | 
|                 |             | 

| | The
shares are traded on stock exchanges in Tel-Aviv and in the U.S. (AMEX).  The
quoted prices per share, as of December 31, 2006 are NIS 182.9and $ 45.70 (NIS 193.08),
respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

29



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

# NOTE 6  SHAREHOLDERSEQUITY(continued):

| | b. |  | Employee
stock option plans:
| | -- |  | ----------------------------

| | 1) |  | The
2001 plan for senior officers in the Group
| | -- |  | ----------------------------------------------

| | On
April 2, 2001, the Companys board of directors approved a stock option plan
for senior officers in the Group (hereafter  the 2001 plan for senior officers).
Under this plan, 194,300 options were allotted on July 5, 2001 without consideration.
Each option can be exercised to purchase one ordinary share of NIS 0.01 par value of the
Company. The options are exercisable in four equal annual batches. The blocking period of
the first batch is two years, commencing on the date of grant; the blocking period of the
second batch is three years from the date of grant, and so forth. Each batch is
exercisable within two years from the end of the blocking period.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
exercise price of the options granted as above was set at NIS 217.00, linked to the
CPI, on the basis of the known CPI on April 2, 2001. The exercise price for each
batch is determined as the lesser of the aforementioned exercise price or the average
price of the Companys shares as quoted on the Tel-Aviv Stock Exchange (hereafter -
the Stock Exchange) during the thirty trading days preceding to the effective date of
each batch, less 10%. As stipulated by the 2001 plan for senior officers, the exercise
price of unexercised options is to be adjusted, in the event of cash dividend
distributions. Accordingly, the exercise price as of December 31, 2006 is batch, NIS 78.66
for the third batch and NIS 132.09 for the fourth batch. In July2005, the remaining
options from the first batch expired and in July 2006, the remaining options from the
second batch expired.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
quoted price of the Companys shares on the Tel Aviv Stock Exchange,
immediately prior to the date of the board of directors resolution to grant the
options, was NIS 204.00. Immediately prior to the granting of the options, the price
was NIS 185.8.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of each option  computed on the basis of the Black-Scholes
option-pricing model  as prescribed by the regulations of the Tel-Aviv Stock
Exchange  was approximately NIS 56.69 on the date of grant.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Notwithstanding
the above, the number of shares resulting from the exercise of the options and the actual
exercise price will be determined as follows: Upon receipt of an exercise request from an
option holder, a computation will be made of the difference between the quoted price of
the Companys shares at the beginning of that trading day and the exercise price;
that difference is to be multiplied by the number of exercisable options (hereafter -
the benefit). The number of shares that the Company will actually issue to the option
holder will be the number of shares the market value of which is equal to the amount of
the benefit computed as above. In consideration for the shares, the option holder will
pay their par value only.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Immediately
upon issuance, the ordinary shares issued upon exercise of the options will have all the
same rights as other ordinary shares of the Company.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

30



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

# NOTE 6  SHAREHOLDERSEQUITY
(continued):

| | In
2006, 2005 and 2004, 44,998, 13,877 and 55,525options, respectively, were exercised
under the 2001 plan for senior officers, and 24,303 4,307 and 24,295 shares of NIS 0.01,
respectively, were issued following the exercise of the options, as above. 8,250 options
expired in 2005 (from the first batch) and 10,225 options expired in 2006 (from the
second batch). In 2006 12,225 option were cancelled from the third batch and 12,225 were cancelled
from the forth batch. As of December 31, 2006, the unexercised balance of the options
granted is 35,425. During 2007, after the balance sheet date, 10,321 options were
exercised under the 2001 plan for senior officers, and 3,696 shares were issued.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
plan is designed to be governed by the terms stipulated by Section 102 of the Israeli
Income Tax Ordinance. Inter alia, these terms provide that the Company is allowed
to claim, as an expense for tax purposes, the amounts credited to the employees as a benefit
in respect of shares or options granted under the plan.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
amount allowed as an expense for tax purposes, at the time the employee utilizes such
benefit, is limited to the amount of the benefit that is liable to tax as labor income,
in the hands of the employee; all being subject to the restrictions specified in Section
102 of the Income Tax Ordinance.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Since,
in accordance with Israeli accounting principles, the Company does not recognize the
expense in its accounts (with respect to the salary benefit embodied in these grants),
then under Clarification No. 7 of the IASB (See note 1j(7)), the Company credited the tax
saving derived from the exercise of benefits by employees in the years 2005-2006 to
capital surplus.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) |  | The
2001 employee plan
| | -- |  | ----------------------

| | On
August 29, 2001, the Companys board of directors approved a stock option plan
for employees in the Group, according to a specification (hereafter  the 2001
employee plan). Under this plan, up to 125,000 options will be allotted without
consideration. Each option can be exercised to purchase one ordinary share of NIS 0.01
par value of the Company. The blocking period of the options is two years from the date
of grant. Each option is exercisable within three years from the end of the blocking
period.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
November 4, 2001, 81,455 options were granted under the 2001 employee plan.
| | ------------------------------------------------------------------------------

| | The
exercise price of all the options granted as above was set at NIS 160.99, linked to
the CPI, on the basis of the known CPI on August 29, 2001. This price represents the
average price of the Companys shares as quoted on the Tel-Aviv Stock Exchange
during the thirty trading days prior to the date of the board of directors approval,
less 10%. The 2001 employee Plan was expired during November 2006.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
2006, 2005 and 2004, 10,091, 2,405 and 8,615 options, respectively, were exercised under
the 2001 employee plan, and 6,215, 1,224 and 4,084 shares of NIS 0.01, respectively,
were issued following the exercise of options, as above. The last of the options that
were granted and were not exercised, expired during 2006.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

31



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 6  SHAREHOLDERS
EQUITY(continued):

| | This
plan is designed to be governed by the terms stipulated by Section 102 of the Israeli
Income Tax Ordinance. Inter alia, these terms provide that the Company is allowed
to claim, as an expense for tax purposes, the amounts credited to the employees as a benefit
in respect of shares or options granted under the plan.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
amount allowed as an expense for tax purposes, at the time the employee utilizes such
benefit, is limited to the amount of the benefit that is liable to tax as labor income,
in the hands of the employee; all being subject to the restrictions specified in Section 102
of the Income Tax Ordinance.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Since,
in accordance with Israeli accounting principles, the Company does not recognize the
expense in its accounts (with respect to the salary benefit embodied in these grants),
then under Clarification No. 7 of the IASB (See note 1j(7)), the Company credited the tax
saving derived from the exercise of benefits by employees in 2005 to capital surplus.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 7  TAXES ON
INCOME:

| | a. |  | Tax
benefits under the Law for the Encouragement of Capital Investments,           1959 (hereafter
 the law)
| | -- |  | -------------------------------------------------------------------------------------------------------------

| | Under
the law, by virtue of the approved enterprise status granted to certain of
their production facilities, certain subsidiaries were entitled to various tax benefits
(mainly reduced tax rates) until 2003.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the period of benefits  mainly 7 years commencing in the first year in which the
companies earn taxable income from the approved enterprises, provided the maximum period
to which it is restricted by law has not elapsed  reduced tax rates or exemption
from tax apply, as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1) |  | Corporate
tax rate of 25%, instead of the regular tax rate (see d. below).
| | -- |  | --------------------------------------------------------------------------

| | 2) |  | Tax
exemption on income from certain approved enterprises in respect of which
               the companies have elected the alternative benefits (involving
               waiver of government guaranteed loans instead of the tax exemption); the
length                of the exemption period is 4 years, after which the income
from these                enterprises is taxable at the rate of 25% for 3 years.
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
part of the taxable income, which is entitled to the tax benefits, is determined on the
basis of the ratio of the turnover attributed to the approved enterprise to
the total turnover of these companies, taking into account the ratio of the approved
enterprise assets to total assets of these companies. The turnover that is
attributed to the approved enterprise is generally computed on the basis of
the ratio of the increase in turnover to the basic turnover stipulated in the
instrument of approval.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
period of benefits in respect of the approved enterprises of these companies
expired at the end of 2003.
| | --------------------------------------------------------------------------------------------------------------

| | The
entitlement to the above benefits is conditional upon the companies fulfilling the
conditions stipulated by the law, regulations published thereunder and the
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

32



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 7  TAXES ON INCOME(continued):

| | instruments
of approval for the specific investments in approved enterprises. In the event
of failure to comply with these conditions, the benefits may be cancelled and the
companies may be required to refund the amount of the benefits, in whole or in part, with
the addition of CPI linkage differences and interest.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | c. |  | The
Law for the Encouragement of Industry (Taxation), 1969
| | -- |  | ----------------------------------------------------------

| | The
Company and certain consolidated subsidiaries are industrial companies as
defined by this law. These companies claimed depreciation at accelerated rates on
equipment used in industrial activity as stipulated by regulations published under the
inflationary adjustments law.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company also files consolidated tax returns with certain consolidated subsidiaries as
permitted under this law.
| | -------------------------------------------------------------------------------------------------------------------

| | d. |  | Tax
rates applicable to income not derived from approved           enterprises
| | -- |  | --------------------------------------------------------------------------------

| | The
income of the Company and its Israeli subsidiaries (other than income fromapproved
enterprises, see a. above) is taxed at the regular rate. Through to December 31,
2003, the corporate tax was 36%. In July 2004, an amendment No. 140, to the Income Tax
Ordinance was published fixing, among others that corporate tax rate is gradually reduced
from 36% to 30%. In August 2005, an additional amendment (No. 147) to the Income Tax
Ordinance was published which makes a further revision to the corporate tax rates
prescribed by Amendment No. 140. As a result of the aforementioned amendments, the tax
rates for 2004 and thereafter are as follows: 2004  35%, 2005  34%, 2006
 31%, 2007  29%, 2008  27%, 2009  26% and 2010 and thereafter
 25%.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
a result of the said changes in the tax rates, the Company adjusted  in each of the
years 2004 and 2005  at the time the aforementioned amendments were made, its
deferred tax balances, in accordance with the tax rates expected to be in effect in the
coming years; the effect of the change has been carried to income in these years.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Capital
gains (except for the real capital gain from the sale of marketable securities  to
which the regular tax rates will apply) are taxed at a reduced tax rate of 25% on capital
gains that arose after January 1, 2003, and at the regular corporate tax rate on income
that arose until that date.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. |  | Carryforward
tax losses
| | -- |  | -----------------------

| | Carryforward
tax losses in subsidiary companies are NIS 24,036,000 and NIS 22,470,000 as of
December 31, 2006 and 2005, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------

| | The
Company examines on each balance sheet date the possibility of recording deferred taxes
in respect of carryforward tax losses based on an assessment of all evidence, both
positive and negative, regarding the likelihood of their being taxable income in the
foreseeable future.  Under
the inflationary adjustments law, carryforward losses are linked to the Israeli CPI, and
may be utilized indefinitely.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

33



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 7  TAXES ON INCOME
(continued):

| | f. |  | Deferred
income taxes
| | -- |  | ---------------------

| | The
composition of the deferred taxes at balance sheet dates, and the changes therein during
the years 2006 and 2005, are as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------

|                             | In respect of balance sheet items | 
|---------------------------- | --------------------------------- | 
|
|
|
|Balance at January 1, 2005   |                                   | 
|Changes in 2005 -            |                                   | 
|amounts carried to income    |                                   | 
|                             |                                   | 
|Balance at December 31, 2005 |                                   | 
|Changes in 2006 -            |                                   | 
|amounts carried to income    |                                   | 
|                             |                                   | 
|Balance at December 31, 2006 |                                   | 
|                             |                                   | 

| | The
deferred taxes are computed at the rate of 25%-29%.
| | -------------------------------------------------------

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

|                                 | December 31
|-------------------------------- | -----------
|
|
|Among current assets             |            
|Among long-term asset balances   |            
|Among long-term liabilities      |            
|                                 |            
|B a l a n c e - liability  - net |            
|                                 |            

34



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 7  TAXES ON INCOME
(continued):

| | g. |  | Taxes
on income included in the income statements:
| | -- |  | --------------------------------------------------

| | 1) |  | As
follows:
| | -- |  | -----------

|                                    | 2006 |  | 2005 |        | 2004 | 
|----------------------------------- | ---- |  | ---- | ------ | ---- | 
|
|For the reported year:              |      |  |      |        |      | 
|Current                             |      |  |      | 22,457 |      | 
|Deferred, see f. above:             |      | 
|In respect of changes to tax rates, |      | 
|see d. above                        |      |  |      |        |      | 
|In respect of the reporting period  |      |  |      | (5,755 | )    | 
|                                    |      |  |      |        |      | 
|                                    |      |  |      | 16,702 |      | 
|                                    |      |  |      |        |      | 

| | Current
taxes in 2006 were computed at an average tax rate of 31%, 2005 - 34%      and 2004- 35%,
see (2)                        below.
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | 2) |  | Following
is a reconciliation of the theoretical tax expense,                assuming
all income is taxed at the regular rate applicable to companies in                Israel,
as stated in d. above, and the actual tax expense:
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                               | 2006 |  | 2005 |       | 2004 | 
|---------------------------------------------- | ---- |  | ---- | ----- | ---- | 
|
|Income before taxes on income, as reported     |      |  |      |       |      | 
|in the statements of income                    |      |  |      | 100.0 |      | 
|                                               |      |  |      |       |      | 
|Theoretical tax on the above amount            |      |  |      | 31.0  |      | 
|                                               |      | 
|Decrease in taxes resulting from computation   |      | 
|of deferred taxes at a rate which is           |      | 
|different from the theoretical rate            |      |  |      | (2.1  | )    | 
|Decrease in taxes resulting from adjustment to |      | 
|deferred tax balances due to changes           |      | 
|in tax rates, see d. above                     |      |  |      |       |      | 
|Tax deduction in respect of options            |      | 
|exercised by employees according to            |      | 
|Section 102 of the Israeli Income              |      | 
|Tax Ordinance (2006 and 2005 - see note 1j(7)) |      |  |      |       |      | 
|Other - net                                    |      |  |      | 0.6   |      | 
|                                               |      |  |      |       |      | 
|Taxes on income for the reported year          |      |  |      | 29.5  |      | 
|                                               |      |  |      |       |      | 

| | h. |  | Tax
assessments
| | -- |  | ---------------

| | The
Company and most of its subsidiaries have received final tax assessments through the year
ended December 31, 2000.
| | ----------------------------------------------------------------------------------------------------------------------

| | At
the end of 2006 assessments discussions for the years
2002- 2004 for the Company and most of its subsidiaries have begun with the tax authority.  It is the managements opinion, at
this stage based, on the course of the discussion, which were held so far, it does not seem that the
assessments will have material effect on the financial reports.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

35



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

# NOTE 8  LINKAGE
TERMS OF MONETARY BALANCES:

| | a. |  | As
follows:
| | -- |  | -----------

|                                                      | December 31, 2006 |  | December 31, 2005 |       
|----------------------------------------------------- | ----------------- |  | ----------------- | ------
|
|
|Assets:                                               |                   |  |                   |       
|Current assets:                                       |                   |  |                   | 8,573 
|Cash and cash equivalents                             |                   |  |                   |       
|Marketable securities                                 |                   |  |                   |       
|Receivables                                           |                   |  |                   | 59,849
|Investments in associated companies - long-term       |                   | 
|loans and capital notes                               |                   |  |                   | 6,337 
|                                                      |                   |  |                   |       
|                                                      |                   |  |                   | 74,759
|                                                      |                   |  |                   |       
|                                                      |                   | 
|Liabilities:                                          |                   | 
|Current liabilities:                                  |                   | 
|Short-term credit from banks                          |                   |  |                   |       
|Accounts payables and accruals                        |                   |  |                   | 8,422 
|Long-term liabilities (including current maturities): |                   | 
|Long -term loans                                      |                   |  |                   |       
|Notes                                                 |                   |  |                   |       
|Other liability                                       |                   |  |                   |       
|                                                      |                   |  |                   |       
|                                                      |                   |  |                   | 8,422 
|                                                      |                   |  |                   |       

| | As
to exposures relating to fluctuations in foreign currency exchange rates and the use of
derivatives for hedging purposes  see note 12a.
| | -------------------------------------------------------------------------------------------------------------------------------------------

36



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 8  LINKAGE TERMS OF
MONETARY BALANCES (continued):

| | b. |  | Data
regarding the exchange rate and the Israeli CPI:
| | -- |  | -----------------------------------------------------

|                    | Exchange rate of
one dollar |       | CPI*
|------------------- | --------------------------- | ----- | ----
|
|At end of year:     |                             |       |     
|2006                |                             | 4.225 |     
|2005                |                             | 4.603 |     
|2004                |                             | 4.308 |     
|                    |                             |       |     
|Change in the year: |                             |       |     
|2006                |                             | (8.2) |     
|2005                |                             | 6.8   |     
|2004                |                             | (1.6) |     

| |  |  | * |  | Based
on the index for the month ending on each balance sheet date, on the basis of 1993 average = 100.
| |  |  | - |  | -------------------------------------------------------------------------------------------------------

# NOTE 9 
COMMITMENTS, CONTINGENT LIABILITIES AND LIABILITIES SECURED BY PLEDGES:

| | a. |  | In
respect of investment grants
| | -- |  | -------------------------------

| | Under
the Law for the Encouragement of Capital Investments, 1959, certain subsidiaries and an
associated company have received investment grants from the State of Israel. In the event
of failure to comply with the terms attached to the receipt of the grants, the companies
may be required to refund the amount of the grants, in whole or in part, with linkage
differences and interest from the date of receipt thereof.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
abovementioned subsidiaries have registered floating charges on all their assets in favor
of the State of Israel in order to secure compliance with the terms of the investment
grants received. In respect of the grant received by the associated company, the Company
has provided a guarantee, with another associated company, for the repayment of the
grant. As of December 31, 2005, the grant was repaid in full, as agreed with
the Investment Center.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. |  | The
Company has provided guarantees of NIS 2,113,000 in favor of an           associated
company, in connection with the latters participation in a           tender. If the
associated company does not win the tender, the guarantee will           become null and
void.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. |  | Subsidiaries
provided guarantees to various entities, in connection with           tenders, in the
aggregate amount of approximately NIS 1,917,000.
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

37



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE  9  COMMITMENTS,
CONTINGENT LIABILITIES AND LIABILITIES SECURED BY   PLEDGES(continued):

| | d. |  | On
May 7, 2001, the Companys board of directors resolved to carry out           a
plan, which was approved by the shareholders meeting, to remunerate the
          Companys former chairman of the board of directors. According to the
plan,           remuneration will be granted, equal to the increase in the value of
50,000           shares of the Company in the period from May 7, 2001 (share price
          NIS 194.37, linked to the terms of the plan) to May 7, 2008.
The           remuneration will be spread over the period commencing two years from the
          resolution of the board of directors, until the end of seven years from said
          resolution  or until the time of termination of duty in certain conditions, the earlier.
Up to December 31 2006, all of the remuneration was exercised.
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. |  | In
accordance with the Companies Law, 1999, the Company issued new letters of
          indemnity to its officers in 2004, pursuant to which the Company undertakes to
          indemnify the officers for any liability or expense, for which indemnification
          may be paid under the law, that may be incurred by the officers in connection
          with actions performed by them as part of their duties as officers in the
          Company, which are directly or indirectly related to the events specified in
the           addendum to the letters of indemnity, provided that the total amount of
          indemnification payable to the officers, shall not exceed 25% of the
          Companys shareholders equity as per its latest financial statements
          published prior to the actual indemnification. The liability of officers in
          connection with the performance of their duties, as above, is partly covered by
          an insurance policy.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | f. |  | The
Company is preparing for the conversion of its energy-generation plant to           using
natural gas, instead of fuel oil. The transition is planned for the second           half
of 2007, subject to the arrival of the gas in Hadera.
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
this capacity, the Company signed an agreement in London on July 29, 2005, with the
Thetis Sea Group, for the purchase of natural gas. The gas that will be purchased is
intended to fulfill the Companys requirements in the coming years, for the
operation of the existing energy generation plants using cogeneration at the Hadera
plant, when it will be converted for the use of natural gas, instead of the current use
of fuel oil. The overall financial scope of the transaction totals $ 40 million over
the term of the agreement (5 years from the initial supply of gas, but no later than July
1, 2011).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
this capacity the Company also contracted with Alstom Power Boiler Service gmbh, a
manufacturer of equipment in the energy industry, in an agreement worth approximately
 1.74 million, for the purchase of the systems needed for the conversion and
assistance with their installation at the plant in Hadera. Up to December 31, the
remainder of the agreement was worth approximately  0.6 million.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | g. |  | In
November 2006, the Environmental Protection Ministry announced that, even
          though the company plant at Hadera has made considerable investments in sewage
          treatment and environmental protection issues, an investigation may be launched
          against it to review deviations from certain emission standards into the air.
          Based on the opinion of its legal advisors, the Company anticipates that the
          investigation will not materially impact its results of operations.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | h. |  | In
November 2003 an associated company Hogla Kimberly received a claim and a
          petition for the approval of a class action against the Company. According to
          the petition the Company has reduced the number of units of diapers in a
package           of its Huggies Freedom brand .The plaintiffs estimate the
scope of           the class action to be NIS 18 million.  A court hearing took place in this petition,
but a decision was not given.
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

38



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 9  COMMITMENTS,
CONTINGENT LIABILITIES AND LIABILITIES SECURED BY PLEDGES(continued):

| | In
August, 2006 a request for a class action claim was filed against an associated company
Hogla-Kimberly Ltd. in the amount of NIS 47 million for reducing the number of diapers in
the Titulim Premium brand Packages.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
December, 2006 a request for a class action claim was filed against an associated company
Hogla-Kimberly Ltd in the amount of NIS 43 million for reducing the quantity of papers in
the toilet paper Kleeneks premium Packages.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
January, 2007 a request for a class action claim was filed against the Company in the
amount of NIS 28 million for reducing the number of Wet Wipes in the  Titulim
premium wet wipes Packages.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
regards to the class action claims mentioned above, based on the associated companys
legal counsels opinion, at this stage, the company is unable to estimate the result
of these class action claims but, Hogla-Kimberly has good defense prospects and therefore
Hogla Kimberly did not include in its financial statements any provisions for these claims.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

39



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

# NOTE 10 
SUPPLEMENTARY FINANCIAL STATEMENT INFORMATION:

| | Balance
sheets:
| | ---------------

|   |  | Weighted average
interest rate |                                                             | December 31 | 
|-- |  | ------------------------------ | ----------------------------------------------------------- | ----------- | 
|
|
|a. |  |                                | Receivables:                                                |             | 
|   |  |                                | 1) Trade:                                                   |             | 
|   |  |                                | Open accounts                                               |             | 
|   |  |                                | Checks collectible                                          |             | 
|   |  |                                |                                                             |             | 
|   |  |                                |                                                             |             | 
|   |  |                                |                                                             |             | 
|   |  |                                | The item is:                                                |             | 
|   |  |                                | Net of allowance for doubtful                               |             | 
|   |  |                                |                                                             |             | 
|   |  |                                | Includes associated companies                               |             | 
|   |  |                                |                                                             |             | 
|   |  |                                | 2) Other:                                                   |             | 
|   |  |                                | Employees and employee institutions                         |             | 
|   |  |                                | Associated companies - current debt                         |             | 
|   |  |                                | Prepaid expenses                                            |             | 
|   |  |                                | Advances to suppliers                                       |             | 
|   |  |                                | Deferred income taxes, see note 7f                          |             | 
|   |  |                                | Proceeds from sale of land in (see note 10i)                |             | 
|   |  |                                | Sundry                                                      |             | 
|   |  |                                |                                                             |             | 
|   |  |                                |                                                             |             | 
|   |  |                                |                                                             |             | 
|b. |  |                                | Inventories:                                                |             | 
|   |  |                               
|   |  |                                | For industrial activities:                                  |             | 
|   |  |                                | Finished goods                                              |             | 
|   |  |                                | Raw materials and supplies                                  |             | 
|   |  |                                |                                                             |             | 
|   |  |                                |                                                             |             | 
|   |  |                                | For commercial activities - purchased products              |             | 
|   |  |                                |                                                             |             | 
|   |  |                                |                                                             |             | 
|   |  |                                | Maintenance and spare parts *                               |             | 
|   |  |                                |                                                             |             | 
|   |  |                                |                                                             |             | 
|   |  |                                |                                                             |             | 
|   |  |                               
|   |  |                                | *Including inventories for the use of associated companies. |             | 
|c. |  |                                | Credit from banks:                                          |             | 
|   |  |                               
|   |  |                                | Unlinked                                                    |             | 
|   |  |                                |                                                             |            

40



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 10  SUPPLEMENTARY
FINANCIAL STATEMENT INFORMATION(continued):

| | d. |  | Accounts
payable and accruals  other:
| | -- |  | --------------------------------------

|   | December 31 | 
|-- | ----------- | 
|
|
|1) |             | 
|   |             | 
|   |             | 
|   |             | 
|   |             | 
|   |             | 
|   |             | 
|2) |             | 
|   |             | 
|   |             | 
|   |             | 
|   |             | 
|   |             | 
|   |             | 
|   |             | 
|   |             | 
|   |             | 
|   |             | 

| | Statements
of income:
| | ---------------------

|   | 2006 |  | 2005                                        |  | 2004 | 
|-- | ---- |  | ------------------------------------------- |  | ---- | 
|
|e. |      |  | Sales- net (1):                             |  |      | 
|   |      | 
|   |      |  | Industrial operations (2)                   |  |      | 
|   |      |  | Commercial operations                       |  |      | 
|   |      |  |                                             |  |      | 
|   |      |  |                                             |  |      | 
|   |      |  |                                             |  |      | 
|   |      |  | (1) Including sales to associated companies |  |      | 
|   |      |  |                                             |  |      | 
|   |      |  | (2) Including sales to export               |  |      | 
|   |      |  |                                             |  |      | 

|   |  |  |                                               | 
|-- |  |  | --------------------------------------------- | 
|f. |  |  | Cost of sales:                                | 
|   |  |  | Industrial operations:                        | 
|   |  |  | Materials consumed                            | 
|   |  |  | Payroll and related expenses                  | 
|   |  |  | Depreciation                                  | 
|   |  |  | Other manufacturing costs                     | 
|   |  |  | Decrease (increase) in inventory of           | 
|   |  |  | finished goods                                | 
|   |  |  |                                               | 
|   |  |  |                                               | 
|   |  |  | Commercial operations - cost of products sold | 
|   |  |  |                                               | 
|   |  |  |                                               | 
|   |  |  |                                               | 
|   |  |  | Including purchases from associated           | 
|   |  |  | companies                                     | 
|   |  |  |                                               | 

41



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 10  SUPPLEMENTARY
FINANCIAL STATEMENT INFORMATION(continued):

|   | 2006 |  | 2005                                                                              |  | 2004 | 
|-- | ---- |  | --------------------------------------------------------------------------------- |  | ---- | 
|
|g. |      |  | Selling, marketing, administrative and                                            |  |      | 
|   |      |  | general expenses:                                                                 |  |      | 
|   |      |  | Selling and marketing:                                                            |  |      | 
|   |      |  | Payroll and related expenses                                                      |  |      | 
|   |      |  | Packaging, transport and shipping                                                 |  |      | 
|   |      |  | Commissions                                                                       |  |      | 
|   |      |  | Depreciation                                                                      |  |      | 
|   |      |  | Other                                                                             |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      | 
|   |      |  | Administrative and general:                                                       |  |     
|   |      |  | Payroll and related expenses                                                      |  |      | 
|   |      |  | Office supplies, rent and maintenance                                             |  |      | 
|   |      |  | Professional fees                                                                 |  |      | 
|   |      |  | Depreciation                                                                      |  |      | 
|   |      |  | Doubtful accounts and bad debts                                                   |  |      | 
|   |      |  | Other                                                                             |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      | 
|   |      |  | Less - rent and participation from                                                |  |     
|   |      |  | associated companies                                                              |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  |                                                                                   | 
|h. |      |  | Financial expenses - net*:                                                        |  |     
|   |      |  |                                                                                   | 
|   |      |  | Expenses:                                                                         |  |     
|   |      |  | In respect of long-term loans                                                     |  |      | 
|   |      |  | In respect of notes - including amortization of deferred                          |  |      | 
|   |      |  | charges and net of related hedges                                                 |  |      | 
|   |      |  | In respect of increase in value of operating monetary balance-net                 |  |      | 
|   |      |  | In respect of short-term balances                                                 |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  | Income:                                                                           |  |     
|   |      |  | In respect of long-term loans                                                     |  |      | 
|   |      |  | In respect of increase in value of operating monetary balances                    |  |      | 
|   |      |  | In respect of short-term balances                                                 |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      |  |                                                                                   |  |      | 
|   |      | 
|   |      |  |                                                                                   |  |      | 
|** |      |  | Including financial income (expenses) in respect of loans to associated companies |  |      | 
|   |      |  |                                                                                   |  |      | 
|*  |      |  | Reclassified                                                                      |  |      | 
|   |      |  |                                                                                   | 

42



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 10  SUPPLEMENTARY FINANCIAL
STATEMENT INFORMATION(continued):

| | i. |  | Other
income
| | -- |  | ------------

|                                                         | 2006 |  | 2005 |         | 2004 | 
|-------------------------------------------------------- | ---- |  | ---- | ------- | ---- | 
|
|Proceeds from sale of land                               |      |  |      | *40,641 |      | 
|Capital gain from sale of fixed assets                   |      |  |      | 317     |      | 
|Gains (losses) from sale of the operation in Switzerland |      |  |      | (3,653  | )    | 
|                                                         |      |  |      |         |      | 
|                                                         |      |  |      | 37,305  |      | 
|                                                         |      |  |      |         |      | 

| | *On December 31, 2006, the Company sold a land estate. As a result
of this sale, the Company recorded a capital gain in the amount of approximately NIS 28.5 million, net of tax,
betterment levy, and expenses related to the sale. The proceeds of the sale, in the amount of NIS 43 million,
were deposited on December 31, 2006 with a trustee in order to secure the liabilities of the Company. At the
beginning of January 2007, the balance in the amount of approximately NIS 30 million was received, and in during
the course of February this balance was transferred from the trustee to the Company.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 11  NET
INCOME PER SHARE

| | Following
are data relating to the net income and the number of shares (including adjustments to
such data) used for the purpose of computing the basic and fully diluted net income per
ordinary share. (The data for the years 2005 and 2004 are after retroactive application
of the provisions of Accounting Standard No. 21 of the IASB, see note 1r):
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                    | Net income
Year ended December 31 | 
|--------------------------------------------------- | --------------------------------- | 
|
|
|Net income  for the period, as reported in the      |                                   | 
|income statements, used in computation of           |                                   | 
|basic net income per share                          |                                   | 
|                                                    |                                   | 
|Total net income for the purpose of computing       |                                   | 
|diluted income per share                            |                                   | 
|                                                    |                                   | 
|                                                    |                                   | 
|
|
|Weighted average number of shares used for          |                                   | 
|computing the basic income  per share               |                                   | 
|Adjustment in respect of incremental shares arising |                                   | 
|from exercise of warrants                           |                                   | 
|                                                    |                                   | 
|Weighted average number of shares used for          |                                   | 
|computing the diluted income  per share             |                                   | 
|                                                    |                                   | 

| | The
number of shares used in the computation of net income per share reflects the weighted
average number of shares issued during the year.
| | -------------------------------------------------------------------------------------------------------------------------------------------

43



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

# NOTE 12  FINANCIAL
INSTRUMENTS AND RISK MANAGEMENT:

| | a. |  | Derivative
financial instruments
| | -- |  | --------------------------------

| | The
Company has limited involvement with derivative financial instruments. The Company uses
these instruments as hedges. The Company utilizes derivatives, mainly forward exchange
contracts, to protect its expected cash flows in respect of existing assets and
liabilities denominated in currencies other than the functional currency of the Company
or that are linked to the CPI. As the counter-parties to these derivatives are Israeli
banks, the Company considers the inherent credit risks remote.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
December 2005, the Company entered into forward transactions for a period of one year, in
order to hedge an amount of NIS 230 million against increases in the CPI, following
the termination of the 2004 transaction that was finalized.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
December 2006, the Company entered into forward transactions for a period of one year, in
order to hedge an amount of NIS 100 million against increases in the CPI, following
the termination of the aforementioned transaction. In January 2007, the Company entered
into forward transactions for a period of one year , in order to hedge an amount of NIS
120 million against increases in the CPI, following the termination of the aforementioned
transaction.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. |  | Credit
risks
| | -- |  | ------------

| | The
Company and its subsidiaries cash and cash equivalents
as of December 31, 2006 and 2005 are deposited mainly with major banks. The Company and
its subsidiaries consider the credit risks in respect of these balances to be remote.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Most
of these companies sales are made in Israel, to a large number of customers. The
exposure to credit risks relating to trade receivables is limited due to the relatively
large number of customers. The Group performs ongoing credit evaluations of its customers
to determine the required amount of allowance for doubtful accounts. An appropriate
allowance for doubtful accounts is included in the financial statements.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. |  | Exchange rate risks
| | -- |  | -------------------

| | Approximately
half of the Companys sales are nominated in US dollars, while a substantial part of
its expenditures and its liabilities are in NIS, and as a result, the Company has an
exposure to the changes in the rate of exchange of the NIS against the US dollar. This
exposure includes an economic exposure (resulting from the excess of receipts over
payments, in foreign currency on linked to it) and reporting exposure (relating to the
excess of dollar linked assets over liabilities).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has trade receivables balances linked to the US dollar  see note 8(a).
| | -----------------------------------------------------------------------------------

| | d. |  | Fair
value of financial instruments
| | -- |  | -----------------------------------

| | The following table specifies the carrying amount and fair value of financial instrument
groups that are not presented in the financial statements at their value:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                 | Carrying Amount |  | Fair Value |        
|-------------------------------- | --------------- |  | ---------- | -------
|
|Long term loans and capital note |                 |  |            | 63,704 
|                                 |                 |  |            |        
|Financial Liabilities            |                 | 
|Notes - series 1*                |                 |  |            | 20,522 
|Notes - series 2*                |                 |  |            | 206,627
|Other liability*                 |                 |  |            | 32,770 
|                                 |                 |  |            |        
|                                 |                 |  |            | 259,919
|                                 |                 |  |            |        

| | *
The above carrying amounts are based on the computation of the present value of cash
flows at interest rates applicable to similar characterized loans (in 2006  5%).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

44



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

# NOTE 13 
INTERESTED PARTIES  TRANSACTIONS AND BALANCES:

| | a. |  | Transactions:
| | -- |  | -------------

| | 1) |  | Income
(expenses):
| | -- |  | ------------------

|                   | 2006 |  | 2005 |         | 2004 | 
|------------------ | ---- |  | ---- | ------- | ---- | 
|
|Sales              |      |  |      | 47,803  |      | 
|                   |      |  |      |         |      | 
|Costs and expenses |      |  |      | (20,175 | )    | 
|                   |      |  |      |         |      | 
|Financial expenses |      |  |      | (2,191  | )    | 
|                   |      |  |      |         |      | 

| | The
amounts presented above represent transactions that the Company carried out in the
ordinary course of business with interested parties (companies which are held by the
Companys principal shareholder), at terms and prices similar to those applicable to
non-affiliated customers and suppliers.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) |  | Benefits
to interested parties:
| | -- |  | -------------------------------

|                                             | 2006 |  | 2005 |        | 2004 | 
|-------------------------------------------- | ---- |  | ---- | ------ | ---- | 
|Payroll to interested parties employed       |      |  |      |        |      | 
|by the Company - NIS  in thousands           |      |  |      | *8,094 |      | 
|                                             |      |  |      |        |      | 
|Number of people to whom the benefits relate |      |  |      | 2      |      | 
|                                             |      |  |      |        |      | 
|Remuneration of directors who are not        |      | 
|employed by the Company -                    |      | 
|NIS in thousands                             |      |  |      | 504    |      | 
|                                             |      |  |      |        |      | 
|Number of people to whom                     |      | 
|the benefits relate                          |      |  |      | 11     |      | 
|                                             |      |  |      |        |      | 

| |  |  |  | * | In
2006 includes the payroll of CEO and of the former Chairman of the Board of Directors and, in addition a
payment to the former chairman of the Board of directors as a result of exercise of a
bonus according to a remuneration plan. In 2005 including the CEO and the former Chairman
of the Board of Directors. 2005 includes a special bonus to the Chairman of the Board of
Directors, in a sum of NIS 800,000, subject to the general meetings approval. In
2004 a CEO was in position only part of the year. | 
| |  |  |  | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | 

| | 3) |  | At
December 31, 2006, an interested party employed by the Company (the CEO) held
               1,975 options under the 2001 plan for senior employees in the group (see
note                6b(1)).
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) |  | As
to the plan for the remuneration of the Companys former chairman of the Board
               of Directors  see note 9e.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------

| | b. |  | Balances
with interested parties:
| | -- |  | ---------------------------------

|                                             | December 31
|-------------------------------------------- | -----------
|
|
|Accounts receivable - commercial operations* |            
|                                             |            
|Accounts payables and accruals               |            
|                                             |            
|Notes                                        |            
|                                             |            

| |  |  |  | *There
were no significant changes in the balance during the year. |  | 
| |  |  |  | ------------------------------------------------------------------ |  | 

# NOTE 14 
SEGMENT INFORMTION:

| | a. |  | Activities
of the Company and its subsidiaries:
| | -- |  | -----------------------------------------------

| | 1) |  | Manufacturing
and marketing of packaging paper, including collection and                recycling of
paper waste. The manufacturing of paper relies mainly on paper                waste as
raw material.
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) |  | Marketing
of office supplies and paper, mainly to institutions.Most
of the sales are on the local (Israeli) market and most of the assets are located in
Israel.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

45



---

AMERICAN ISRAELI
PAPER MILLS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

NOTE 14  SEGMENT
INFORMATION (continued):

| | b. |  | Business
segment data:
| | -- |  | ----------------------

|                                                           | Paper and recycling |  | Marketing of office supplies |         | T o t a l | 
|---------------------------------------------------------- | ------------------- |  | ---------------------------- | ------- | --------- | 
|
|
|Sales - net(1)                                             |                     |  |                              | 408,045 |           | 
|                                                           |                     |  |                              |         |           | 
|Income (loss) from ordinary operations                     |                     |  |                              | 50,359  |           | 
|Financial expenses, net                                    |                     |  |                              |         |           | 
|Other income                                               |                     |  |                              |         |           | 
|                                                           |                     |  |                              |         |           | 
|Income before taxes on income                              |                     |  |                              |         |           | 
|Taxes on income                                            |                     |  |                              |         |           | 
|                                                           |                     |  |                              |         |           | 
|Income from operations of the Company and its subsidiaries |                     |  |                              |         |           | 
|Share in profits of associated companies - net             |                     |  |                              |         |           | 
|                                                           |                     |  |                              |         |           | 
|Net income                                                 |                     |  |                              |         |           | 
|                                                           |                     |  |                              |         |           | 
|Segment assets (at end of year)                            |                     |  |                              | 574,319 |           | 
|Unallocated corporate assets (at end of year) (2)          |                     |  |                              |         |           | 
|                                                           |                     |  |                              |         |           | 
|Consolidated total assets (at end of year)                 |                     |  |                              |         |           | 
|                                                           |                     |  |                              |         |           | 
|Segment liabilities (at end of year)                       |                     |  |                              | 69,923  |           | 
|Unallocated corporate liabilities (at end of year)         |                     |  |                              |         |           | 
|                                                           |                     |  |                              |         |           | 
|Consolidated total liabilities (at end of year)            |                     |  |                              |         |           | 
|                                                           |                     |  |                              |         |           | 
|Depreciation and amortization                              |                     |  |                              | 30,137  |           | 
|                                                           |                     |  |                              |         |           | 

|(1) |  | Represents
sales to external customers.
|--- |  | ---------------------------------------

|(2) |  | Including
investments in associated                     companies.
|--- |  | ------------------------------------------------------------------

_________________

__________________________________

_________________

46



---

Schedule

# Details of
Subsidiaries and Associated CompaniesAt December 31, 2006

|                                                        | Percentage of direct and
indirect holding in shares
conferring equity and
voting rights
|------------------------------------------------------- | ---------------------------------------------------------------------------------------
|
|Main subsidiaries:                                      |                                                                                        
|Amnir Recycling Industries Limited                      |                                                                                        
|Graffiti Office Supplies and Paper Marketing Ltd.       |                                                                                        
|Attar Marketing Office Supplies Ltd.                    |                                                                                        
|American Israeli Paper Mills Paper Industry (1995) Ltd. |                                                                                        
|                                                        |                                                                                        
|Main associated companies:                              |                                                                                        
|Hogla-Kimberly Ltd.                                     |                                                                                        
|Subsidiaries of Hogla-Kimberly Ltd.:                    |                                                                                        
|Hogla-Kimberly Marketing Limited                        |                                                                                        
|Molett Marketing Limited                                |                                                                                        
|Shikma For Personal Comfort Ltd.                        |                                                                                        
|Turketim Mallari Sanayi ve Ticaret A.S (KCTR)           |                                                                                        
|Mondy Business Paper Hadera Ltd.                        |                                                                                        
|Subsidiary of Mondy Business Paper Hadera Ltd.:         |                                                                                        
|Mondy Business Paper Hadera Marketing Ltd.              |                                                                                        
|Carmel Container Systems Limited                        |                                                                                        
|Frenkel C.D.  Limited**                                 |                                                                                        
|Barthelemi Holdings Ltd.                                |                                                                                        
|T.M.M. Integrated Recycling Industries Ltd.***          |                                                                                        

|* |  | Not
including dormant companies.
|- |  | --------------------------------

|** |  | Frenkel
C.D. Limited is partly held through Carmel Container Systems Limited (an associated
company); the holding in voting shares of C.D. Packaging Systems Limited is 27.85%.
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|*** |  | At
the beginning of 2007 all the holding at T.M.M and Barthelmi were sold, from this date
were desisted this companies as mentioned above to be an associated companies.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

47



---

Item 19(a)(ii)

# MONDI BUSINESS PAPER
HADERA LTD.

# FINANCIAL STATEMENTS

# AS OF DECEMBER 31, 2006



---

# MONDI BUSINESS PAPER HADERA
LTD.

# FINANCIAL STATEMENTS AS OF DECEMBER 31, 2006

# TABLE OF CONTENTS

|                                                        | Page
|------------------------------------------------------- | ----
|                                                        |     
|                                                       
|Report of Independent Registered Public Accounting Firm | 1   
|                                                       
|Financial Statements:                                  
|                                                       
|Balance Sheets                                          | 2   
|                                                       
|Statements of Operations                                | 3   
|                                                       
|Statements of Changes in Shareholders' Equity           | 4   
|                                                       
|Statements of Cash Flows                                | 5-6 
|                                                       
|Notes to the Financial Statements                       | 7-31



---

-1-



---

# MONDI BUSINESS PAPER
HADERA LTD. BALANCE SHEETS (Reported Amounts) (NIS in thousands)

|                                       |  | Consolidated |    | Company | 
|-------------------------------------- |  | ------------ | -- | ------- | 
|
|
|Current Assets                         |  |              |    |         | 
|Cash and cash equivalents              |  |              |    |         | 
|Trade receivables                      |  |              | 3  |         | 
|American Israeli Paper Mills           |  |             
|Group, net                             |  |              |    |         | 
|Other receivables                      |  |              | 4  |         | 
|Inventories                            |  |              | 5  |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|Long-Term Investments                  |  |             
|Investments in Subsidiaries            |  |              | 6  |         | 
|                                       |  |              |    |         | 
|Fixed Assets                           |  |              | 7  |         | 
|Cost                                   |  |              |    |         | 
|Less - accumulated depreciation        |  |              |    |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|Long -Term Assets                      |  |             
|Goodwill                               |  |              | 6B |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|Current Liabilities                    |  |             
|Short term bank credit                 |  |              |    |         | 
|Current maturities of long-term        |  |             
|bank loans                             |  |              | 10 |         | 
|Capital notes to shareholders          |  |              | 11 |         | 
|Trade payables                         |  |              | 8  |         | 
|American Israeli Paper Mills           |  |             
|Group, net                             |  |              |    |         | 
|Subsidiaries                           |  |              |    |         | 
|Other payables and accrued expenses    |  |              | 9  |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|Long-Term Liabilities                  |  |             
|Long-term bank loans                   |  |              | 10 |         | 
|Capital notes to shareholders          |  |              | 11 |         | 
|Deferred taxes                         |  |              | 20 |         | 
|Accrued severance pay, net             |  |              | 12 |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|Commitments and Contingent Liabilities |  |              | 13 |         | 
|Shareholders' Equity                   |  |             
|Share capital                          |  |              | 14 |         | 
|Premium                                |  |              |    |         | 
|Retained earnings                      |  |              |    |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 
|                                       |  |              |    |         | 

|                   |                   |                                        
|------------------ | ----------------- | ---------------------------------------
|/s/ D. Muhlgay     | /s/ A. Solel      | /s/ A. Brener                          
|                   |                   |                                        
|D. Muhlgay         | A. Solel          | A. Brener                              
|Financial Director | Managing Director | Vice-Chairman of the Board of Directors

Approval date of the financial
statements: February 6, 2007.

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

-2-



---

# MONDI BUSINESS PAPER
HADERA LTD. STATEMENTS OF
OPERATIONS (Reported amounts) (NIS in thousands)

|                                                |  | Consolidated |    | Company | 
|----------------------------------------------- |  | ------------ | -- | ------- | 
|
|
|Net sales                                       |  |              | 15 |         | 
|                                                |  |              |    |         | 
|Cost of sales                                   |  |              | 16 |         | 
|                                                |  |              |    |         | 
|                                                |  |              |    |         | 
|Gross profit                                    |  |              |    |         | 
|                                                |  |              |    |         | 
|Selling expenses                                |  |              | 17 |         | 
|                                                |  |             
|General and administrative expenses             |  |              | 18 |         | 
|                                                |  |              |    |         | 
|                                                |  |              |    |         | 
|Operating profit (loss)                         |  |              |    |         | 
|                                                |  |              |    |         | 
|Financing expenses, net                         |  |              | 19 |         | 
|                                                |  |              |    |         | 
|Other income, net                               |  |              |    |         | 
|                                                |  |              |    |         | 
|                                                |  |              |    |         | 
|                                                |  |             
|Income (loss) before income taxes               |  |              |    |         | 
|                                                |  |              |    |         | 
|                                                |  |             
|tax benefits (Income taxes)                     |  |              | 20 |         | 
|                                                |  |              |    |         | 
|                                                |  |              |    |         | 
|                                                |  |             
|                                                |  |             
|Income (loss) after income taxes (tax benefits) |  |              |    |         | 
|                                                |  |              |    |         | 
|                                                |  |             
|Equity in net earnings (losses) of Subsidiaries |  |              |    |         | 
|                                                |  |              |    |         | 
|                                                |  |              |    |         | 
|                                                |  |             
|Net income (loss) for the year                  |  |              |    |         | 
|                                                |  |              |    |         | 
|                                                |  |              |    |         | 

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

-3-



---

# MONDI BUSINESS PAPER
HADERA LTD.

# STATEMENTS OF CHANGES
IN SHAREHOLDERS EQUITY (Reported amounts) (NIS in thousands)

|                            | Share
capital |  | Premium |   | Retained
earnings |  | Total  | 
|--------------------------- | ------------- |  | ------- | - | ----------------- |  | ------ | 
|Balance - January 1, 2004   |               |  |         | 1 |                   |  | 43,352 | 
|                            |               |  |         |  
|Changes during 2004:        |               | 
|                            |               |  |         |  
|Net income for the year     |               |  |         | - |                   |  | -      | 
|                            |               |  |         |   |                   |  |        | 
|Balance - December 31, 2004 |               |  |         | 1 |                   |  | 43,352 | 
|                            |               |  |         |  
|Changes during 2005:        |               | 
|                            |               |  |         |  
|Loss for the year           |               |  |         | - |                   |  | -      | 
|                            |               |  |         |   |                   |  |        | 
|Balance - December 31, 2005 |               |  |         | 1 |                   |  | 43,352 | 
|                            |               |  |         |  
|Changes during 2006:        |               | 
|                            |               |  |         |  
|Loss for the year           |               |  |         | - |                   |  | -      | 
|                            |               |  |         |   |                   |  |        | 
|Balance - December 31, 2006 |               |  |         | 1 |                   |  | 43,352 | 
|                            |               |  |         |   |                   |  |        | 

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

-4-



---

# MONDI BUSINESS PAPER
HADERA LTD. STATEMENTS OF CASH
FLOWS (Reported amounts) (NIS in thousands)

|                                                 | Consolidated |  | Company |        
|------------------------------------------------ | ------------ |  | ------- | -------
|
|
|Cash flows - operating activities                |              |  |         |        
|Net income (loss) for the year                   |              |  |         | (7,719 
|Adjustments to reconcile net                     |              | 
|income (loss) to net cash provided               |              | 
|by (used in) operating activities                |              | 
|(Appendix A)                                     |              |  |         | (2,667 
|                                                 |              |  |         |        
|Net cash provided by (used in)                   |              | 
|operating activities                             |              |  |         | (10,386
|                                                 |              |  |         |        
|Cash flows - investing activities                |              | 
|Acquisition of fixed assets                      |              |  |         | (8,414 
|Proceeds from sale of fixed assets               |              |  |         | 189    
|                                                 |              |  |         |        
|Net cash used in investing                       |              | 
|activities                                       |              |  |         | (8,225 
|                                                 |              |  |         |        
|Cash flows - financing activities                |              | 
|Short-term bank credit, net                      |              |  |         | 10,853 
|Repayment of long-term bank  loans               |              |  |         | (16,002
|Proceeds of long-term bank loans                 |              |  |         | 28,000 
|Repayment of long-term capital                   |              | 
|notes to shareholders                            |              |  |         | (4,225 
|                                                 |              |  |         |        
|Net cash provided by (used in)                   |              | 
|financing activities                             |              |  |         | 18,626 
|                                                 |              |  |         |        
|                                                 |              | 
|Increase (decrease) in cash and cash equivalents |              |  |         | 15     
|                                                 |              | 
|Cash and cash equivalents - beginning of year    |              |  |         | -      
|                                                 |              |  |         |        
|                                                 |              | 
|Cash and cash equivalents - end of year          |              |  |         | 15     
|                                                 |              |  |         |        

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

-5-



---

# MONDI BUSINESS PAPER
HADERA LTD. APPENDICES TO
STATEMENTS OF CASH FLOWS (Reported amounts) (NIS in thousands)

|                                    | Consolidated |  | Company |        
|----------------------------------- | ------------ |  | ------- | -------
|
|
|A.  Adjustments to reconcile net    |              |  |         |        
|income (loss) to net cash provided  |              | 
|by (used in) operating activities   |              | 
|                                    |              | 
|Income and expenses items           |              | 
|not involving cash flows:           |              | 
|                                    |              | 
|Equity in net losses (earnings) of  |              | 
|Subsidiaries                        |              |  |         | -      
|Depreciation and amortization       |              |  |         | 10,907 
|Deferred taxes, net                 |              |  |         | (1,330 
|Decrease in liability for severance |              | 
|pay, net                            |              |  |         | (5     
|Capital gain                        |              | 
|from sale of fixed assets           |              |  |         | (37    
|Effect of exchange rate and linkage |              | 
|differences of long-term bank       |              | 
|loans and long-term loan to         |              | 
|Subsidiary                          |              |  |         | (935   
|Effect of exchange rate             |              | 
|differences of long-term            |              | 
|capital notes to shareholders       |              |  |         | (1,512 
|                                    |              | 
|Changes in assets and liabilities:  |              | 
|                                    |              | 
|Increase in trade receivables       |              |  |         | (12,299
|Decrease (increase)                 |              | 
|in other receivables                |              |  |         | (261   
|Decrease (increase)                 |              | 
|in inventories                      |              |  |         | 4,816  
|Increase (decrease) in trade        |              | 
|payables                            |              |  |         | 4,354  
|Increase (decrease) in              |              | 
|American Israeli Paper Mills        |              | 
|Group, net                          |              |  |         | (7,047 
|Increase (decrease) in Subsidiaries |              |  |         | -      
|Increase (decrease) in other        |              | 
|payables and accrued expenses       |              |  |         | 682    
|                                    |              |  |         |        
|                                    |              |  |         | (2,667 
|                                    |              |  |         |        
|B. Non-cash activities              |              |  |         |        
|Acquisition of fixed                |              | 
|assets on credit                    |              |  |         | 669    
|                                    |              |  |         |        

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

-6-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS

|NOTE
 1  | DESCRIPTION OF BUSINESS AND GENERAL
|--------- | -----------------------------------

| |  | A. |  | Description of Business
| |  | -- |  | -----------------------

| | Mondi
Business Paper Hadera Ltd. (the Company) was incorporated and commenced
operations on January 1, 2000. The Company and its Subsidiaries are engaged in the
production and marketing of paper, mainly in Israel.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is presently owned by Neusiedler Holdings BV. (NHBV or the Parent
Company) (50.1%) and American-Israeli Paper Mills Ltd. (AIPM) (49.9%).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
financial statements are prepared in accordance with the Israeli Securities Regulations
(Preparation of Annual Financial Statements), 1993.
| | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  | B. |  | Definitions:
| |  | -- |  | ------------

| | The Company |  |  | Mondi Business Paper Hadera Ltd.
| | ----------- |  | - | --------------------------------

| | The Group |  |  | the
Company and its Subsidiaries, a list of which is presented in Note 6C.
| | --------- |  | - | --------------------------------------------------------------------------

| | Subsidiaries |  |  | companies
in which the Company exercises over 50% ownership and control, directly or indirectly,
and whose financial statements are fully consolidated with those of the Company.
| | ------------ |  | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Related Parties |  |  | as  defined  by  Opinion  No.  29  of  the  Institute  of  Certified
  Public Accountants in
Israel.
| | --------------- |  | - | ----------------------------------------------------------------------------------------------------

| | Interested Parties |  |  | as defined in the Israeli Securities
Regulations  (Presentation of Financial Statements), 1993.
| | ------------------ |  | - | -----------------------------------------------------------------------------------------------

| | Controlling Shareholder |  |  | as
defined in the Israeli Securities Regulations (Presentation of Transactions between a
Corporation and its Controlling Shareholder in the Financial Statements), 1996.
| | ----------------------- |  | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | NIS |  |  | New Israeli Shekel.
| | --- |  | - | -------------------

| | CPI |  |  | the Israeli consumer price index.
| | --- |  | - | ---------------------------------

| | Dollar |  |  | the U.S. dollar.
| | ------ |  | - | ----------------

| | Euro |  |  | the United European currency.
| | ---- |  | - | -----------------------------

| | Reported Amount |  |  | see Note 2A(1) below.
| | --------------- |  | - | ---------------------

-7-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS

|NOTE 1  | DESCRIPTION OF BUSINESS AND GENERAL (cont.)
|-------- | -------------------------------------------

| |  | C. |  | Use
of Estimates
| |  | -- |  | ----------------

| | The
preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities as
of the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from those estimates.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
following are the principal accounting policies applied in the preparation of the
financial statements in a manner consistent with previous years with the exception of the
application of the provisions of Standard No. 20 (Revised)  Accounting
Treatment for Goodwill and Other Intangibles upon the Acquisition of an Investee
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | A. |  | Cessation
of Financial Statement Adjustment and Change toReporting           in Reported
Amounts  Standard No. 12
| |  | -- |  | ------------------------------------------------------------------------------------------------------------------

| |  |  | (1) |  | Definitions
| |  |  | --- |  | -----------

| | Adjusted
Amounthistorical nominal amount adjusted for changes in the exchange
rate of the U.S. dollar as of December 31, 2003, in accordance with Opinion No. 36 of the
Institute of Certified Public Accountants in Israel.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Reported
Amount  Adjusted Amount plus amounts in nominal terms added subsequent to
December 31, 2003, and less amounts subtracted after that date.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | (2) |  | General
| |  |  | --- |  | -------

| | In
January 2004, Israeli Accounting Standard No. 12 Cessation of Financial
Statements Adjustment came into effect. Following the initial implementation of
Standard No. 12, commencing January 1, 2004, the Group ceased the presentation of its
financial statements based on nominal historical cost adjusted for the changes in the
exchange rate of the U.S. dollar in relation to the NIS. Effective with the interim
financial statements as of March 31, 2004 and for the reporting periods thereafter,
including the years ended December 31, 2004 and 2005, the Groups financial
statements are prepared and presented in Reported Amounts.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Comparative
figures included in these financial statements relating to the year ended December 31,
2003, are presented in Adjusted Amounts.
| | -------------------------------------------------------------------------------------------------------------------------------------------

| | The
amounts at which non-monetary items are presented in these financial statements do not
necessarily represent their realization value or economic value, but solely their
Reported Amount.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys condensed financial statements in nominal values, on the basis of which
the Companys financial statements in Reported amounts and Adjusted Amounts were
prepared, are presented in Note 24.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-8-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS

|NOTE
2  | SIGNIFICANT ACCOUNTING POLICIES (cont.)
|-------- | ---------------------------------------

| |  | A. |  | Cessation
of Financial Statement Adjustment and Change toReporting in Reported Amounts Standard
No. 12 (cont.)
| |  | -- |  | ---------------------------------------------------------------------------------------------------------------

| |  |  | (3) |  | Principles
of Adjustment applicable for financial statements in reporting           amaunts
| |  |  | --- |  | -------------------------------------------------------------------------------------------

| |  |  |  | a. | Balance
Sheet Items | 
| |  |  |  | -- | ------------------- | 

| | Non-monetary
items (items whose balances reflect historical value at acquisition or upon establishment)
are presented at their Adjusted Amounts as of December 31, 2003 plus additions and
dispositions occurring subsequent to such date. Additions made subsequent to December 31,
2003 and dispositions of items added subsequent to such date, are presented at their
historical nominal value. Dispositions of items added on or prior to December 31, 2003 are
presented at their Adjusted Amount.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Monetary
items (items whose balance sheet amount reflects their current value or realization value
at the balance sheet date) are presented at their nominal value as of the balance sheet
date.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Investments
in Subsidiaries are presented based on the financial statements of these companies
prepared in accordance with the guidance of Standard No. 12.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | b. | Statement
of Operations Items | 
| |  |  |  | -- | ----------------------------- | 

| | Income
and expenses reflecting transactions, and financial income and expenses, are presented at
their nominal value.
| | ---------------------------------------------------------------------------------------------------------------------

| | Income
and expenses deriving from non-monetary items (mainly depreciation, amortization and
changes in inventory) were presented in a manner corresponding to the presentation of the
related non-monetary balance sheet item, as illustrated above.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys share in the results of Subsidiaries is determined based on the financial
statements of these companies prepared in accordance with the guidance of Standard No. 12.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-9-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS

|NOTE
2  | SIGNIFICANT ACCOUNTING POLICIES (cont.)
|-------- | ---------------------------------------

| |  | B. |  | Principles
of Consolidation
| |  | -- |  | ---------------------------

| | The
 consolidated financial statements include consolidation of the financial statements
of all Subsidiaries. Material inter-company balances and transactions of and between
Subsidiaries have been fully eliminated. The unallocated excess cost due to investment in
an investee deriving from the difference between the fair value of the investees
identifiable assets (including intangible assets) over the fair value of its identifiable
liabilities (after deferred taxes) at the acquisition date is goodwill, which has been
depreciated by December 31, 2005 over about 4 years.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | See
note H below for the accounting for goodwill as of January 1, 2006.
| | -----------------------------------------------------------------------

| |  | C. |  | Cash
and Cash Equivalents
| |  | -- |  | -------------------------

| | Cash
and cash equivalents include bank deposits, available for immediate withdrawal, as well
as unrestricted short-term deposits with maturities of less than three months from the
date of deposit.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | D. |  | Allowance
for Doubtful Accounts
| |  | -- |  | -------------------------------

| | The
allowance for doubtful accounts is computed on the specific identification basis for
accounts whose collectibility, on managements estimation, is uncertain.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | E. |  | Inventories
| |  | -- |  | -----------

| | Inventories
are stated at the lower of cost or net realizable value. Cost is determined for raw
materials, auxiliary materials and finished products on the basis of weighted moving
average cost per unit.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | F. |  | Investments
in Subsidiaries
| |  | -- |  | ---------------------------

| | Investments
in Subsidiaries are presented using the equity method. For amortization of goodwill
included in an investment in a Subsidiary, see H below.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | G. |  | Fixed
Assets
| |  | -- |  | ------------

| | Fixed
assets are presented at cost, including interest and other capitalizable costs
(capitalizable costs include only incremental direct costs that are identifiable with,
and related to, the property and equipment and are incurred prior to its initial
operation), less accumulated depreciation and amortization. Depreciation is calculated
using the straight-line method at rates considered adequate to depreciate the assets over
their estimated useful lives. Amortization of leasehold improvements is computed over the
shorter of the term of the lease, including any option period, where the Company intends
to exercise such option, or their useful life.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                    |                 
|--------------------------------------------------- | ----------------
|The annual depreciation and amortization rates are: | %               
|                                                   
|Leasehold improvements                              | 10              
|Machinery and equipment                             | 5-20 (mainly 5%)
|Motor vehicles                                      | 15-20           
|Office furniture and equipment                      | 7-33            

-10-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS

|NOTE
2  | SIGNIFICANT ACCOUNTING POLICIES (cont.)
|-------- | ---------------------------------------

| |  | G. |  | Fixed
Assets (cont.)
| |  | -- |  | --------------------

| | Impairment
of Long-Lived Assets
| | -------------------------------

| | Management
reviews long-lived assets on a periodic basis, as well as when such a review is required
based upon relevant circumstances, to determine whether events or changes in
circumstances indicate that the carrying amount of such assets may not be recoverable.
According to the Israeli Accounting Standards Boards Standard No. 15, Impairment
of Assets, an assets recoverable value is the higher of the assets
net selling price and the assets value in use, the latter being equal to the assets
discounted expected cash flows. If applicable, an impairment charge is recorded at the
amount in which the carrying amount of the asset exceeds its recoverable value.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | H. |  | Other Assets-Goodwill
| |  | -- |  | ---------------------

| | As
of January 1, 2006 the Company applies Standard No. 20 (revised) Accounting
Treatment for Goodwill and Other Intangibles upon the Acquisition of an Investee (in
this paragraph- the standard). By December 31, 2005 the Company had
systematically amortized its goodwill deriving from the Acquisition of investees using
the straight line method over periods of 10 years.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of January 1, 2006 the Company applies the Standard.
| | -------------------------------------------------------

| | In
accordance with the standard, goodwill is the unallocated excess cost due to investment
in an investee deriving from the difference between the fair value of the investees
identifiable assets (including intangible assets) over the fair value of its identifiable
liabilities (after deferred taxes) at the acquisition date. Goodwill is no longer
amortized in a systematic manner, but is examined for impairment annually, or more
frequently if events or changes in circumstances indicate that it might be impaired.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
case of a realization of an investment in a subsidiary the goodwill will be taken into
consideration in determining the profit or loss from the realization.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | I. |  | Deferred
Income Taxes
| |  | -- |  | ---------------------

| | The
Group records deferred income taxes in respect of temporary differences between the
carrying values of assets and liabilities in the financial statements and their values
for tax purposes, including depreciation differences on leased property and fixed assets.
The Group records deferred-tax assets in respect of temporary differences as well as in
respect of carry-forward tax losses so long as it is probable that those assets will be
realized. The deferred income taxes are computed by the tax rates expected to be in
effect at realization, as they are known at the balance sheet date.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
computation of deferred income taxes has not taken into account taxes that would have
been applicable in case of future realization of investments in Subsidiaries, since the
Group does not contemplate such realization in the foreseeable future.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | J. |  | Revenue
Recognition
| |  | -- |  | -------------------

| | Revenues
are recognized upon shipment, when title has been transferred and collectibility is
reasonably assured. Revenues are presented net of discounts granted. The accrual for
estimated discounts granted is computed according to the provisions stipulated in the
agreements, and is recorded when revenues are recognized.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-11-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS

|NOTE
2  | SIGNIFICANT ACCOUNTING POLICIES (cont.)
|-------- | ---------------------------------------

| |  | K. |  | Supplier
Discounts
| |  | -- |  | ------------------

| | Ongoing
discounts granted by suppliers, as well as year end discounts, in respect of which no
commitments to meet given targets are required by the Group, are included in the
financial statements upon the execution of purchases that grant the Group said discounts.
Supplier discounts contingent upon the Groups fulfillment of certain targets, such
as meeting a minimal annual volume (in quantities or amount), or an increase in purchases
over previous periods, are included in the financial statements in proportion to Groups
purchases from suppliers during the reported period, which advance the Group towards the
stated targets, only if it is expected that those targets will be reached and the
discounts can reasonably be estimated. Managements estimate of meeting the targets
is based, inter-alia, on historical experience, Groups relationships established
with the suppliers and the estimated volume of purchases during the remaining reported
period.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | L. |  | Exchange
Rates and Linkage Basis
| |  | -- |  | --------------------------------

| |  |  | (1) |  | Balances
 in foreign currency or linked thereto are included in the financial
          statements based on the representative exchange rates, as published by the Bank
          of Israel, that were prevailing at the balance sheet date.
| |  |  | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | (2) |  | Following
are the changes in the representative exchange rate of the U.S.           dollar
vis-a-vis the NIS and in the Israeli CPI:
| |  |  | --- |  | ------------------------------------------------------------------------------------------------------------------------------------

|As of:                 | Representative
exchange rate
of the Dollar
(NIS per $1) | CPI
"in respect of"
(in points)
|---------------------- | ------------------------------------------------------- | -------------------------------
|December 31, 2006      | 4.225                                                   | 184.87                         
|December 31, 2005      | 4.603                                                   | 185.05                         
|December 31, 2004      | 4.308                                                   | 180.74                         
|                       |                                                         |                                
|Increase (decrease)   
|during the year ended: | %                                                       | %                              
|                       |                                                         |                                
|December 31, 2006      | (8.2)                                                   | -                              
|December 31, 2005      | 6.8                                                     | 2.4                            
|December 31, 2004      | (1.6)                                                   | 1.2                            

| |  |  | (3) |  | Exchange-rate
differences are charged to operations as incurred.
| |  |  | --- |  | ----------------------------------------------------------------

-12-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS

|NOTE
2  | SIGNIFICANT ACCOUNTING POLICIES (cont.)
|-------- | ---------------------------------------

| |  | M. |  | Recent
Accounting Standards
| |  | -- |  | ---------------------------

| | Standard
No. 23 Accounting for Transactions between an Entity and a controlling party
| | ---------------------------------------------------------------------------------------

| | In
December 2006 the Israeli Accounting Standards Board published Accounting Standard No.
23, Accounting for Transactions between an Entity and a controlling party
(hereinafter  the Standard). The Standard applies to entities subject to the
Israeli Securities Law-1968.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Standard establishes the requirements for accounting for transactions between an entity
and its controlling party, which involve asset transfers, assumption of liability,
reimbursement or debt concession, and receipt of loans. The Standard does not apply to
business combinations between entities under common control.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Standard stipulates that transactions between an entity and a controlling party will be
measured based on fair value; transactions which in nature are owner investments or
distributions to owners should be reported directly in equity and not be recognized in
the controlled entitys profit and loss; the differences between the consideration
in transactions between an entity and a controlling party and their fair value will be
recognized directly in equity. Current and deferred taxes pertaining to the items
recognized in equity due to transactions with controlling parties will be recognized
directly in equity as well.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Standard is effective for transactions between an entity and a controlling party taking
place subsequent to January 1, 2007 and for loans granted from or given to a controlling
party prior to the Standards effective date, starting on the Standards
effective date.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is currently examining this new standard, including the election between the cost
and the revaluation methods; however, at this stage, it is unable to estimate the standards
effect, if any, on its financial position, results of operations and cash flows.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-13-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS

|NOTE
2  | SIGNIFICANT ACCOUNTING POLICIES (cont.)
|-------- | ---------------------------------------

| |  | M. |  | Recent
Accounting Standards (cont.)
| |  | -- |  | -----------------------------------

| | Application
 of Standard No.26 Inventory
| | ------------------------------------------

| | In
August 2006 the Israeli  Accounting  Standards Board published  Accounting  Standard No.
26 - "Inventory"  ("the                      Standard"), which outlines the accounting
treatment of inventory.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard applies to all types of inventory, other than buildings constructed for sale and
addressed by Accounting Standard No.2 (Construction of Buildings for Sale),
inventory of work in progress stemming from performance contracts, addressed by
Accounting Standard No.4 (Work Based on Performance Contract), financial
instruments and biological assets relating to agricultural activity and agricultural
production during harvest.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard establishes, among other things, that inventory should be stated at the lower
between cost and net realizable value. Cost is determined by the first in, first out
(FIFO) method or by average weighted cost used consistently for all types of inventory of
similar nature and uses. In certain circumstances the standard requires cost
determination by a specific identification of cost, which includes all purchase and
production costs, as well as any other costs incurred in reaching the inventorys
present stage.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | When
inventory is acquired on credit incorporating a financing component, the inventory should
then be presented at cost equaling purchase cost in cash. The financing component is
recognized as a financing expense over the term of the credit period.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Any
reduction of inventory to net realizable value following impairment as well as any other
inventory loss should be expensed in the current period.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------

| | Subsequent
elimination of an impairment write-down that stems from an increase in net realizable
value will be allocated to operations during the period in which the elimination took
place. This standard will apply to financial statements covering periods beginning
January 1, 2007 and onwards and be implemented retroactively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Management
believes that the standard will not affect the Companys financial position, results
of operations and cash flows.
| | -----------------------------------------------------------------------------------------------------------------------------

-14-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS

|NOTE
2  | SIGNIFICANT ACCOUNTING POLICIES (cont.)
|-------- | ---------------------------------------

| |  | M. |  | Recent
Accounting Standards (cont.)
| |  | -- |  | -----------------------------------

| | Application
of Standard No. 27 Fixed Asset
| | --------------------------------------------

| | In
September 2006 the Israeli Accounting Standards Board published Accounting Standard No.
27 (Fixed Assets), which establishes the accounting treatment of fixed
assets, including recognition of assets, determination of their book value, related
depreciation, losses from impairment as well as the disclosure required in the financial
statements.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard states that a fixed-asset item will be measured at the initial recognition date
based cost which includes, in addition to the purchase price, all the related costs
incurred for bringing the item to the position enabling it to operate in the manner
contemplated by management. The cost also includes the initial estimate of costs required
to dismantle and remove the item, along with the expenses incurred in reconstructing the
site on which the item had been placed and in respect of which the entity incurred that
obligation when the item had been acquired or following its use over a given period of
time not in the production of inventory during that period.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard also states that when acquiring assets in exchange for a non-monetary asset or a
combination of monetary as well as non-monetary assets, the cost will be determined at
fair value unless (a) the barter transaction has no commercial essence or (b) it is
impossible to reliably measure the fair value of the asset received and the asset
provided. Should the provided asset not be measured at fair value, its cost would equal
book value.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Following
the initial recognition, the standard permits the entity to implement in its accounting
policy the measurement of the fixed assets by the cost method or by revaluation so long
as this policy is implemented in regard to all the items in that Company.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Cost
method  an item will be presented at net book value, less accumulated impairment
losses.
| | ----------------------------------------------------------------------------------------------

| | Revaluation
method  an item whose fair value can be measured reliably will be presented at its
estimated amount, which equals its fair value at the revaluation date, net of
depreciation accumulated subsequently and less accumulated impairment losses.
Revaluations should take place on a current basis in order to ensure that book value does
not materially differ from the fair value that would have been determined on the
balance-sheet date. The revaluation of a single item calls for the revaluation of the
entire Company and if the assets book value rises following this revaluation, this
increase should be allocated directly to shareholders equity (revaluation
reserve). Nevertheless, this increase will be recognized as an operating item up to
the amount offsetting the decrease from that assets revaluation recognized
previously as income or loss. Should book value decline following revaluation, this
decline will be recognized as an operating item yet allocated directly to shareholders equity
(revaluation reserve) up to the amount leaving any credit balance in that
reserve in respect of that asset.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-15-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS

|NOTE
2  | SIGNIFICANT ACCOUNTING POLICIES (cont.)
|-------- | ---------------------------------------

| |  | M. |  | Recent
Accounting Standards (cont.)
| |  | -- |  | -----------------------------------

| | Application
of Standard No. 27 Fixed Asset (cont.)
| | ----------------------------------------------------

| | Any
fixed asset with a meaningful cost in relation to the items total cost should be
depreciated separately. Moreover, the depreciation method used will be reviewed at least
once at yearend and, if any meaningful change had taken place in the estimated
consumption of future economic benefits inherent in the asset, the method should be
modified to reflect such changes. This change will be treated as a change in an
accounting estimate.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
new standard will apply to financial statements covering periods beginning January 1,
2007 and onwards and implemented retroactively, except for the following:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | An
entity which chooses on January 1, 2007 the revaluation method will treat the difference
between the assets estimated book value and its cost as a revaluation reserve at
that time.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | An
entity which did not include in the cost of an item, upon initial recognition, the
initial estimate of dismantling and removing costs along with site reconstruction costs
will be required to:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | 1. |  | Measure
the liability on January 1, 2007 in conformity with generally accepted accounting
principles;
| |  |  | -- |  | -----------------------------------------------------------------------------------------------------

| |  |  | 2. |  | Compute
the amount that would have been included in the cost of the relevant asset, when the
liability was initially created, by capitalizing the amount of the liability, as noted in
item 1 above at the time when that liability was initially created (the Capitalized
Amount);
| |  |  | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | 3. |  | Compute
the Capitalized Amounts accumulated depreciation on January 1,           2007 on
the basis of the assets useful life at that time;
| |  |  | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | 4. |  | The
difference between the amount to be allocated to the asset, in accordance           with
items 2 and 3 above and the amount of the liability, based on item 1 above,
          will be allocated to retained earnings.
| |  |  | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is currently examining this new standard; however, at this stage, it is unable to
estimate the standards effect, if any, on its financial position, results of
operations. In January 2007 the Israeli Accounting Standard Board published a proposal
for accounting standard no. 28 that amends standard no.27 to allow, at transition, the
alternatives allowed under IFRS 1 regarding fixed assets.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-16-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS

|NOTE
2  | SIGNIFICANT ACCOUNTING POLICIES (cont.)
|-------- | ---------------------------------------

| |  | M. |  | Recent
Accounting Standards (cont.)
| |  | -- |  | -----------------------------------

| | Application
of Standard No.29 Adoption of International Financial Reporting Standards
| | ---------------------------------------------------------------------------------------

| | In
July 2006, the Israeli Accounting Standards Board published Accounting Standard No. 29 -Adoption
of International Financial Reporting Standards  IFRS (the Standard).
According to this Standard, the financial statements of an entity subject to the Israeli
Securities Law and authoritative Regulations thereunder, other than foreign corporations
as defined by this Law that prepares its financial statements in other than Israeli GAAP,
will be prepared for the reporting periods commencing January 1, 2008, including interim
periods, in accordance with the IFRS and related interpretations published by the
International Accounting Standards Board.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | An
entity adopting IFRS as of January 1, 2008 and electing to report comparative figures in
accordance with the IFRS for only 2007, will be required to prepare opening balance-sheet
amounts as of January 1, 2007 based on the IFRS.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Reporting
in accordance with the IFRS will be carried out based on the provisions of IFRS No. 1,
First-time Adoption of IFRS Standards, which establishes guidance on
implementing the transition from financial reporting based on domestic national
accounting standards to reporting in accordance with the IFRS.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | IFRS
No. 1 supersedes the transitional provisions established in other IFRSs (including those
established in former domestic national accounting standards), stating that all IFRSs
should be adopted retroactively for the opening balance-sheet amounts. Nevertheless, IFRS
No. 1 grants allowances on certain issues by not applying the retroactive application in
respect thereof. In addition, IFRS No. 1 contains certain exceptions with regard to the
retroactive application of certain aspects stipulated in other IFRSs.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Management
intends to examine the effect of the transition to IFRS, yet at this stage, is unable to
estimate the extent of such conversion on the Companys financial position and
results of operations.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Standard
No. 29 allows for earlier application in a manner by which applicable entities may
convert their financial statements published subsequent to July 31, 2006 to the IFRS.
Management has not yet decided whether to early-adopt the IFRS.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-17-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (Reported amounts) (NIS in thousands)

|NOTE
3  | TRADE RECEIVABLES
|-------- | -----------------

|                                       | Consolidated | 
|-------------------------------------- | ------------ | 
|
|
|Domestic                               |              | 
|Open accounts                          |              | 
|Checks receivable                      |              | 
|                                       |              | 
|                                       |              | 
|                                       |              | 
|Foreign                                |              | 
|Open accounts                          |              | 
|Related parties                        |              | 
|                                       |              | 
|                                       |              | 
|                                       |              | 
|                                       |              | 
|                                       |              | 
|Less - allowance for doubtful accounts |              | 
|                                       |              | 
|                                       |              | 
|                                       |              | 

|NOTE
4  | OTHER RECEIVABLES
|-------- | -----------------

|                          | Consolidated |  | Company |      
|------------------------- | ------------ |  | ------- | -----
|
|
|Deferred taxes (Note 20D) |              |  |         | 2,376
|Prepaid expenses          |              |  |         | 952  
|Advances to suppliers     |              |  |         | 1,861
|Value Added Tax           |              |  |         | -    
|Income tax advances, net  |              |  |         | 138  
|Others                    |              |  |         | 1,283
|                          |              |  |         |      
|                          |              |  |         | 6,610
|                          |              |  |         |      

-18-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (Reported amounts) (NIS in thousands)

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

|                                           | Consolidated |  | Company |        
|------------------------------------------ | ------------ |  | ------- | -------
|
|
|Raw and auxiliary materials                |              |  |         | 33,630 
|Finished products and goods in process (*) |              |  |         | 78,413 
|                                           |              |  |         |        
|                                           |              |  |         | 112,043
|                                           |              |  |         |        
|(*) Includes products in transit           |              |  |         | 4,440  
|                                           |              |  |         |        
|The inventories are presented net of       |              | 
|impairment provision                       |              |  |         | 540    
|                                           |              |  |         |        

|NOTE
6  | INVESTMENTS IN SUBSIDIARIES
|-------- | ---------------------------

| | Company | 
| | ------- | 
|
|
| |         | 

| |  | A. |  | Composition
| |  | -- |  | -----------

|                                          |  | 
|----------------------------------------- |  | 
|Cost of shares                            |  | 
|Accumulated losses since acquisition, net |  | 
|                                          |  | 
|                                          |  | 
|                                          |  | 

| | Consolidated | 
| | ------------ | 
|
|
| |              | 

| |  | B. |  | Goodwill
| |  | -- |  | --------

|                                |  | 
|------------------------------- |  | 
|Cost                            |  | 
|Less - accumulated amortization |  | 
|                                |  | 
|                                |  | 
|                                |  | 

| |  | C. |  | Consolidated
Subsidiaries
| |  | -- |  | -------------------------

| | The
consolidated financial statements as of December 31, 2006, include the financial
statements of the following Subsidiaries:
| | ------------------------------------------------------------------------------------------------------------------------------

|                                           | Ownership and control
As of December 31,
2 0 0 6
|------------------------------------------ | ------------------------------------------------
|
|Mondi Business Paper Hadera Marketing Ltd. |                                                 
|Grafinir Paper Marketing Ltd.              |                                                 
|Yavnir (1999) Ltd.                         |                                                 
|Miterani Paper Marketing 2000 (1998) Ltd.  |                                                 

-19-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (Reported amounts) (NIS in thousands)

|NOTE
7  | FIXED ASSETS
|-------- | ------------

|                            | Leasehold
improvements |  | Machinery
and
equipment |       | Motor
vehicles |  | Office
Furniture,
Computers
and
equipment |   | Total |      
|--------------------------- | ---------------------- |  | ----------------------- | ----- | -------------- |  | ----------------------------------------- | - | ----- | -----
|Consolidated                |                        |  |                         |       |                |  |                                           |   |       |      
|                            |                        | 
|Cost:                       |                        | 
|Balance - January 1, 2006   |                        |  |                         | 3,724 |                |  | 193,133                                   |   |       | 2,482
|Changes during 2006:        |                        | 
|Additions                   |                        |  |                         | -     |                |  | 8,062                                     |   |       | 776  
|Dispositions                |                        |  |                         | -     |                |  | (158                                      | ) |       | (151 
|                            |                        |  |                         |       |                |  |                                           |   |       |      
|Balance - December 31, 2006 |                        |  |                         | 3,724 |                |  | 201,037                                   |   |       | 3,107
|                            |                        |  |                         |       |                |  |                                           |   |       |      
|Accumulated depreciation:   |                        | 
|Balance - January 1, 2006   |                        |  |                         | 2,204 |                |  | 37,472                                    |   |       | 1,557
|Changes during 2006:        |                        | 
|Additions                   |                        |  |                         | 389   |                |  | 9,819                                     |   |       | 306  
|Dispositions                |                        |  |                         | -     |                |  | (6                                        | ) |       | (151 
|                            |                        |  |                         |       |                |  |                                           |   |       |      
|Balance - December 31, 2006 |                        |  |                         | 2,593 |                |  | 47,285                                    |   |       | 1,712
|                            |                        |  |                         |       |                |  |                                           |   |       |      
|Net book value:             |                        | 
|December 31, 2006           |                        |  |                         | 1,131 |                |  | 153,752                                   |   |       | 1,395
|                            |                        |  |                         |       |                |  |                                           |   |       |      
|December 31, 2005           |                        |  |                         | 1,520 |                |  | 155,661                                   |   |       | 925  
|                            |                        |  |                         |       |                |  |                                           |   |       |      
|Company                     |                        | 
|                            |                        | 
|Cost:                       |                        | 
|Balance - January 1, 2006   |                        |  |                         | 2,651 |                |  | 191,840                                   |   |       | 1,223
|Changes during 2006:        |                        | 
|Additions                   |                        |  |                         | -     |                |  | 8,062                                     |   |       | 776  
|Dispositions                |                        |  |                         | -     |                |  | (158                                      | ) |       | -    
|                            |                        |  |                         |       |                |  |                                           |   |       |      
|Balance - December 31, 2006 |                        |  |                         | 2,651 |                |  | 199,744                                   |   |       | 1,999
|                            |                        |  |                         |       |                |  |                                           |   |       |      
|Accumulated depreciation:   |                        | 
|Balance - January 1, 2006   |                        |  |                         | 1,570 |                |  | 36,558                                    |   |       | 373  
|Changes during 2006:        |                        | 
|Additions                   |                        |  |                         | 265   |                |  | 9,716                                     |   |       | 211  
|Dispositions                |                        |  |                         | -     |                |  | (6                                        | ) |       | -    
|                            |                        |  |                         |       |                |  |                                           |   |       |      
|Balance - December 31, 2006 |                        |  |                         | 1,835 |                |  | 46,268                                    |   |       | 584  
|                            |                        |  |                         |       |                |  |                                           |   |       |      
|Net book value:             |                        | 
|December 31, 2006           |                        |  |                         | 816   |                |  | 153,476                                   |   |       | 1,415
|                            |                        |  |                         |       |                |  |                                           |   |       |      
|December 31, 2005           |                        |  |                         | 1,081 |                |  | 155,282                                   |   |       | 850  
|                            |                        |  |                         |       |                |  |                                           |   |       |      

-20-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (Reported amounts) (NIS in thousands)

|NOTE
 8  | TRADE PAYABLES
|--------- | --------------

|                                      | Consolidated |  | Company |        
|------------------------------------- | ------------ |  | ------- | -------
|
|
|In Israeli currency                   |              |  |         | 29,006 
|In foreign currency or linked thereto |              |  |         | 79,001 
|                                      |              |  |         |        
|                                      |              |  |         | 108,007
|                                      |              |  |         |        

|NOTE
9  | OTHER PAYABLES AND ACCRUED EXPENSES
|-------- | -----------------------------------

|                               | Consolidated |  | Company |       
|------------------------------ | ------------ |  | ------- | ------
|
|
|Accrued payroll and            |              |  |         |       
|related expenses               |              |  |         | 12,719
|Value Added Tax                |              |  |         | 1,559 
|Advances from customers        |              |  |         | 1,165 
|NHBV - Accrual for license fee |              |  |         | 910   
|Interest payable               |              |  |         | 2,803 
|Other                          |              |  |         | 1,728 
|                               |              |  |         |       
|                               |              |  |         | 20,884
|                               |              |  |         |       

|NOTE
10  | LONG-TERM BANK LOANS
|--------- | --------------------

|                          |  | Consolidated | 
|------------------------- |  | ------------ | 
|
|
|
|A.     Composition        |  |              | 
|In U.S. dollar (**)       |  |              | 
|In NIS indexed to the CPI |  |              | 
|                          |  |              | 
|                          |  |              | 
|Less - current maturities |  |              | 
|                          |  |              | 
|                          |  |              | 
|                          |  |              | 

| | (*)                 Average
interest rate as of December 31, 2006.
| | ------------------------------------------------------------------

| | (**)              As
of December 31, 2006, NIS 6,360 thousand bear interest based on Libor plus +
          0.5%-0.6%.
| | ----------------------------------------------------------------------------------------------------------------------

-21-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (Reported amounts) (NIS in thousands)

|NOTE 10  | LONG-TERM BANK LOANS (cont.)
|--------- | ----------------------------

| | Consolidatedand Company | 
| | ----------------------- | 
|
|
| |                         | 

| |  | B. |  | Maturities
| |  | -- |  | ----------

|                   | 
|------------------ | 
|
|
|First year - 2007  | 
|Second year - 2008 | 
|Third year - 2009  | 
|Fourth year - 2010 | 
|Fifth year - 2011  | 
|                   | 
|                   | 
|                   | 

| |  | C. |  | According
to the loan agreements with the banks, as amended in the second half           of 2005,
the Company has to achieve, inter alia, financial ratio at the end of           each
audited fiscal year of total shareholders equity (which includes capital           notes
to shareholders) to total assets to be no less than 22%. In case the           Company
fails to fulfill these covenants, the banks are entitled to demand early
          repayment of the loans, in whole or in part.
| |  | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006, the Company was in full compliance with the covenants stipulated in
the bank agreements and this financial ratio amounted to 22.31%.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | D. |  | As
to a negative pledge agreement signed by the Company, see Note           13B.
| |  | -- |  | ----------------------------------------------------------------------------------

| |  | E. |  | In
2004 and 2003, the Company and its Subsidiaries entered into an agreement           for a
bank credit facility, pursuant to which the Company and its Subsidiaries           may,
from time to time, borrow an aggregate principal amount of up to adjusted           NIS
122,000 thousand. Under the terms of the agreement, the credit facility has           no
time limit. As of the balance sheet date, the Group utilized NIS 96,740
          thousand of the credit facility.
| |  | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 11  | CAPITAL NOTES TO SHAREHOLDERS
|--------- | -----------------------------

| | The
capital notes to shareholders are linked to the dollar and bear no interest. According to
the terms of the capital notes, the Company has the ultimate discretion upon the dates of
repayment of the capital notes. As of December 31, 2006 the total capital notes amount is
NIS 12,675 thousand. Management intends to repay NIS 6,337 thousand of the capital note
balance during 2007.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 12  | ACCRUED SEVERANCE PAY, NET
|--------- | --------------------------

| | Israeli
law and labor agreements determine the obligations of the Group to make severance
payments to dismissed employees and to employees leaving employment under certain other
circumstances. The liability for severance pay benefits, as determined by Israeli Law, is
based upon length of service and the employees most recent monthly salary. The
liability of the Group for severance pay to its permanent employees is covered by current
deposits to pension and severance funds. Accumulated amounts so funded are not under the
control or administration of the Group, and accordingly, neither those amounts nor the
corresponding accruals are reflected in the financial statements. The amounts presented
in the balance sheet as of December 31, 2006 reflects the severance pay liability in
respect of temporary employees.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-22-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (Reported amounts) (NIS in thousands)

|NOTE 13  | COMMITMENTS AND CONTINGENT LIABILITIES
|--------- | --------------------------------------

| |  | A. |  | Commitments:
| |  | -- |  | ------------

| |  |  | (1) |  | The
Group is obligated to pay license fees to a shareholder (see Note 21).
| |  |  | --- |  | --------------------------------------------------------------------------

| |  |  | (2) |  | The
Company and its Subsidiaries lease certain of their facilities under           operating
leases for varying periods with renewal options primarily from AIPM.           Future
minimum lease rentals as of December 31, 2006 are as follows:
| |  |  | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|     | Consolidated |  | Company |       
|---- | ------------ |  | ------- | ------
|2007 |              |  |         | 4,510 
|2008 |              |  |         | 4,367 
|2009 |              |  |         | 3,380 
|     |              |  |         |       
|     |              |  |         | 12,257
|     |              |  |         |       

| |  | B. |  | Liens
| |  | -- |  | -----

| | To
secure long-term bank loans and short-term bank credits (the balance of which as of
December, 31 2006 is NIS 161,094 thousand), the Company entered into a negative
pledge agreement under which the Company is committed not to pledge any of its
assets, excluding fixed pledges relating to assets financed by others, prior to the
consent of the banks.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | C. |  | Guarantees
| |  | -- |  | ----------

| | The
Company from time to time and in the course of its ongoing operations provides
guarantees, the amount of which as of December, 31 2006 was NIS 23,603 thousand.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 14  | SHARE CAPITAL
|--------- | -------------

| |  | A. |  | As
of December 31, 2006 and 2005, share capital is composed of ordinary shares
               of NIS 1.00 par value each. Authorized  38,000 shares; issued and
paid up                 1,000 shares.
| |  | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | B. |  | Holders
of ordinary shares are entitled to participate equally in the payment           of cash
dividends and bonus share (stock dividend) distributions and, in the           event of
the liquidation of the Company, in the distribution of assets after
          satisfaction of liabilities to creditors (See also Note 1A).
| |  | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-23-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (Reported amounts) (NIS in thousands)

|NOTE 15  | NET SALES
|--------- | ---------

|                      | Consolidated |  | Company |        
|--------------------- | ------------ |  | ------- | -------
|
|
|Industrial operations |              |  |         | 534,214
|Commercial operations |              |  |         | 177,331
|                      |              |  |         |        
|                      |              |  |         | 711,545
|                      |              |  |         |        

|NOTE 16  | COST OF SALES
|--------- | -------------

|                              | Consolidated |  | Company |        
|----------------------------- | ------------ |  | ------- | -------
|
|
|Purchases (*)                 |              |  |         | 165,168
|Materials consumed            |              |  |         | 343,801
|Salaries and related expenses |              |  |         | 38,082 
|Subcontracting                |              |  |         | 6,464  
|Energy costs                  |              |  |         | 63,013 
|Depreciation                  |              |  |         | 10,510 
|Other manufacturing costs     |              | 
|and expenses (including rent) |              |  |         | 28,884 
|                              |              |  |         |        
|                              |              |  |         | 655,922
|Change in finished goods ,    |              | 
|goods in process, and         |              | 
|products in transit (**)      |              |  |         | 3,923  
|                              |              |  |         |        
|                              |              |  |         | 659,845
|                              |              |  |         |        

| | (*)                 The
purchases of the Group are related principally to commercial operations.
| | ------------------------------------------------------------------------------------------------

| | (**)               Change
in raw and auxiliary materials are included in materials consumed.
| | --------------------------------------------------------------------------------------------

-24-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (Reported amounts) (NIS in thousands)

|NOTE 17  | SELLING EXPENSES
|--------- | ----------------

|                                              | Consolidated |  | Company |       
|--------------------------------------------- | ------------ |  | ------- | ------
|
|
|Salaries and related expenses                 |              |  |         | 19,190
|Packaging and shipping to customers           |              |  |         | 13,469
|Maintenance and rent                          |              |  |         | 8,494 
|Transportation expenses                       |              |  |         | 1,995 
|Advertising                                   |              |  |         | 70    
|Commissions and license fees to a shareholder |              |  |         | 961   
|Depreciation                                  |              |  |         | 327   
|Other                                         |              |  |         | -     
|                                              |              |  |         |       
|                                              |              |  |         | 44,506
|                                              |              |  |         |       

(*)              Reclassified.

|NOTE 18  | GENERAL AND ADMINISTRATIVE EXPENSES
|--------- | -----------------------------------

|                                 | Consolidated |  | Company |      
|-------------------------------- | ------------ |  | ------- | -----
|
|
|Salaries and related expenses    |              |  |         | 3,829
|Office maintenance               |              |  |         | 209  
|Professional and management fees |              |  |         | 1,792
|Depreciation                     |              |  |         | 70   
|Amortization of goodwill         |              |  |         | -    
|Bad and doubtful debts           |              |  |         | 1,627
|Other                            |              |  |         | 1,718
|                                 |              |  |         |      
|                                 |              |  |         | 9,245
|                                 |              |  |         |      

|NOTE 19  | FINANCING INCOME (EXPENSES), NET
|--------- | --------------------------------

|                                                | Consolidated |  | Company |       
|----------------------------------------------- | ------------ |  | ------- | ------
|
|
|Interest on long-term bank loans                |              |  |         | 5,803 
|                                                |              |  |         |       
|Erosion of monetary assets and liabilities, net |              |  |         | (3,036
|                                                |              |  |         |       
|Forward transaction                             |              |  |         | 515   
|                                                |              |  |         |       

-25-



---

# MONDI BUSINESS PAPER HADERA
LTD. NOTES TO FINANCIAL
STATEMENTS (Reported amounts) (NIS in thousands)

|NOTE 20  | INCOME TAXES (TAXES BENEFITS)
|--------- | -----------------------------

|A. |  | The
Company and its Subsidiaries are taxed according to the provisions of The
               Income Tax Ordinance and the Income Tax Law (Inflationary Adjustments),
1985.                The Company is an industrial company in conformity with the Law for
the                Encouragement of Industry (Taxes), 1969. The major benefit the Company
is                entitled to under this law is accelerated depreciation rates.
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|   | Consolidated |  | Company                         | 
|-- | ------------ |  | ------------------------------- | 
|
|
|B. |              |  | Composition                     | 
|   |              |  |                                 | 
|   |              |  | Current taxes                   | 
|   |              |  | Taxes in respect of prior years | 
|   |              |  | Deferred taxes (D. below)       | 
|   |              |  |                                 | 
|   |              |  |                                 | 
|   |              |  |                                 | 

|C. |  | Reconciliation
of the statutory tax rate to the effective tax rate
|-- |  | ------------------------------------------------------------------

| | Consolidated |  | Company                                       | 
| | ------------ |  | --------------------------------------------- | 
|
|
| |              |  | Income (loss) before income taxes             | 
| |              |  |                                               | 
| |              |  | Statutory tax rate                            | 
| |              |  | Tax computed by statutory tax rate            | 
| |              |  |                                               | 
| |              |  | Tax increments (savings) due to:              | 
| |              |  | Non-deductible expenses                       | 
| |              |  | Non-taxable income                            | 
| |              |  | Reduction in corporate tax rates - (E. below) | 
| |              |  | Differences arising from basis of measurement | 
| |              |  | Prior years income taxes                      | 
| |              |  |                                               | 
| |              |  |                                               | 
| |              |  |                                               | 

-26-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (Reported amounts) (NIS in thousands)

|NOTE 20  | INCOME TAXES (TAXES BENEFITS) (cont.)
|--------- | -------------------------------------

| |  | D. |  | Deferred
Taxes
| |  | -- |  | --------------

|                                             | Consolidated |  | Company |        
|-------------------------------------------- | ------------ |  | ------- | -------
|
|
|                                             |              |  |         |        
|Balance as of beginning year                 |              |  |         | (13,001
|Changes during the year                      |              |  |         | 1,330  
|Adjustment due to change in income tax rates |              |  |         | -      
|                                             |              |  |         |        
|Balance as of end of year                    |              |  |         | (11,671
|                                             |              |  |         |        

|                                            | Consolidated |  | Company |        
|------------------------------------------- | ------------ |  | ------- | -------
|
|
|Deferred taxes are presented in the         |              |  |         |        
|balance sheets as follows:                  |              | 
|                                            |              | 
|Other receivables and prepayments (Note 4): |              | 
|                                            |              | 
|Allowance for doubtful accounts             |              |  |         | 852    
|Vacation and recreation pay                 |              |  |         | 1,524  
|Carry forward tax losses                    |              |  |         | -      
|                                            |              |  |         |        
|                                            |              |  |         | 2,376  
|                                            |              |  |         |        
|Long-term liabilities:                      |              | 
|Depreciable fixed assets                    |              |  |         | (25,401
|Accrued severance pay, net                  |              |  |         | 11     
|Less- Carry forward tax losses              |              |  |         | 11,343 
|                                            |              |  |         |        
|                                            |              |  |         | (14,047
|                                            |              |  |         |        
|                                            |              |  |         | (11,671
|                                            |              |  |         |        

For 2005-2006 - Deferred taxes
were computed at rates between 31%-25%, primarily - 25%.

Deferred taxes are recognized in
respect of all carry forward losses of the Group, see F.

-27-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (Reported amounts) (NIS in thousands)

|NOTE 20  | INCOME TAXES (TAXES BENEFITS) (cont.)
|--------- | -------------------------------------

| |  | E. |  | Reduction
of Corporate Tax Rates
| |  | -- |  | --------------------------------

| | In
July 2005, the Israeli Knesset passed the Law for Amending the Income Tax Ordinance (No.
147), 2005, according to which commencing in 2006 the corporate income-tax rate would be
gradually reduced, for which a 31% tax rate was established, through 2010, in respect of
which a 25% tax rate was established. The effect of this amendment on the Groups
deferred income tax provisions is reflected by an increase of NIS 3,888 thousand in
income tax benefit for the year ended December 31, 2005.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | F. |  | Carryforward
tax losses of the Group and the Company are NIS 51,044 thousand           and NIS 50,271
thousand as of December 31, 2006, respectively.
| |  | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------

| |  | G. |  | The
Company and its Subsidiaries have tax assessments that are final through           the
2002 tax year.
| |  | -- |  | ---------------------------------------------------------------------------------------------------------

|NOTE 21  | RELATED PARTIES AND INTERESTED PARTIES
|--------- | --------------------------------------

| |  | A. |  | Balances
with Related Parties and Subsidiaries
| |  | -- |  | ----------------------------------------------

|                                           | Consolidated |  | Company | 
|------------------------------------------ | ------------ |  | ------- | 
|
|
|Trade receivables - AIPM                   |              |  | -       | 
|                                           |              |  |         | 
|Trade receivables - related parties        |              |  | 7,188   | 
|                                           |              |  |         | 
|Trade payables - AIPM                      |              |  | 62,807  | 
|                                           |              |  |         | 
|Trade payables - related parties           |              |  | 4,714   | 
|                                           |              |  |         | 
|Other payables and accrued expenses - AIPM |              |  | 2,402   | 
|                                           |              |  |         | 
|Other payables and accrued expenses -      |              | 
|related parties                            |              |  | 910     | 
|                                           |              |  |         | 
|Capital notes to shareholders              |              |  | 12,675  | 
|                                           |              |  |         | 

-28-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (Reported amounts) (NIS in thousands)

|NOTE 21  | RELATED PARTIES AND INTERESTED PARTIES (cont.)
|--------- | ----------------------------------------------

| |  | B. |  | Transactions
with Related Parties and Subsidiaries
| |  | -- |  | --------------------------------------------------

|                                         | Consolidated |  | Company | 
|---------------------------------------- | ------------ |  | ------- | 
|
|
|Sales to related parties                 |              |  | 96,520  | 
|                                         |              |  |         | 
|Sales to Subsidiaries                    |              |  | -       | 
|                                         |              |  |         | 
|Cost of sales                            |              |  | 106,679 | 
|                                         |              |  |         | 
|Selling expenses, net                    |              | 
|(Participation in selling expenses, net) |              |  | 4,413   | 
|                                         |              |  |         | 
|General and administrative expenses      |              |  | 1,234   | 
|                                         |              |  |         | 
|Financing expenses (income), net         |              |  | 2,361   | 
|                                         |              |  |         | 

| |  | C. | (1) |  | The Company leases its premises from AIPM and receives services (including
          electricity, water, maintenance and professional services) under agreements,
          which are renewed every year.
| |  | -- | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | (2) |  | The
Group is obligated to pay commissions and license fees to NAG.
| |  |  | --- |  | ------------------------------------------------------------------

|NOTE 22  | DISCLOSURE AND PRESENTATION OF FINANCIAL INSTRUMENTS
|--------- | ----------------------------------------------------

| |  | A. |  | Credit
Risk
| |  | -- |  | -----------

| | The
Groups revenue derives from a large number of customers mainly in Israel and in
Europe. Management regularly monitors the balance of trade receivables and the financial
statements include an allowance for doubtful accounts based on managements
estimation. Taking the aforementioned into consideration, the exposure to credit risk
from trade receivables is immaterial.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Cash
and cash equivalents (including amounts in foreign currency) are deposited with major
commercial banks in Israel.
| | ----------------------------------------------------------------------------------------------------------------------

| |  | B. |  | Fair
Value of Financial Instruments
| |  | -- |  | -----------------------------------

| | The
financial instruments of the Group consist primarily of non-derivative assets and
liabilities. Non-derivative assets include cash and cash equivalents, receivables and
other current assets. Non-derivative liabilities include short-term bank credit, trade
payables, other current liabilities, long-term loans from banks and capital notes to
shareholders. Due to the nature of these financial instruments, their fair value,
generally, is identical or close to the value at which they are presented in the
financial statements, unless stated otherwise.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of the long-term loans approximates their carrying value, since they bear
interest at rates close to the prevailing market rates.
| | ------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Group enters from time to time into off-balance sheet financial instruments for hedging
against currency and interest-rate risks.
| | -------------------------------------------------------------------------------------------------------------------------------------

-29-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (NIS in thousands)

|NOTE 23  | COMPANYS FINANCIAL STATEMENTS IN NOMINAL VALUES FOR TAX PURPOSES
|--------- | -----------------------------------------------------------------

| |  | A. |  | Balance
Sheets
| |  | -- |  | --------------

|                                           | Company | 
|------------------------------------------ | ------- | 
|
|
|Current Assets                             |         | 
|American Israeli Paper Mills Group, net    |         | 
|Other receivables                          |         | 
|Inventories                                |         | 
|                                           |         | 
|                                           |         | 
|                                           |         | 
|Long-Term Investments                      |         | 
|Investments in Subsidiaries                |         | 
|                                           |         | 
|Fixed Assets, net                          |         | 
|                                           |         | 
|Long -Term Assets                          |         | 
|Deferred Taxes                             |         | 
|                                           |         | 
|                                           |         | 
|                                           |         | 
|Current Liabilities                        |         | 
|Short  term bank credit                    |         | 
|Current maturities of long-term bank loans |         | 
|Capital notes to shareholders              |         | 
|Trade payables                             |         | 
|Subsidiaries                               |         | 
|Other payables and accrued expenses        |         | 
|                                           |         | 
|                                           |         | 
|                                           |         | 
|Long term liabilities                      |         | 
|Long-term bank loans                       |         | 
|Capital notes to shareholders              |         | 
|Accrued severance pay, net                 |         | 
|                                           |         | 
|                                           |         | 
|                                           |         | 
|Shareholders' Equity                       |         | 
|                                           |         | 
|                                           |         | 
|                                           |         | 

-30-



---

# MONDI BUSINESS PAPER
HADERA LTD. NOTES TO FINANCIAL
STATEMENTS (NIS in thousands)

|NOTE 23  | COMPANYS FINANCIAL STATEMENTS IN NOMINAL VALUES FOR TAX PURPOSES
(cont.)
|--------- | -------------------------------------------------------------------------

| |  | B. |  | Statement
of Operations
| |  | -- |  | -----------------------

|                                                | Year ended December 31, | 
|----------------------------------------------- | ----------------------- | 
|
|Net sales                                       |                         | 
|Cost of sales                                   |                         | 
|                                                |                         | 
|Gross profit                                    |                         | 
|                                                |                         | 
|Selling expenses                                |                         | 
|General and administrative expenses             |                         | 
|                                                |                         | 
|Operating profit (loss)                         |                         | 
|                                                |                         | 
|Financing (expenses) income, net                |                         | 
|Other income, net                               |                         | 
|                                                |                         | 
|Income (loss) before income tax benefits        |                         | 
|                                                |                         | 
|Income tax benefits                             |                         | 
|                                                |                         | 
|Income (loss) after income tax benefits         |                         | 
|                                                |                         | 
|Equity in net earnings (losses) of Subsidiaries |                         | 
|                                                |                         | 
|Net income (loss) for the year                  |                         | 
|                                                |                         | 

| |  | C. |  | Statements
of Changes in Shareholders' Equity
| |  | -- |  | ---------------------------------------------

|                            | Share
Capital |  | Premium |   | Retained
earnings |  | Total  | 
|--------------------------- | ------------- |  | ------- | - | ----------------- |  | ------ | 
|Balance - January 1, 2004   |               |  |         | 1 |                   |  | 41,125 | 
|Changes during 2004:        |               | 
|Net income for the year     |               |  |         | - |                   |  | -      | 
|                            |               |  |         |   |                   |  |        | 
|Balance - December 31, 2004 |               |  |         | 1 |                   |  | 41,125 | 
|Changes during 2005:        |               | 
|Loss for the year           |               |  |         | - |                   |  | -      | 
|                            |               |  |         |   |                   |  |        | 
|Balance - December 31, 2005 |               |  |         | 1 |                   |  | 41,125 | 
|Changes during 2006:        |               | 
|Loss for the year           |               |  |         | - |                   |  | -      | 
|                            |               |  |         |   |                   |  |        | 
|Balance - December 31, 2006 |               |  |         | 1 |                   |  | 41,125 | 
|                            |               |  |         |   |                   |  |        | 

-31-



---

| |                
| | ---------------
| | Item 19(a)(iii)

# HOGLA-KIMBERLY LTD.

# FINANCIAL STATEMENTS

# AS OF DECEMBER 31, 2006



---

# HOGLA-KIMBERLY LTD.

# FINANCIAL STATEMENTS AS OF DECEMBER 31, 2006

# TABLE OF CONTENTS

|                                                        | Page
|------------------------------------------------------- | ----
|Report of Independent Registered Public Accounting Firm | 1   
|Financial Statements:                                   |     
|Balance Sheets                                          | 2   
|Statements of Operations                                | 3   
|Statements of Changes in Shareholders' Equity           | 4   
|Statements of Cash Flows                                | 5-6 
|Notes to the Financial Statements                       | 7-36



---



---

HOGLA-KIMBERLY LTD.
BALANCE SHEETS(REPORTED AMOUNTS)(NIS in thousands)

|                                           |  | Consolidated |    | Company | 
|------------------------------------------ |  | ------------ | -- | ------- | 
|
|
|Current Assets                             |  |              |    |         | 
|Cash and cash equivalents                  |  |              | 3  |         | 
|Trade receivables                          |  |              | 4  |         | 
|Other receivables                          |  |              | 5  |         | 
|Inventories                                |  |              | 6  |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|Long-Term Investments                      |  |             
|Capital note of shareholder                |  |              | 7  |         | 
|Investments in Subsidiaries                |  |              | 8  |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|Fixed Assets                               |  |              | 9  |         | 
|Cost                                       |  |              |    |         | 
|Less - accumulated depreciation            |  |              |    |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|Other Assets                               |  |             
|Goodwill                                   |  |              | 8B |         | 
|Deferred taxes                             |  |              | 21 |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|Current Liabilities                        |  |             
|Short-term bank credit                     |  |              |    |         | 
|Current maturities of long-term bank loans |  |              | 12 |         | 
|Trade payables                             |  |              | 10 |         | 
|Other payables and accrued expenses        |  |              | 11 |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|Long-Term Liabilities                      |  |             
|Deferred taxes                             |  |              | 21 |         | 
|                                           |  |              |    |         | 
|Commitments and Contingent Liabilities     |  |              | 14 |         | 
|                                           |  |              |    |         | 
|Minority Interest                          |  |              |    |         | 
|                                           |  |              |    |         | 
|Shareholders' Equity                       |  |             
|Share capital                              |  |              | 15 |         | 
|Capital reserves                           |  |              |    |         | 
|Translation adjustments relating to        |  |             
|foreign held autonomous Subsidiary         |  |              |    |         | 
|Accumulated other comprehensive income     |  |              |    |         | 
|Retained earnings                          |  |              |    |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 
|                                           |  |              |    |         | 

|                                   |                         |                        
|---------------------------------- | ----------------------- | -----------------------
|/s/ T. Davis                       | /s/ O. Argov            | /s/ A. Shor            
|                                   |                         |                        
|T. Davis                           | O. Argov                | A. Schor               
|Chairman of the Board of Directors | Chief Financial Officer | Chief Executive Officer

Approval date of the financial
statements: March 1, 2007.

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

-2-



---

HOGLA-KIMBERLY LTD.
STATEMENTS OF OPERATIONS
(REPORTED AMOUNTS)
(NIS in thousands)

|                                 |  | Consolidated |  | Company   |  
|-------------------------------- |  | ------------ |  | --------- | -
|
|
|Net sales                        |  | 16           |  | 1,254,908 |  
|Cost of sales                    |  | 17           |  | 883,908   |  
|                                 |  |              |  |           |  
|Gross profit                     |  |              |  | 371,000   |  
|Selling and marketing expenses   |  | 18           |  | 269,223   |  
|General and                      | 
|administrative expenses          |  | 19           |  | 57,906    |  
|                                 |  |              |  |           |  
|Operating profit                 |  |              |  | 43,871    |  
|Financing income                 | 
|(expenses), net                  |  | 20           |  | (25,627   | )
|Other income, net                |  |              |  | 774       |  
|                                 |  |              |  |           |  
|Income before income taxes       |  |              |  | 19,018    |  
|                                 | 
|Income taxes                     |  | 21           |  | (35,903   | )
|                                 |  |              |  |           |  
|Income after income taxes        |  |              |  | (16,885   | )
|Equity in losses of Subsidiaries |  |              |  | -         |  
|Minority interest in losses      | 
|(earnings) of Subsidiary         |  |              |  | 6,214     |  
|                                 |  |              |  |           |  
|Net income (loss) for            | 
|the year                         |  |              |  | (10,671   | )
|                                 |  |              |  |           |  

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

-3-



---

HOGLA-KIMBERLY LTD.
STATEMENTS OF CHANGES
IN SHAREHOLDERS EQUITY
(REPORTED AMOUNTS)
(NIS in thousands)

|                             | Share capital |        | Capital
reserves |         | Translation
adjustments
relating to
foreign held
autonomous
Subsidiary |         | Accumulate other
comprehensive
income |     | Retained
earnings |         | Total |        
|---------------------------- | ------------- | ------ | ---------------- | ------- | ---------------------------------------------------------------------- | ------- | ------------------------------------- | --- | ----------------- | ------- | ----- | -------
|Balance - January 1, 2004    |               | 28,788 |                  | 156,799 |                                                                        | -       |                                       | -   |                   | 227,394 |       | 412,981
|Changes during 2004:         |              
|Distribution of bonus shares |               | 250    |                  | 23,615  |                                                                        | -       |                                       | -   |                   | (23,865 | )     | -      
|Translation adjustments      |               |        |                  |         |                                                                        |         |                                       |     |                   |         |       |        
|relating to foreign held     |               |        |                  |         |                                                                        |         |                                       |     |                   |         |       |        
|autonomous Subsidiary        |               | -      |                  | -       |                                                                        | (3,377  | )                                     | -   |                   | -       |       | (3,377 
|Net income for the year      |               | -      |                  | -       |                                                                        | -       |                                       | -   |                   | 26,928  |       | 26,928 
|                             |               |        |                  |         |                                                                        |         |                                       |     |                   |         |       |        
|Balance - December 31, 2004  |               | 29,038 |                  | 180,414 |                                                                        | (3,377  | )                                     | -   |                   | 230,457 |       | 436,532
|Changes during 2005:         |              
|Translation adjustments      |               |        |                  |         |                                                                        |         |                                       |     |                   |         |       |        
|relating to foreign held     |               |        |                  |         |                                                                        |         |                                       |     |                   |         |       |        
|autonomous Subsidiary        |               | -      |                  | -       |                                                                        | 3,995   |                                       | -   |                   | -       |       | 3,995  
|Dividend paid                |               | -      |                  | -       |                                                                        | -       |                                       | -   |                   | (43,619 | )     | (43,619
|Net income for the year      |               | -      |                  | -       |                                                                        | -       |                                       | -   |                   | 43,276  |       | 43,276 
|                             |               |        |                  |         |                                                                        |         |                                       |     |                   |         |       |        
|Balance - December 31, 2005  |               | 29,038 |                  | 180,414 |                                                                        | 618     |                                       | -   |                   | 230,114 |       | 440,184
|                             |               |        |                  |         |                                                                        |         |                                       |     |                   |         |       |        
|Changes during 2006:         |              
|Shares issued                |               | 600    |                  | 49,739  |                                                                        | -       |                                       | -   |                   | -       |       | 50,339 
|Translation adjustments      |               |        |                  |         |                                                                        |         |                                       |     |                   |         |       |        
|relating to foreign held     |               |        |                  |         |                                                                        |         |                                       |     |                   |         |       |        
|autonomous Subsidiary        |               | -      |                  | -       |                                                                        | (15,011 | )                                     | -   |                   | -       |       | (15,011
|Movement in capital reserve  |               |        |                  |         |                                                                        |         |                                       |     |                   |         |       |        
|of hedging transactions, net |               | -      |                  | -       |                                                                        | -       |                                       | (76 | )                 | -       |       | (76    
|Dividend paid                |               | -      |                  | -       |                                                                        | -       |                                       | -   |                   | (34,000 | )     | (34,000
|Loss for the year            |               | -      |                  | -       |                                                                        | -       |                                       | -   |                   | (10,671 | )     | (10,671
|                             |               |        |                  |         |                                                                        |         |                                       |     |                   |         |       |        
|Balance - December 31, 2006  |               | 29,638 |                  | 230,153 |                                                                        | (14,393 | )                                     | (76 | )                 | 185,443 |       | 430,765
|                             |               |        |                  |         |                                                                        |         |                                       |     |                   |         |       |        

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

-4-



---

HOGLA-KIMBERLY LTD.STATEMENTS OF CASH
FLOWS(REPORTED AMOUNTS)(NIS in thousands)

|                                              | Consolidated |         | Company |         
|--------------------------------------------- | ------------ | ------- | ------- | --------
|
|
|Cash flows - operating activities             |              |         |         |         
|Net income                                    |              | (10,671 | )       | 43,276  
|Adjustments to reconcile net income to        |             
|net cash provided by operating                |             
|activities (Appendix A)                       |              | (29,096 | )       | (37,622 
|                                              |              |         |         |         
|Net cash provided by (used in)                |              |         |         |         
|operating activities                          |              | (39,767 | )       | 5,654   
|                                              |              |         |         |         
|Cash flows - investing activities             |             
|Withdrawal of long-term bank deposit          |              | -       |         | 73,648  
|Capital notes and loans to Subsidiary         |              | -       |         | -       
|Merger of subsidiaries                        |              | -       |         | -       
|Acquisition of fixed assets                   |              | (26,822 | )       | (44,634 
|Proceeds from sale of fixed assets            |              | 150     |         | 293     
|                                              |              |         |         |         
|Net cash provided by (used in)                |              |         |         |         
|investing activities                          |              | (26,672 | )       | 29,307  
|                                              |              |         |         |         
|Cash flows - financing activities             |             
|Dividend paid                                 |              | (34,000 | )       | (43,619 
|Long-term loans received                      |              | -       |         | -       
|Repayment of long-term loans                  |              | (23,432 | )       | (94,437 
|Short-term bank credit                        |              | 96,156  |         | 21,475  
|                                              |              |         |         |         
|Net cash provided by                          |              |         |         |         
|(used in) financing activities                |              | 38,724  |         | (116,581
|                                              |              |         |         |         
|Translation adjustments of cash               |              |         |         |         
|and cash equivalents of foreign               |              |         |         |         
|held autonomous Subsidiary                    |              | (646    | )       | (193    
|                                              |              |         |         |         
|Increase (decrease) in cash and               |              |         |         |         
|cash equivalents                              |              | (28,361 | )       | (81,813 
|Cash and cash equivalents - beginning of year |              | 35,551  |         | 117,364 
|                                              |              |         |         |         
|Cash and cash equivalents - end of year       |              | 7,190   |         | 35,551  
|                                              |              |         |         |         

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

-5-



---

HOGLA-KIMBERLY LTD.
APPENDICES TO STATEMENTS OF CASH FLOWS 
(REPORTED AMOUNTS)
(NIS in thousands)

|                                       | Consolidated |         | Company |        
|-------------------------------------- | ------------ | ------- | ------- | -------
|
|
|A. Adjustments to reconcile net income |              |         |         |        
|to net cash provided by                |              |         |         |        
|operating activities                   |              |         |         |        
|Income and expenses items              |              |         |         |        
|not involving cash flows:              |              |         |         |        
|Minority interest in earnings of       |              |         |         |        
|Subsidiary                             |              | (6,215  | )       | 4,424  
|Equity in losses of Subsidiaries       |              | -       |         | -      
|Depreciation and amortization          |              | 24,820  |         | 25,162 
|Deferred taxes, net                    |              | (12,408 | )       | (12,740
|Gain from sale of fixed assets         |              | 37      |         | (293   
|Effect of exchange rate                |              |         |         |        
|differences, net                       |              | 5,332   |         | 20     
|Changes in assets and liabilities:     |              |         |         |        
|Decrease (increase) in trade           |              |         |         |        
|receivables                            |              | (12,229 | )       | (41,401
|Increase in other receivables          |              | 664     |         | (18,974
|Increase in inventories                |              | (37,114 | )       | (2,357 
|(Decrease) increase in trade payables  |              | (8,468  | )       | 6,167  
|Net change in balances with            |             
|related parties                        |              | 9,179   |         | (10,515
|Increase in other payables and         |             
|accrued expenses                       |              | 7,306   |         | 12,885 
|                                       |              |         |         |        
|                                       |              | (29,096 | )       | (37,622
|                                       |              |         |         |        
|B. Assets and liabilities of           |              |         |         |        
|mergered subsidiaries:                 |              |         |         |        
|Working capital (other than cash       |              |         |         |        
|and cash equivalents)                  |              | -       |         | -      
|Fixed assets                           |              | -       |         | -      
|Investments                            |              | -       |         | -      
|Other assets                           |              | -       |         | -      
|Long-term liabilities                  |              | -       |         | -      
|Short-term liabilities                 |              | -       |         | -      
|C. Non-cash activities                 |              |         |         |        
|Acquisition of fixed assets on credit  |              | 11,091  |         | 37,617 
|                                       |              |         |         |        
|Shares issue to share holders          |              |         |         |        
|considering there share in the         |              |         |         |        
|merged subsidiaries                    |              | 50,339  |         | -      
|                                       |              |         |         |        

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

-6-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 1    GENERAL

| | A. |  | Description
| | -- |  | -----------

| | Hogla
Kimberly Ltd. (the Company) and its Subsidiaries are engaged principally in
the production and marketing of paper and hygienic products. The Companys results
of operations are affected by transactions with shareholders and affiliated companies
(see Note 22).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is owned by  Kimberly  Clark  Corp.  ("KC" or the "Parent  Company")
                 (50.1%) and American-Israeli Paper Mills Ltd. ("AIPM") (49.9%).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
financial statements of the Company are prepared in accordance with the Israeli
Securities Regulations (Preparation of Annual Financial Statements), 1993.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. |  | Definitions:
| | -- |  | ------------

| |  | The Company |  | Hogla-Kimberly Ltd.
| |  | ----------- | - | -------------------

| |  | The Group |  | the  Company  and  its  Subsidiaries,  a list of which is  presented in Note 8D.
| |  | --------- | - | --------------------------------------------------------------------------------

| |  | Subsidiaries |  | companies  in which the Company  exercises  over
50%   ownership   and   control,
  directly or indirectly,  and whose
financial  statements are fully
consolidated with those of the Company.
| |  | ------------ | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Related Parties |  | as defined by  Opinion  No. 29 of the  Institute of Certified Public Accountants in Israel.
| |  | --------------- | - | -------------------------------------------------------------------------------------------

| |  | Interested Parties |  | as   defined   by   the    Israeli    Securities
Regulations     (Preparation     of
Financial Statements), 1993.
| |  | ------------------ | - | -----------------------------------------------------------------------------------------------------------------

| |  | Controlling Shareholder |  | as   defined   by   the    Israeli    Securities
Regulations Presentation   of Transactions between  a  Corporation
and  its   Controlling Shareholder in
the Financial Statements), 1996.
| |  | ----------------------- | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | NIS |  | New Israeli Shekel.
| |  | --- | - | -------------------

| |  | CPI |  | the Israeli consumer price index.
| |  | --- | - | ---------------------------------

| |  | Dollar |  | the U.S. dollar.
| |  | ------ | - | ----------------

| |  | Reported Amound |  | see Note 2A(1) below.
| |  | --------------- | - | ---------------------

| | C. |  | Use
of Estimates
| | -- |  | ----------------

| | The
preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities as
of the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from those estimates.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-7-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 2  
SIGNIFICANT ACCOUNTING POLICIES

| | The
following are the principal accounting policies applied in the preparation of the
financial statements in a manner consistent with previous years with the exception of the
application of the provisions of Standard No. 20 (Revised)  Accounting
Treatment for Goodwill and Other Intangibles upon the Acquisition of an Investee.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A. |  | Cessation
of Financial Statement Adjustment and Change to Reporting in Reported Amounts  Standard
No. 12
| | -- |  | ---------------------------------------------------------------------------------------------------------

| |  | (1) |  | Definitions
| |  | --- |  | -----------

| | Adjusted
Amounthistorical nominal amount adjusted for changes in the exchange
rate of the U.S. dollar as of December 31, 2003, in accordance with Opinion No. 36 of the
Institute of Certified Public Accountants in Israel.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Reported
Amount  Adjusted Amount plus amounts in nominal terms added subsequent to
December 31, 2003, and less amounts subtracted after that date.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------

| |  | (2) |  | General
| |  | --- |  | -------

| | In
January 2004, Israeli Accounting Standard No. 12 Cessation ofFinancial
Statements Adjustment came into effect. Following the initial implementation of
Standard No. 12, commencing January 1, 2004, the Group ceased the presentation of its
financial statements based on nominal historical cost adjusted for the changes in the
exchange rate of the U.S. dollar in relation to the NIS. Effective with the interim
financial statements as of March 31, 2004 and for the reporting periods thereafter,
including the years ended December 31, 2004 and 2005, the Groups financial
statements are prepared and presented in Reported Amounts.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Comparative
figures included in these financial statements relating to the year ended December 31,
2003, are presented in Adjusted Amounts.
| | -------------------------------------------------------------------------------------------------------------------------------------------

| | The
amounts at which non-monetary items are presented in these financial statements do not
necessarily represent their realization value or economic value, but solely their
Reported Amount.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys condensed financial statements in nominal values, on the basis of which
the Companys financial statements in Reported amounts and Adjusted Amounts were
prepared, are presented in Note 24.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-8-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 2  
SIGNIFICANT ACCOUNTING POLICIES (cont.)

| | A. |  | Cessation
of Financial Statement Adjustment and Change toReporting in
Reported Amounts  Standard No. 12 (cont.)
| | -- |  | ----------------------------------------------------------------------------------------------------------------

| |  | (3) |  | Principles
of Adjustment applicable for financial statements inreporting amounts
| |  | --- |  | --------------------------------------------------------------------------------

| |  |  | a. |  | Balance
Sheet Items
| |  |  | -- |  | -------------------

| | Non-monetary
items (items whose balances reflect historical value at acquisition or upon
establishment) are presented at their Adjusted Amounts as of December 31, 2003 plus
additions and dispositions occurring subsequent to such date. Additions made subsequent
to December 31, 2003 and dispositions of items added subsequent to such date, are
presented at their historical nominal value. Dispositions of items added on or prior to
December 31, 2003 are presented at their Adjusted Amount.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Monetary
items (items whose balance sheet amount reflects their current value or realization value
at the balance sheet date) are presented at their nominal value as of the balance sheet
date.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Investments
in Subsidiaries are presented based on the financial statements of these companies
prepared in accordance with the guidance of Standard No. 12.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | b. |  | Statement
of Operations Items
| |  |  | -- |  | -----------------------------

| | Income
and expenses reflecting transactions, and financial income and expenses, are presented at
their nominal value.
| | ---------------------------------------------------------------------------------------------------------------------

| | Income
and expenses deriving from non-monetary items (mainly depreciation, amortization and
changes in inventory) were presented in a manner corresponding to the presentation of the
related non-monetary balance sheet item, as illustrated above.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys share in the results of Subsidiaries is determined based on the financial
statements of these companies prepared in accordance with the guidance of Standard No.
12.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-9-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 2  
SIGNIFICANT ACCOUNTING POLICIES (cont.)

| | B. |  | Translation
of Foreign Operations Financial Statements           Standard No. 13
| | -- |  | ----------------------------------------------------------------------------------

| | In
January 2004, Israeli Accounting Standard No.           13 Effect of Changes inForeign Exchange Rates came           into effect. This Standard
addresses the translation of transactions denominated           in foreign currency, as
well as the translation of financial statements of a           foreign entity, for
inclusion in the financial statements of the reporting           company. Standard No. 13
supersedes Clarifications No. 8 and 9 to Opinion No. 36           of the Institute of
Certified Public Accountants in Israel, which were nullified           on the date on
which Accounting Standard No. 12 came into effect, as described           in A above.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Principles
of Translation of financial Statements of Foreign Held AutonomousSubsidiary
applicable for financial statements relating to reporting periodsended in
December 31, 2006, 2005 and 2004
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | Monetary
and non-monetary assets and liabilities of the foreign entity are translated at the
closing rate.
| |  | - |  | ----------------------------------------------------------------------------------------------------------

| |  |  |  | Statement
of operations items and cash flow items of the foreign entity are translated, in general,
by the average exchange rate for the reporting period, rather than by the closing rate as
was previously required under the applicable accounting literature prior to the date in
which Standard No. 13 came into effect (January 1, 2004).
| |  | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | All
differences resulting from the translation of the foreign entitys financial
statements by the method described above, are included in a separate component of
shareholders equity as Translation adjustments relating to foreign held
autonomous Subsidiary.
| |  | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  |  | Following
the implementation of Standard No. 13, commencing January 2004 goodwill derived from an
investment made in another entity is to be treated as one of that entitys assets.
Accordingly, the goodwill associated with the Groups investment in Ovisan (a
Subsidiary located in Turkey) is translated to NIS at the closing rate, rather than at
the exchange rate at the date in which said investment was made, as was previously
required under the applicable accounting literature in effect through December 31, 2003.
| |  | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-10-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 2  
SIGNIFICANT ACCOUNTING POLICIES (cont.)

| | C. |  | Principles
of Consolidation
| | -- |  | ---------------------------

| | The
consolidated financial statements include consolidation of the financial statements of
the Company and all its Subsidiaries. Material inter-company balances and transactions of
and between Subsidiaries and the Company have been fully eliminated.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
data included in the consolidated financial statements is based on audited financial
statements of the Subsidiaries included therein.
| | -----------------------------------------------------------------------------------------------------------------------------------------

| | The
excess cost of an investment in a Subsidiary in Turkey over the net book value upon
acquisition of that Subsidiary is allocated to fixed assets and is amortized at the rate
applicable to those assets, or upon their realization. The unallocated excess cost
deriving from the difference between the fair value of the subsidiary identifiable assets
(including intangible assets) over the fair value of the subsidiary identifiable
liabilities (after deferred taxes) at the acquisition date reflects goodwill, which is
presented in the consolidated balance sheet as other assets and has been
amortized by December 31, 2005 over about 6.5 years.See
note I below for the accounting for goodwill as of January 1, 2006.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. |  | Cash
and Cash Equivalents
| | -- |  | -------------------------

| | Cash
and cash equivalents include bank deposits, available for immediate withdrawal, as well
as unrestricted short-term deposits with maturities of less than three months from the
date of deposit.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. |  | Allowance
for Doubtful Accounts
| | -- |  | -------------------------------

| | The allowance for doubtful accounts is generally computed as percentage from the relevant
balances, on the basis of historical experience, with the addition of a specific
provision in respect of accounts, which on management estimate are doubtful of
collection.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. |  | Inventories
| | -- |  | -----------

| | Inventories
are presented at the lower of cost or market value, with cost determined as follows:
| | ------------------------------------------------------------------------------------------------

| | Finished products                  | - | Based on actual production cost.
| | ---------------------------------- | - | --------------------------------
| | Raw, auxiliary materials and other | - | Based on moving-average basis.  

| | See
also Note 2P below with regards to standard No 26 Inventory.
| | ------------------------------------------------------------------

| | G. |  | Investments
in Subsidiaries
| | -- |  | ---------------------------

| | Investments
in Subsidiaries are presented using the equity method based on their audited financial
statements. In relation to excess cost of investment in Subsidiary in Turkey, see C
above.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-11-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 2  
SIGNIFICANT ACCOUNTING POLICIES (cont.)

| | H. |  | Fixed
Assets
| | -- |  | ------------

| | Fixed
assets are presented at cost less accumulated depreciation and amortization. Depreciation
is calculated using the straight-line method at rates considered adequate to depreciate
the assets over their estimated useful lives. Amortization of leasehold improvements is
computed over the shorter of the term of the lease, including any option period, where
the Company intends to exercise such option, or their useful life.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|The annual depreciation and amortization rates are: | %    
|--------------------------------------------------- | -----
|Buildings                                           | 2-4  
|Leasehold improvements                              | 10-25
|Machinery and equipment                             | 5-10 
|Motor vehicles                                      | 15-20
|Office furniture and equipment                      | 6-33 

| | Impairment
of Long-Lived Assets
| | -------------------------------

| | Management
reviews long-lived assets on a periodic basis, as well as when such a review is required
based upon relevant circumstances, to determine whether events or changes in
circumstances indicate that the carrying amount of such assets may not be recoverable.
According to Standard No. 15 of the Israeli Accounting Standards Board, Impairment
of Assets, an assets recoverable value is the higher of the assets
net selling price and the assets value in use, the latter being equal to the assets
discounted expected cash flows. If applicable, an impairment charge is recorded at the
amount in which the carrying amount of the asset exceeds its recoverable value.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | See
Note 2P below with regards to standard No. 27 Fixed Asset.
| | ----------------------------------------------------------------

| | I. |  | Other
Assets Goodwill
| | -- |  | ----------------------

| | As
of January 1, 2006 the Company applies Standard No. 20 (revised) Accounting
Treatment for Goodwill and Other Intangibles upon the Acquisition of an Investee (in
this paragraph- the standard).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | By
December 31, 2005 the Company had systematically amortized its goodwill deriving from the
Acquisition of investees using the straight line method over periods of 15 years.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As of January 1, 2006 the Company applies the Standard.
In
accordance with the standard, goodwill is the unallocated excess cost due to investment in
an investee deriving from the difference between the fair value of the investees
identifiable assets (including intangible assets) over the fair value of its identifiable
liabilities (after deferred taxes) at the acquisition date. Goodwill is no longer
amortized in a systematic manner, but is examined for impairment annually, or more
frequently if events or changes in circumstances indicate that it might be impaired.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
case of a realization of an investment in a subsidiary the goodwill will be taken into
consideration in determining the profit or loss from the realization.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

-12-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL STATEMENTS(REPORTED AMOUNTS)

# NOTE 2  
SIGNIFICANT ACCOUNTING POLICIES (cont.)

| | J. |  | Supplier
Discounts
| | -- |  | ------------------

| | Ongoing
discounts granted by suppliers, as well as year end discounts, in respect of which no
commitments to meet given targets are required by the Group, are included in the
financial statements upon the execution of purchases that grant the Group said discounts.
Supplier discounts contingent upon the Groups fulfillment of certain targets, such
as meeting a minimal annual volume (in quantities or amount), or an increase in purchases
over previous periods, are included in the financial statements in proportion to the Groups
purchases from suppliers during the reported period, which advance the Group towards the
stated targets, only if it is expected that those targets will be reached and the
discounts can reasonably be estimated. The estimate of meeting the targets is based,
inter-alia, on historical experience, Groups relationships established with the
suppliers and the estimated volume of purchases during the remaining reported period.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | K. |  | Deferred
Income Taxes
| | -- |  | ---------------------

| | The
Group records deferred income taxes in respect of temporary differences between the
carrying values of assets and liabilities in the financial statements and their values
for tax purposes, including those that result from depreciation differences on leased
property and fixed assets. The Group records deferred-tax assets in respect of temporary
differences as well as in respect of carry-forward tax losses so long as it is probable
that those assets will be realized in the foreseeable future. The deferred income taxes
are computed using the tax rates expected to be in effect at realization according to tax
laws that have been substantively enacted by the balance sheet date.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
computation of deferred income taxes has not taken into account taxes that would have
been applicable in case of future realization of investments in Subsidiaries, since the
Group does not contemplate such realization in the foreseeable future. Moreover, the
computation also excludes deferred taxes in respect of dividend distributions within the
Group for cases in which such dividend distributions are expected to be tax-exempt.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | L. |  | Dividends
| | -- |  | ---------

| | Dividends
proposed or declared subsequent to the balance-sheet date, but prior to the financial
statements approval date, are presented as a separate component of shareholdersequity.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | M. |  | Revenue
Recognition
| | -- |  | -------------------

| | Revenues
are recognized upon shipment, when title has been transferred and collectibility is
reasonably assured.
| | ----------------------------------------------------------------------------------------------------------------

| | Revenues
are presented net of sales incentives, primarily: bonuses granted to chains as a
percentage of their purchases (target bonus); volume discounts; and coupons distributed
to customers entitling price discounts.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | An
accrual for estimated returns and sales incentives, computed primarily on the basis of
historical experience, is recorded at the time revenues are recognized and deducted from
revenues.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-13-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 2  
SIGNIFICANT ACCOUNTING POLICIES (cont.)

| | N. |  | Freestanding
derivative financial instruments
| | -- |  | ---------------------------------------------

| | The
Company recognizes freestanding derivative financial instruments as either assets or
liabilities in its balance sheets and measures those instruments at fair value.
Accounting for changes in the fair value of a derivative depends on the intended use of
the derivative and the resulting designation. For a foreign exchange derivative
instrument designated as a cash flow hedge, the effective portion of the derivative is
initially reported as a component of shareholders equity as accumulated other
comprehensive income subsequently recognized into earnings as the hedged item affects
earnings. The ineffective portion of the derivative is recognized in earnings
immediately. For derivative instruments that are not designated as cash flow hedges,
changes in fair value are recognized in earnings according to changes in their fair
value.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company formally documents all relationships between hedging instruments and hedged items
and the risk management objective and strategy for each hedge transaction. At inception
of the hedge and quarterly thereafter, the Company performs a correlation assessment to
determine whether changes in the fair values or cash flows of the derivatives are deemed
highly effective in offsetting changes in the fair values or cash flows of the hedged
items. If at any time subsequent to the inception of the hedge, the correlation
assessment indicates that the derivative is no longer highly effective as a hedge, the
Company discontinues hedge accounting and recognizes all subsequent derivative gains and
losses in the results of operations.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | O. |  | Exchange
Rates and Linkage Basis
| | -- |  | --------------------------------

| |  | (1) |  | Balances
in foreign currency or linked thereto are included in the financial           statements
based on the representative exchange rates, as published by the Bank           of Israel
that were prevailing at the balance sheet date.
| |  | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | (2) |  | Exchange-rate
differences are charged to operations as incurred.
| |  | --- |  | ----------------------------------------------------------------

| |  | (3) |  | Following are the changes in the representative exchange rate of the U.S.           dollar
vis-a-vis the NIS and the Turkish Lira, and in the CPI:
| |  | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------

|As of:                                    | Representative
exchange
rate of the Dollar
(NIS per $1) |  | Turkish Lira exchange
rate vis-a-vis the
U.S. dollar
(TL'000 per $1) |        | CPI
"in respect of"
(in points) | 
|----------------------------------------- | ------------------------------------------------------- |  | -------------------------------------------------------------------- | ------ | ------------------------------- | 
|December 31, 2006                         |                                                         |  |                                                                      | 4.225  |                                 | 
|December 31, 2005                         |                                                         |  |                                                                      | 4.603  |                                 | 
|December 31, 2004                         |                                                         |  |                                                                      | 4.308  |                                 | 
|                                          |                                                         | 
|Increase (decrease)during the year ended: |                                                         |  |                                                                      | %      |                                 | 
|December 31, 2006                         |                                                         |  |                                                                      | (8.21) |                                 | 
|December 31, 2005                         |                                                         |  |                                                                      | 6.85   |                                 | 
|December 31, 2004                         |                                                         |  |                                                                      | (1.62) |                                 | 

-14-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 2  
SIGNIFICANT ACCOUNTING POLICIES (cont.)

| | P. |  | Recent
Accounting Standards
| | -- |  | ---------------------------

| | Standard
No. 23 Accounting for Transactions between an Entity and a
controlling party
| | ---------------------------------------------------------------------------------------

| | In
December 2006 the Israeli Accounting Standards Board published Accounting Standard No.
23, Accounting for Transactions between an Entity and a controlling party
(hereinafter  the Standard). The Standard applies to entities subject to the
Israeli Securities Law-1968.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Standard establishes the requirements for accounting for transactions between an entity
and its controlling party, which involve asset transfers, assumption of liability,
reimbursement or debt concession, and receipt of loans. The Standard does not apply to
business combinations between entities under common control.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Standard stipulates that transactions between an entity and a controlling party will be
measured based on fair value; transactions which in nature are owner investments or
distributions to owners should be reported directly in equity and not be recognized in
the controlled entitys profit and loss; the differences between the consideration
in transactions between an entity and a controlling party and their fair value will be
recognized directly in equity. Current and deferred taxes pertaining to the items
recognized in equity due to transactions with controlling parties will be recognized
directly in equity as well.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Standard is effective for transactions between an entity and a controlling party taking
place subsequent to January 1, 2007 and for loans granted from or given to a controlling
party prior to the Standards effective date, starting on the Standards
effective date.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Management
is currently examining this new standard, at this stage, it is unable to estimate the
standards effect, if any, on its financial position, results of operations and cash
flows.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Application
of Standard No.26 Inventory
| | -----------------------------------------

| | In
August 2006 the Israeli Accounting Standards Board published Accounting Standard No. 26
 Inventory (the Standard), which outlines the accounting
treatment of inventory.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard applies to all types of inventory, other than buildings constructed for sale and
addressed by Accounting Standard No.2 (Construction of Buildings for Sale),
inventory of work in progress stemming from performance contracts, addressed by
Accounting Standard No.4 (Work Based on Performance Contract), financial
instruments and biological assets relating to agricultural activity and agricultural
production during harvest.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard establishes, among other things, that inventory should be stated at the lower
between cost and net realizable value. Cost is determined by the first in, first out
(FIFO) method or by average weighted cost used consistently for all types of inventory of
similar nature and uses. In certain circumstances the standard requires cost
determination by a specific identification of cost, which includes all purchase and
production costs, as well as any other costs incurred in reaching the inventorys
present stage.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-15-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 2  
SIGNIFICANT ACCOUNTING POLICIES (cont.)

| | P. |  | Recent
Accounting Standards (cont.)
| | -- |  | -----------------------------------

| | Application
of Standard No. 26 Inventory (cont.)
| | --------------------------------------------------

| | When
inventory is acquired on credit incorporating a financing component, the inventory should
then be presented at cost equaling purchase cost in cash. The financing component is
recognized as a financing expense over the term of the credit period.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Any
reduction of inventory to net realizable value following impairment as well as any other
inventory loss should be expensed in the current period.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------

| | Subsequent
elimination of an impairment write-down that stems from an increase in net realizable
value will be allocated to operations during the period in which the elimination took
place.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
standard will apply to financial statements covering periods beginning January 1, 2007
and onwards and be implemented retroactively.
| | -----------------------------------------------------------------------------------------------------------------------------------------

| | Management
believes that the standard will not affect the Companys financial position, results
of operations and cash flows.
| | -----------------------------------------------------------------------------------------------------------------------------

| | Application
of Standard No. 27 Fixed Asset
| | --------------------------------------------

| | In
September 2006 the Israeli Accounting Standards Board published Accounting Standard No.
27 (Fixed Assets), which establishes the accounting treatment of fixed
assets, including recognition of assets, determination of their book value, related
depreciation, losses from impairment as well as the disclosure required in the financial
statements.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard states that a fixed-asset item will be measured at the initial recognition date
based cost which includes, in addition to the purchase price, all the related costs
incurred for bringing the item to the position enabling it to operate in the manner
contemplated by management. The cost also includes the initial estimate of costs required
to dismantle and remove the item, along with the expenses incurred in reconstructing the
site on which the item had been placed and in respect of which the entity incurred that
obligation when the item had been acquired or following its use over a given period of
time not in the production of inventory during that period.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard also states that when acquiring assets in exchange for a non-monetary asset or a
combination of monetary as well as non-monetary assets, the cost will be determined at
fair value unless (a) the barter transaction has no commercial essence or (b) it is
impossible to reliably measure the fair value of the asset received and the asset
provided. Should the provided asset not be measured at fair value, its cost would equal
book value.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Following
the initial recognition, the standard permits the entity to implement in its accounting
policy the measurement of the fixed assets by the cost method or by revaluation so long
as this policy is implemented in regard to all the items in that Company.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Cost
method  an item will be presented at net book value, less accumulated impairment
losses.
| | ----------------------------------------------------------------------------------------------

-16-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 2  
SIGNIFICANT ACCOUNTING POLICIES (cont.)

| | P. |  | Recent
Accounting Standards (cont.)
| | -- |  | -----------------------------------

| | Application
of Standard No. 27 Fixed Asset(cont.)
| | ---------------------------------------------------

| | Revaluation
method  an item whose fair value can be measured reliably will be presented at its
estimated amount, which equals its fair value at the revaluation date, net of
depreciation accumulated subsequently and less accumulated impairment losses.
Revaluations should take place on a current basis in order to ensure that book value does
not materially differ from the fair value that would have been determined on the
balance-sheet date. The revaluation of a single item calls for the revaluation of the
entire Company and if the assets book value rises following this revaluation, this
increase should be allocated directly to shareholders equity (revaluation
reserve). Nevertheless, this increase will be recognized as an operating item up to
the amount offsetting the decrease from that assets revaluation recognized
previously as income or loss. Should book value decline following revaluation, this
decline will be recognized as an operating item yet allocated directly to shareholders equity
(revaluation reserve) up to the amount leaving any credit balance in that
reserve in respect of that asset.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Any
fixed asset with a meaningful cost in relation to the items total cost should be
depreciated separately. Moreover, the depreciation method used will be reviewed at least
once at yearend and, if any meaningful change had taken place in the estimated
consumption of future economic benefits inherent in the asset, the method should be
modified to reflect such changes. This change will be treated as a change in an
accounting estimate.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
new standard will apply to financial statements covering periods beginning January 1,
2007 and onwards and implemented retroactively, except for the following:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | An
entity which chooses on January 1, 2007 the revaluation method will treat the difference
between the assets estimated book value and its cost as a revaluation reserve at
that time.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | An
entity which did not include in the cost of an item, upon initial recognition, the
initial estimate of dismantling and removing costs along with site reconstruction costs
will be required to:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 1. |  | Measure the liability on January 1, 2007 in conformity with generally accepted
          accounting principles;
| |  | -- |  | ---------------------------------------------------------------------------------------------------------------

| |  | 2. |  | Compute
the amount that would have been included in the cost of the relevant           asset,
when the liability was initially created, by capitalizing the amount of           the
liability, as noted in item 1 above at the time when that liability was
          initially created (the Capitalized Amount);
| |  | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 3. |  | Compute
the Capitalized Amounts accumulated depreciation on January 1,           2007 on
the basis of the assets useful life at that time;
| |  | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------

| |  | 4. |  | The
difference between the amount to be allocated to the asset, in accordance           with
items 2 and 3 above and the amount of the liability, based on item 1 above,
          will be allocated to retained earnings.
| |  | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is currently examining this new standard; however, at this stage, it is unable to
estimate the standards effect, if any, on its financial position, results of
operations and cash flows.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
January 2007 the Israeli Accounting Standard Board published a proposal for accounting
standard no. 28 that amends standard no.27 to allow, at transition, the alternatives
allowed under IFRS 1 regarding fixed assets.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-17-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 2    
SIGNIFICANT ACCOUNTING POLICIES (cont.)

| | P. |  | Recent
Accounting Standards (cont.)
| | -- |  | -----------------------------------

| | Application
of Standard No.29 Adoption of International Financial Reporting
Standards
| | ---------------------------------------------------------------------------------------

| | In
July 2006, the Israeli Accounting Standards Board published Accounting Standard No. 29 -Adoption
of International Financial Reporting Standards  IFRS (the Standard).
According to this Standard, the financial statements of an entity subject to the Israeli
Securities Law and authoritative Regulations thereunder, other than foreign corporations
as defined by this Law that prepares its financial statements in other than Israeli GAAP,
will be prepared for the reporting periods commencing January 1, 2008, including interim
periods, in accordance with the IFRS and related interpretations published by the
International Accounting Standards Board.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | An
entity adopting IFRS as of January 1, 2008 and electing to report comparative figures in
accordance with the IFRS for only 2007, will be required to prepare opening balance-sheet
amounts as of January 1, 2007 based on the IFRS.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Reporting
in accordance with the IFRS will be carried out based on the provisions of IFRS No. 1,
First-time Adoption of IFRS Standards, which establishes guidance on
implementing the transition from financial reporting based on domestic national
accounting standards to reporting in accordance with the IFRS.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | IFRS
No. 1 supersedes the transitional provisions established in other IFRSs (including those
established in former domestic national accounting standards), stating that all IFRSs
should be adopted retroactively for the opening balance-sheet amounts. Nevertheless, IFRS
No. 1 grants allowances on certain issues by not applying the retroactive application in
respect thereof. In addition, IFRS No. 1 contains certain exceptions with regard to the
retroactive application of certain aspects stipulated in other IFRSs.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Management
intends to examine the effect of the transition to IFRS, yet at this stage, is unable to
estimate the extent of such conversion on the Companys financial position and
results of operations.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Standard
No. 29 allows for earlier application in a manner by which applicable entities may
convert their financial statements published subsequent to July 31, 2006 to the IFRS.
Management has not yet decided whether to early-adopt the IFRS.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 3  
CASH AND CASH EQUIVALENTS

|                      | Consolidated |  | Company |      
|--------------------- | ------------ |  | ------- | -----
|
|
|
|In NIS                |              |  |         | 464  
|In foreign currencies |              |  |         | 6,726
|                      |              |  |         |      
|                      |              |  |         | 7,190
|                      |              |  |         |      

-18-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 4   
TRADE RECEIVABLES

|                                       | Consolidated |  | Company |        
|-------------------------------------- | ------------ |  | ------- | -------
|
|
|
|Domestic - Open accounts               |              |  |         | 174,509
|-  Checks receivable                   |              |  |         | 34,312 
|-  Related parties (*)                 |              |  |         | 428    
|                                       |              |  |         |        
|                                       |              |  |         | 209,249
|                                       |              |  |         |        
|Foreign - Open accounts                |              |  |         | 70,917 
|-  Related parties                     |              |  |         | -      
|                                       |              |  |         |        
|                                       |              |  |         | 70,917 
|                                       |              |  |         |        
|                                       |              |  |         | 280,166
|Less - allowance for doubtful accounts |              |  |         | 17,040 
|                                       |              |  |         |        
|                                       |              |  |         | 263,126
|                                       |              |  |         |        
|                                       |              |  |         |        

| | (*)
                  Balances with Israeli related
parties are linked to the CPI and bear 4% annual           interest
| | -----------------------------------------------------------------------------------------------------------------------

| | The
Companys products are marketed principally by its Subsidiaries.
| | --------------------------------------------------------------------

# NOTE 5   OTHER
RECEIVABLES

|                          | Consolidated |  | Company |       
|------------------------- | ------------ |  | ------- | ------
|
|
|
|Deferred taxes (Note 21D) |              |  |         | 6,641 
|Prepaid expenses          |              |  |         | 1,753 
|Advances to suppliers     |              |  |         | 5,583 
|Value Added Taxes         |              |  |         | 26,170
|Income tax advances, net  |              |  |         | 10,471
|Loans to employees        |              |  |         | 689   
|Related party             |              |  |         | -     
|Other                     |              |  |         | 2,439 
|                          |              |  |         |       
|                          |              |  |         | 53,746
|                          |              |  |         |       

# NOTE 6   INVENTORIES

|                            | Consolidated |  | Company |        
|--------------------------- | ------------ |  | ------- | -------
|
|
|
|Raw and auxiliary materials |              |  |         | 84,798 
|Finished goods              |              |  |         | 70,043 
|Spare parts and other       |              |  |         | 23,021 
|                            |              |  |         |        
|                            |              |  |         | 177,862
|                            |              |  |         |        

-19-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 7  
CAPITAL NOTE OF SHAREHOLDER

| | The
capital note of AIPM, denominated in NIS, is not linked and does not bear interest.
Repayment date will be mutually agreed upon.
| | ------------------------------------------------------------------------------------------------------------------------------------

# NOTE 8  
INVESTMENTS IN SUBSIDIARIES

|                                                   | Company | 
|-------------------------------------------------- | ------- | 
|                                                   |         | 
|                                                   |         | 
|                                                   |         | 
|                                                   |         | 
|                                                   |         | 
|                                                   |         | 
|A.     Composition                                 |         | 
|                                                   |         | 
|Cost of shares                                     |         | 
|Capital Injection                                  |         | 
|Equity in post-acquisition earnings, net           |         | 
|Merger of subsidiaries (see also E below)          |         | 
|                                                   |         | 
|Translation adjustments relating to                |         | 
|foreign held autonomous Subsidiary                 |         | 
|                                                   |         | 
|                                                   |         | 
|                                                   |         | 
|                                                   |         | 
|Capital notes (1)                                  |         | 
|Translation adjustments on loans and capital notes |         | 
|                                                   |         | 
|                                                   |         | 
|                                                   |         | 
|                                                   |         | 
|                                                   |         | 

| | (1)
                  Non-interest capital notes,
denominated in Turkish Lira, with all principle to           be repaid in 2025. See also
C below.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------

|                                   |  | 
|---------------------------------- |  | 
|                                   |  | 
|                                   |  | 
|                                   |  | 
|                                   |  | 
|                                   |  | 
|                                   |  | 
|                                   |  | 
|B.    Goodwill (see Note 2C above) |  | 
|                                   |  | 
|Cost                               |  | 
|Translation adjustments            |  | 
|                                   |  | 
|                                   |  | 
|Less - accumulated amortization    |  | 
|                                   |  | 
|                                   |  | 
|                                   |  | 

| | C. |  | Investment
in Kimberli Clark Tuketim Mallari Sanayi Ve Ticaret A.S. (KCTR)
(formerly: Ovisan)
| | -- |  | -----------------------------------------------------------------------------------------------

| | As
of December 31, 2006 and 2005, the Groups investment in KCTR (a Turkish Subsidiary)
amounted to NIS 122,379 and 4,358 thousand respectively (including goodwill  see
above). In the recent years KCTR incurred significant losses from operations.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-20-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 8  
INVESTMENTS IN SUBSIDIARIES (cont.)

| | C. |  | Investment
in Kimberli Clark Tuketim Mallari Sanayi Ve Ticaret A.S. (KCTR)
(formerly: Ovisan) (cont.)
| | -- |  | -------------------------------------------------------------------------------------------------------

| | In
2005 and 2006, the Company provided KCTR NIS 213.5 million for the continuation of its on
going operations. In addition, the Company has committed to financially support KCTR in
2007. Such finance support may be granted to KCTR either by cash injection, long-term
loans, or guaranteed if required so by banks according to the financing needs of KCTR.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. |  | Consolidated
Subsidiaries
| | -- |  | -------------------------

| | The
consolidated financial statements as of December 31, 2006, include the financial
statements of the following Subsidiaries:
| | ------------------------------------------------------------------------------------------------------------------------------

|                                                 | Ownership and
control as of
December 31,
2006 | 
|------------------------------------------------ | --------------------------------------------- | 
|
|
|Hogla-Kimberly Marketing Ltd. ("Marketing")      |                                               | 
|                                                 |                                               | 
|Kimberli Clark Tuketim Mallari Sanayi Ve Ticaret |                                               | 
|A.S. ("KCTR")                                    |                                               | 
|Mollet Marketing Ltd. ("Mollet")                 |                                               | 
|H-K Overseas (Holland) B.V                       |                                               | 
|Subsidiary of H-K Overseas (Holland) B.V.:       |                                               | 
|Hogla-Kimberly Holding Anonim Sirketi (*)        |                                               | 

| | * |  | The
company is inactive.
| | - |  | ------------------------

| | E. |  | Supplemental
Data
| | -- |  | -----------------

| | In
July 2006, the Israeli Tax Authority approved the merger of Rakefet Marketing and trade
services Ltd. (Rakefet) and Shikma Ltd. (Shikam) into the Company. According to the
merger, the assets and liabilities of Shikma and Rakefet were merged into those of the
Company on July 1. 2006, and the Company is in the process of issuing shares to its
shareholders, KC and AIPM, in respect of their holdings in Rakefet.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-21-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 9  
FIXED ASSETS

|CONSOLIDATED                |  | Buildings (1) |  |        | Leasehold
improvements |  |        | Machinery
And
equipment |  | Motor
vehicles |   |  | furniture
and
equipment |   |  | Total (2) |   | 
|--------------------------- |  | ------------- |  | ------ | ---------------------- |  | ------ | ----------------------- |  | -------------- | - |  | ----------------------- | - |  | --------- | - | 
|
|Cost:                       |  |               |  |        |                        |  |        |                         |  |                |   |  |                         |   |  |           |   | 
|Balance - January 1, 2006   |  |               |  | 59,838 |                        |  | 10,924 |                         |  | 441,711        |   |  | 14,312                  |   |  | 15,592    |   | 
|Changes during 2006:        |  |              
|Additions                   |  |               |  | 496    |                        |  | 694    |                         |  | 15,450         |   |  | 409                     |   |  | 1,367     |   | 
|Dispositions                |  |               |  | -      |                        |  | -      |                         |  | (3,327         | ) |  | (439                    | ) |  | -         |   | 
|Foreign currency            |  |              
|translation adjustments     |  |               |  | (3,059 | )                      |  | (131   | )                       |  | (5,745         | ) |  | (219                    | ) |  | (487      | ) | 
|                            |  |               |  |        |                        |  |        |                         |  |                |   | 
|                            |  |              
|Balance - December 31, 2006 |  |               |  | 57,275 |                        |  | 11,487 |                         |  | 448,089        |   |  | 14,063                  |   |  | 16,472    |   | 
|                            |  |               |  |        |                        |  |        |                         |  |                |   | 
|                            |  |              
|Accumulated depreciation:   |  |              
|Balance - January 1, 2006   |  |               |  | 19,194 |                        |  | 5,383  |                         |  | 186,848        |   |  | 12,482                  |   |  | 11,237    |   | 
|Changes during 2006:        |  |              
|Additions                   |  |               |  | 1,178  |                        |  | 769    |                         |  | 20,846         |   |  | 1,025                   |   |  | 1,056     |   | 
|Dispositions                |  |               |  | -      |                        |  | -      |                         |  | (2,602         | ) |  | (437                    | ) |  | (611      | ) | 
|Foreign currency            |  |              
|translation adjustments     |  |               |  | (620   | )                      |  | (28    | )                       |  | (1,990         | ) |  | (211                    | ) |  | (274      | ) | 
|                            |  |               |  |        |                        |  |        |                         |  |                |   | 
|                            |  |              
|Balance - December 31, 2006 |  |               |  | 19,752 |                        |  | 6,124  |                         |  | 203,102        |   |  | 12,859                  |   |  | 11,408    |   | 
|                            |  |               |  |        |                        |  |        |                         |  |                |   | 
|                            |  |              
|Net book value:             |  |              
|December 31, 2006           |  |               |  | 37,523 |                        |  | 5,363  |                         |  | 244,987        |   |  | 1,204                   |   |  | 5,064     |   | 
|                            |  |               |  |        |                        |  |        |                         |  |                |   | 
|December 31, 2005           |  |               |  | 40,644 |                        |  | 5,541  |                         |  | 254,863        |   |  | 1,830                   |   |  | 4,355     |   | 
|                            |  |               |  |        |                        |  |        |                         |  |                |   | 
|                            |  |              
|COMPANY                     |  |              
|Cost:                       |  |              
|Balance - January 1, 2006   |  |               |  | 25,291 |                        |  | 7,670  |                         |  | 379,853        |   |  | 2,300                   |   |  | 4,101     |   | 
|Changes during 2006:        |  |              
|Assets of subsidiaries at   |  |              
|merger:                     |  |               |  | 1,058  |                        |  | -      |                         |  | 16,051         |   |  | -                       |   |  | 311       |   | 
|Additions                   |  |               |  | 33     |                        |  | 486    |                         |  | 8,690          |   |  | 356                     |   |  | 25        |   | 
|Dispositions                |  |               |  | -      |                        |  | -      |                         |  | (2,302         | ) |  | -                       |   |  | -         |   | 
|                            |  |               |  |        |                        |  |        |                         |  |                |   | 
|Balance - December 31, 2006 |  |               |  | 26,382 |                        |  | 8,156  |                         |  | 402,292        |   |  | 2,656                   |   |  | 4,437     |   | 
|                            |  |               |  |        |                        |  |        |                         |  |                |   | 
|                            |  |              
|Accumulated depreciation:   |  |              
|Balance - January 1, 2006   |  |               |  | 13,236 |                        |  | 4,348  |                         |  | 156,875        |   |  | 1,810                   |   |  | 3,131     |   | 
|Changes during 2006:        |  |              
|Assets of subsidiaries at   |  |              
|merger:                     |  |               |  | 957    |                        |  | -      |                         |  | 12,248         |   |  | -                       |   |  | 226       |   | 
|Additions                   |  |               |  | 549    |                        |  | 153    |                         |  | 16,123         |   |  | 394                     |   |  | 307       |   | 
|Dispositions                |  |               |  | -      |                        |  | -      |                         |  | (2,286         | ) |  | -                       |   |  | -         |   | 
|                            |  |               |  |        |                        |  |        |                         |  |                |   | 
|Balance - December 31, 2006 |  |               |  | 14,742 |                        |  | 4,501  |                         |  | 182,960        |   |  | 2,204                   |   |  | 3,664     |   | 
|                            |  |               |  |        |                        |  |        |                         |  |                |   | 
|Net book value:             |  |              
|December 31, 2006           |  |               |  | 11,640 |                        |  | 3,655  |                         |  | 219,332        |   |  | 452                     |   |  | 773       |   | 
|                            |  |               |  |        |                        |  |        |                         |  |                |   | 
|December 31, 2005           |  |               |  | 12,055 |                        |  | 3,322  |                         |  | 222,978        |   |  | 490                     |   |  | 970       |   | 
|                            |  |               |  |        |                        |  |        |                         |  |                |   | 

|(1) |  | Company
 leasehold improvements of industrial buildings on lands leased by           the
Company from AIPM (until 2006). The lease agreements are renewed annually.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | The
majority of the Groups fixed assets are located in Israel with the
          remaining located in Turkey.
|--- |  | --------------------------------------------------------------------------------------------------------------

-22-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 10  
TRADE
PAYABLES

|                     | Consolidated |  | Company |        
|-------------------- | ------------ |  | ------- | -------
|
|
|
|In Israeli currency: |              |  |         |        
|Open accounts        |              |  |         | 95,810 
|Related parties      |              |  |         | 22,199 
|In foreign currency: |              | 
|Open accounts        |              |  |         | 70,251 
|Related parties      |              |  |         | 16,676 
|                     |              |  |         |        
|                     |              |  |         | 204,936
|                     |              |  |         |        

# NOTE 11  
OTHER PAYABLES
AND ACCRUED EXPENSES

|                            | Consolidated |  | Company |       
|--------------------------- | ------------ |  | ------- | ------
|
|
|
|
|Accrued income taxes,       |              |  |         |       
|net of advances             |              |  |         | 11,303
|Accrued payroll and related |              | 
|expenses                    |              |  |         | 26,239
|Value Added Tax             |              |  |         | 7,051 
|Advances from customers     |              |  |         | 318   
|Other                       |              |  |         | 13,129
|                            |              |  |         |       
|                            |              |  |         | 58,040
|                            |              |  |         |       

# NOTE 12   LONG-TERM
BANK LOANS

|                          | Interest
rate |  | Consolidated
December 31, | 
|------------------------- | ------------- |  | ------------------------- | 
|
|
|In U.S. dollar            |               |  | Libor +1.22-1.63          | 
|Less - current maturities |               |  |                           | 
|                          |               |  |                           | 
|                          |               |  |                           | 
|                          |               |  |                           | 

# NOTE 13   SEVERANCE PAY

| | Obligations
of the Group for severance pay to its employees are covered by current payments to
pension and severance funds. Accumulated amounts in the pension and severance funds are
not under the control or administration of the Group, and accordingly, neither those
amounts nor the corresponding accruals are reflected in the financial statements.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-23-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 14  
COMMITMENTS AND CONTINGENT LIABILITIES

| | A. |  | Commitments
| | -- |  | -----------

| |  | (1) |  | The
Group is obligated to pay royalties to a shareholder  see also Note           23B.
| |  | --- |  | ---------------------------------------------------------------------------------------

| |  | (2) |  | The
Company and its Subsidiaries lease certain of their facilities under           operating
leases for varying periods with renewal options. Future minimum lease           rentals
as of December 31, 2006 are as follows:
| |  | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                    | Consolidated |  | Company |        
|------------------- | ------------ |  | ------- | -------
|
|2007                |              |  |         | 14,170 
|2008                |              |  |         | 7,535  
|2009                |              |  |         | 7,535  
|2010                |              |  |         | 7,535  
|2011 and thereafter |              |  |         | 79,373 
|                    |              |  |         |        
|                    |              |  |         | 116,148
|                    |              |  |         |        

| | B. |  | Guarantees
| | -- |  | ----------

| |  | (1) |  | The
Company is contingently liable in respect of a guarantee securing bank           loans
provided to a Subsidiary, the balance of which as of December 31, 2006           amounted
to NIS 109,056 thousand.
| |  | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | (2) |  | As
part of their normal course of business, the Company and its Subsidiaries
          provided third parties with bank guarantees for contract performance, the
          balance of which as of December 31, 2006 amounted to NIS 1,091 thousand.
| |  | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. |  | Legal
proceedings
| | -- |  | -----------------

| |  | (1) |  | The
Company received in November, 2003 a claim and a petition that was           filed in the
Tel-Aviv district court for the approval of a class action suit           against the
Company. According to the petition the Company has reduced the           number of units
of diapers in a package of its Huggies Freedom          brand, and thus
misled the public according to the Israeli Consumer Protection           Act. The
plaintiffs estimate the scope of the class action to be NIS 18 million.           The
Company rejects the claim and defended itself against the action. In           addition,
a court hearing took place in which plaintiffs and           defendants
witnesses were cross- examined, and plaintiff submitted its           closing statement.
Based on the opinion of the Companys legal counsel for           this matter, the
Companys management is unable, at this stage, to estimate           the possible
outcome of the lawsuit. However, based on the legal counsels          opinion, the
Companys management estimates that the Company has good           defense claims
against recognizing the petition as a class action, and it is           probable that its
defense will be accepted. Therefore, no provision was recorded           in the financial
statements in respect of this claim.
| |  | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-24-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 14  
COMMITMENTS AND CONTINGENT LIABILITIES (cont.)

| | C. |  | Legal
proceedings (cont.)
| | -- |  | -------------------------

| |  | (2) |  | In
February 2004, a former customer filed a lawsuit against the Company. This
          lawsuit is a part from multi-suppliers lawsuit, filed by the customer claiming
          for one billion NIS from the Company and each other supplier for alleged
          damages. The customer asked for discharge from legal fee and the request was
          denied. The customer appealed and was denied again. Customer faild to pay legal
          fee, and therefore court erased his lawsuit. The customer appealed again. Due
to           the preliminary stage of the proceedings, management is unable to estimate
the           possible outcome of the lawsuit. However, based on the Companys legal
          counsels, management estimates that the Company has valid arguments to oppose
          the lawsuit, and it is probable that its arguments will be accepted. Therefore,
          no provision was recorded in the financial statements relating to this lawsuit.
| |  | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | (3) |  | On
August 23, 2006 a petition was filed against the Company in the Tel-Aviv
          district court for the approval of a class action suit against the Company.
          According to the petition the Company has reduced the number of diapers in the
          Titulim Premium brand Packages, and thus misled the public
according           to the Israeli Consumer Protection Act. The plaintiff estimates the
scope of the           class action to be NIS 47 million. The Company rejects the claim
and defended           itself against the action. Based on the opinion of the Companys
legal           counsel for this matter, the Companys management is unable, at this
stage,           to estimate the possible outcome of the lawsuit. However, based on the
legal           counsels opinion, the Companys management estimates that the
Company           has good defense claims against recognized the petition as a class
action, and           it is probable that its defense will be accepted.
| |  | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company can not evaluate, at this early stage the exposure of the claim if any, and did
not record a reserve.
| | -----------------------------------------------------------------------------------------------------------------

| |  | (4) |  | On
December 10, 2006 a petition was filed against the Company in the Tel-Aviv
          district court for the approval of a class action suit against the Company.
          According to the petition the Company has reduced the number of Tissue paper in
          the Kleenex Premium Packages brand, and thus misled the public
          according to the Israeli Consumer Protection Act. The plaintiff estimates the
          scope of the class action to be NIS 43 million The Company rejects the request
          and acting to dismiss it. Based on the legal counsels opinion, the
          Companys management estimates that the Company has good defense claims
          against recognized the petition as a class action, and it is probable that its
          defense will be accepted. The Company can not evaluate, at this early stage the
          exposure of the claim if any, and did not record a reserve.
| |  | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | (5) |  | On
January 02, 2007 a petition was filed against the Company in the Tel-Aviv
          district court for the approval of a class action suit against the Company.
          According to the petition the Company has reduced the number of Wet Wipes in
the           Titulim premium wet wipes Packages, and thus misled the public
          according to the Israeli Consumer Protection Act. The plaintiff estimates the
          scope of the class action to be NIS 28 million. The Company rejects the request
          and acting to dismiss it. Based on the legal counsels opinion, the
          Companys management estimates that the Company has good defense claims
          against recognized the petition as a class action, and it is probable that its
          defense will be accepted. The Company can not evaluate, at this early stage the
          exposure of the claim if any, and did not record a reserve.
| |  | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-25-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 14  
COMMITMENTS AND CONTINGENT LIABILITIES (cont.)

| | C. |  | Legal
proceedings (cont.)
| | -- |  | -------------------------

| |  | (6) |  | In July 2005, Clubmarket Marketing Chains Ltd. (Clubmarket), a
          customer of the Company and one of the largest retail groups in Israel, applied
          for the regional court in Tel-Aviv (Court) for a staying of
          procedures by creditors. The court protection was granted until August 17,
2005.           As a result, in the second quarter of 2005 a provision of NIS 10.6
million for           doubtful accounts was recorded, which is included in the general
and           administrative expenses line item. In the third quarter of 2005, Shufersal,
          Israels biggest retail chain, won a bid supervised by the Court for the
          purchase of the stores, operations and inventories of Clubmarket. In December
          2005, the Court approved a creditors settlement submitted by the trustees,
          according to which, amongst other matters, the Company is to receive about 51%
          of Clubmarkets debt to the Company. The settlement is subject to various
          conditions, including reaching an understanding between the trustees and the
          Company about the exact amount Clubmarket is to pay the Company, and
          crystallizing certain material issues between the trustees and the Israeli Tax
          Authorities. Due to said uncertainties relating to the exact amounts to be
paid,           and based on the opinions of the Companys legal advisors for this
matter,           management cannot estimate, at this stage, the exact payout of
Clubmarkets           debt to the Company as a result of said settlement. The
remaining net balance of           Clubmarket as of December 31, 2006, that is in excess
of the doubtful accounts           provision recorded in the financial statements, is
approximately NIS 1 million           (excluding VAT).
| |  | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 15   SHARE
CAPITAL

| | A. |  | Composition
of Share Capital in Nominal NIS as of December 31, 2006           and 2005:
| | -- |  | ---------------------------------------------------------------------------------------

|                                      | Number of Shares (*)
|------------------------------------- | --------------------
|
|Ordinary Shares of NIS 1.00 par value |                     
|                                      |                     

| |  | (*) |  | As
of December 31, 2006 the Company has commenced a process of registering 600
          shares by the registrar of companies. The shares were issued to the
shareholders           of the Company as part of the merger process (see also note 8E).
| |  | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. |  | In
connection with the Companys approved enterprise program, following           the
Companys Board of Directors decision in September 2004, the           Companys
issued its shareholders in 2004, 250,000 bonus shares with a           premium of NIS
94.46 for each share.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. |  | Holders
of ordinary shares are entitled to participate equally in the payment           of cash
dividends and bonus share (stock dividend) distributions and, in the           event of
the liquidation of the Company, in the distribution of assets after
          satisfaction of liabilities to creditors. Each ordinary share is entitled to
one           vote on all matters to be voted on by shareholders.
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-26-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 16   NET SALES

|   |  | Consolidated |                                      
|-- |  | ------------ | -------------------------------------
|
|
|
|A. |  |              | Foreign sales (principally in Turkey)
|   |  |              |                                      
|   |  |             
|B. |  |              | Sales to major customers             
|   |  |              | (as percentage from total net sales) 
|   |  |              | Customer A                           
|   |  |              | Customer B                           

# NOTE 17   COST OF
SALES

|                              | Consolidated |  | Company |        
|----------------------------- | ------------ |  | ------- | -------
|
|
|
|Purchases (*)                 |              |  |         | 663,804
|Salaries and related expenses |              |  |         | 95,158 
|Manufacturing expenses        |              |  |         | 114,212
|Depreciation                  |              |  |         | 21,717 
|                              |              |  |         |        
|                              |              |  |         | 894,891
|                              |              | 
|Change in finished            |              | 
|goods inventory               |              |  |         | (10,983
|                              |              |  |         |        
|                              |              |  |         | 883,908
|                              |              |  |         |        

|(*) |  | The purchases of the Company are related to manufacturing operations.
               Consolidated purchases in excess of Company purchases relate principally to
               commercial operations.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 18   SELLING
EXPENSES

|                                | Consolidated |  | Company |        
|------------------------------- | ------------ |  | ------- | -------
|
|
|
|Salaries and related expenses   |              |  |         | 66,024 
|Maintenance and                 |              | 
|transportation expenses         |              |  |         | 45,687 
|Advertising and sales promotion |              |  |         | 80,189 
|Commissions to distributors     |              |  |         | 31,917 
|Royalties                       |              |  |         | 25,864 
|Depreciation                    |              |  |         | 2,534  
|Other                           |              |  |         | 17,008 
|                                |              |  |         |        
|                                |              |  |         | 269,223
|                                |              |  |         |        

-27-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 19   GENERAL
AND ADMINISTRATIVE EXPENSES

|                                | Consolidated |  | Company |       
|------------------------------- | ------------ |  | ------- | ------
|
|
|
|Salaries and related expenses   |              |  |         | 28,457
|Administrative and computer     |              | 
|services                        |              |  |         | 10,234
|Services provided by            |              | 
|Shareholder                     |              |  |         | 1,177 
|Office maintenance              |              |  |         | 5,120 
|Depreciation                    |              |  |         | 611   
|Goodwill amortization           |              |  |         | -     
|Provision for doubtful accounts |              |  |         | 1,865 
|Other                           |              |  |         | 10,442
|                                |              |  |         |       
|                                |              |  |         | 57,906
|                                |              |  |         |       

# NOTE 20   FINANCING
INCOME (EXPENSES), NET

|                                     | Consolidated |  | Company |        
|------------------------------------ | ------------ |  | ------- | -------
|
|
|
|Interest on long-term bank loans     |              |  |         | -      
|                                     |              |  |         |        
|Interest on Short-term bank loans    |              |  |         | (28,323
|                                     |              |  |         |        
|Exchange rate differences            |              |  |         | 5,646  
|                                     |              |  |         |        
|Finance Expenses from                |              | 
|derivative                           |              |  |         | (676   
|                                     |              |  |         |        
|Interest from long-term and          |              | 
|short-term bank deposits             |              |  |         | 465    
|                                     |              |  |         |        
|Interest expenses to tax authorities |              |  |         | 1,006  
|                                     |              |  |         |        

The majority of the remaining
balances of the consolidated financial income (expenses) for each of the periods presented
are comprised of exchange rate differences.

-28-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 21   INCOME
TAXES

| | A. |  | Composition
| | -- |  | -----------

|                          | Consolidated |  | Company |       
|------------------------- | ------------ |  | ------- | ------
|
|
|
|Current taxes             |              |  |         | 35,607
|Taxes in respect of       |              | 
|prior years               |              |  |         | 9,685 
|Deferred taxes - D. below |              |  |         | (9,389
|                          |              |  |         |       
|                          |              |  |         | 35,903
|                          |              |  |         |       

| | B. |  | The
Company and its Israeli Subsidiaries are subject to the Income Tax           Ordinance
and the Income Tax Law (Inflationary Adjustments), 1985. Non-Israeli
          Subsidiaries are subject to income tax provisions of their home country. The
          Company is an industrial company in conformity with the Law for the
          Encouragement of Industry (Taxes), 1969. The principal benefit that the Company
          is entitled to under this law is accelerated depreciation rates and reduced tax
          rates.
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
2002, the Companys program for the establishment of a new facility for
manufacturing paper was granted Approved Enterprise status in accordance with the Law for
the Encouragement of Capital Investments, 1959, under alternative benefits track.
The approval program is for total investments of approximately NIS 97 million. According
to the terms of the program, income derived from the Approved Enterprise will be
tax-exempt for a period of 10 years commencing in the year in which the program was
substantially completed. Distribution of dividends from tax exempt profits of the
Approved Enterprise will be subject to income tax at a rate equal to the income tax rate
of the Approved Enterprise had the Company not elected the alternative benefits track.
The Company completed the investments relating to the new facility and commenced its
operations during 2003.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-29-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 21   INCOME
TAXES (cont.)

| | C. |  | Reconciliation
of the statutory tax rate to the effective tax rate:
| | -- |  | -------------------------------------------------------------------

|                                       | Consolidated |  | Company |       
|-------------------------------------- | ------------ |  | ------- | ------
|
|
|
|Income before income taxes             |              |  |         | 19,018
|                                       |              |  |         |       
|Statutory tax rate (see E. below)      |              |  |         | 31    
|Tax computed by statutory tax rate-    |              |  |         | 5,896 
|                                      
|Tax increments (savings) due to:       |              |  |         |       
|Income in reduced tax rate             |              |  |         | 11,163
|Non-deductible expenses                |              |  |         | 1,550 
|Non-taxable income                     |              |  |         | -     
|Unrecorded deferred taxes in           |              | 
|connection with tax loss carry forward |              |  |         | -     
|Change in deferred taxes due           |              |  |         |       
|decrease in tax rate in Turkey         |              |  |         | 13,449
|Reduction in corporate tax rates       |              |  |         |       
|(E. below)                             |              |  |         | (938  
|Differences arising from               |              | 
|basis of measurement (*)               |              |  |         | (232  
|Income taxes for prior years           |              |  |         | 4,863 
|Other differences, net                 |              |  |         | 152   
|                                       |              |  |         |       
|                                       |              |  |         | 35,903
|                                       |              |  |         |       

| | (*) |  | For
2006, 2005 and 2004  In Israel, Reported Amounts (NIS) for financial
          reporting purposes vis-a-vis the consumer price index for tax purposes; In
          Turkey  U.S. dollar for financial reporting purposes vis-a-vis the
Turkish           Lira for tax purposes.
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-30-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 21   INCOME
TAXES (cont.)

| | D. |  | Deferred
Taxes
| | -- |  | --------------

|                          | Consolidated |  | Company |       
|------------------------- | ------------ |  | ------- | ------
|
|
|
|Balance as of             |              |  |         |       
|beginning of year         |              |  |         | 3,800 
|Changes during the year   |              |  |         | (7,108
|Adjustment due to change  |              | 
|in income tax rates       |              |  |         | (938  
|Foreign currency          |              | 
|translation adjustments   |              |  |         | 2,181 
|                          |              |  |         |       
|Balance as of end of year |              |  |         | (2,065
|                          |              |  |         |       

|                                                          | Consolidated |  | Company |        
|--------------------------------------------------------- | ------------ |  | ------- | -------
|
|
|
|Deferred taxes are presented in the                       |              |  |         |        
|balance sheets as follows:                                |              | 
|                                                          |              | 
|Long-term liabilities (in respect of  depreciable assets) |              |  |         | 35,364 
|Other receivables (in respect of  temporary differences)  |              | 
|- Note 5                                                  |              |  |         | (6,641 
|Other assets                                              |              |  |         | (30,788
|                                                          |              |  |         |        
|                                                          |              |  |         | (2,065 
|                                                          |              |  |         |        

| | For
2006  Deferred taxes were computed at rates between 20%-29%, primarily  20%.
For 2005  Deferred taxes were computed at rates between 26.5%-33%, primarily 26.5%.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006 carryforward tax losses deriving from the Turkish subsidiary sam
up to NIS 185 millions.  Deferred tax assets due to the said carryforward tax
losses were recorded under management assumption that they will be utilized by the five
years limitation in accordance to the Turkish tax laws and based on the new business
structure in Turkey.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. |  | Reduction
of Corporate Tax Rates
| | -- |  | --------------------------------

| |  | 1. |  | In
July 2005, the Israeli Knesset passed the Law for Amending the Income Tax
          Ordinance (No. 147), 2005, according to which commencing in 2006 the corporate
          income-tax rate would be gradually reduced, for which a 31% tax rate was
          established, through 2010, in respect of which a 25% tax rate was established.
          For the effect of the reduction in tax rates, see D. above.
| |  | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 2. |  | During
the second quarter of 2006 the corporate tax in Turkey was reduced from           30% to
20%. The change in the corporate tax resulted in additional tax expenses           in the
amount of NIS 10.6 millions which reflected the impact on the deferred           tax
assets.
| |  | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. |  | The
Company and one of its subsidiaries are Industrial Companies as
          defined in the Israeli Law for the Encouragement of Industry (Taxes)-1969.
Based           on this Law, the Company and that subsidiary file consolidated tax
returns.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

-31-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 21   INCOME
TAXES (cont.)

| | G. |  | Following
a tax assessment of the companys tax return, performed by the           tax
authorities in Israel with respect of tax-years 2003 and 2002 the company
          recorded additional provision for tax expenses, in the amount of NIS 4.2
          millions for the year ended December 31, 2006.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | I. |  | The
Company and its subsidiary Shikma Ltd. possess final tax assessments           through
2003. Hogla Kimberly Marketing Ltd., a subsidiary of the Company,           posseses
final tax assessments through 2004.
Mollet
Marketing Ltd., a subsidiary of the Company, posseses final tax assessments through 2002.
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 22  RELATED
PARTIES AND INTERESTED PARTIES

| | A. |  | Balances
with Related Parties
| | -- |  | -----------------------------

|                                 |  |  |        | 
|-------------------------------- |  |  | ------ | 
|
|
|
|
|Trade receivables (*)            |  |  | 2,991  | 
|                                 |  |  |        | 
|Capital note - shareholder       |  |  | 32,770 | 
|                                 |  |  |        | 
|Other receivables                |  |  | -      | 
|                                 |  |  |        | 
|Loans - Subsidiaries             |  |  | -      | 
|                                 |  |  |        | 
|Capital injection - Subsidiaries |  |  | -      | 
|                                 |  |  |        | 
|Trade payables (*)               |  |  | 70,806 | 
|                                 |  |  |        | 

(*)       
          Company  excludes Subsidiaries. See also Notes 4 and 11.

| | B. |  | Transactions
with Related Parties and Subsidiaries
| | -- |  | --------------------------------------------------

|                      | Consolidated |  | Company |        
|--------------------- | ------------ |  | ------- | -------
|
|
|
|Sales to related      |              |  |         |        
|parties               |              |  |         | 27,552 
|                      |              |  |         |        
|Sales to Subsidiaries |              |  |         | -      
|                      |              |  |         |        
|Cost of sales         |              |  |         | 150,350
|                      |              |  |         |        
|Royalties to the      |              | 
|shareholders          |              |  |         | 24,632 
|                      |              |  |         |        
|General and           |              | 
|administrative        |              | 
|expenses (*)          |              |  |         | 9,966  
|                      |              |  |         |        

(*)       
          Company  excludes Subsidiaries.

-32-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 23  
DISCLOSURE AND PRESENTATION OF FINANCIAL INSTRUMENTS

| | A. |  | Credit
Risk
| | -- |  | -----------

| | The
revenues of the Groups principal Subsidiaries are derived from two major customers
and a large number of smaller customers. Management regularly monitors the balance of
trade receivables and the financial statements include an allowance for doubtful accounts
based on managements estimation. Taking the aforementioned into consideration, the
exposure to credit risk from trade receivables is immaterial.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Cash
and cash equivalents and long-term deposits are deposited with major banks in Israel and
abroad. Therefore, it is not expected that such banks will fail to meet their
obligations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. |  | Fair
Value of Financial Instruments
| | -- |  | -----------------------------------

| | The
financial instruments of the Group consist primarily of non-derivative assets and
liabilities. Non-derivative assets include cash and cash equivalents, receivables and
other current assets. Non-derivative liabilities include trade payables and other current
liabilities. Due to the nature of these financial instruments, their fair value,
generally, is identical or close to the value at which they are presented in the
financial statements, unless stated otherwise.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Due
to the fact that as of December 31, 2006, the terms of the capital note of shareholder do
not include determined payment dates, fair value based on present values cannot be
established. Accordingly, the fair value of the capital note is not disclosed in the
financial statements.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2005 the Company had entered into 30 hedge transaction in respect of
anticipated purchases amounting to NIS 35.8 million, (in U.S. dollar and Euro currency).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
hedge transactions are shown in the balance sheet at fair value. The fair value of future
transactions is based on future exchange rates, as quoted the balance sheet date.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006 the fair value of the cash flow hedging transaction is a net
liability of NIS 0.228 million.
| | --------------------------------------------------------------------------------------------------------------------

-33-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 24  
COMPANYS FINANCIAL INFORMATION IN NOMINAL VALUES FOR TAX PURPOSES

| | A. |  | Balance
Sheets
| | -- |  | --------------

|                                    |  |  |                  |         |  |  |         | 
|----------------------------------- |  |  | ---------------- | ------- |  |  | ------- | 
|                                    |  |  | Company          |        
|                                    |  | 
|                                    |  |  |                  |         |  |  |         | 
|                                    |  |  | December 31,     |        
|                                    |  | 
|                                    |  |  |                  | 2 0 0 6 |  |  | 2 0 0 5 | 
|                                    |  |  |                  |        
|                                    |  |  |                  |         |  |  |         | 
|                                    |  |  | NIS in thousands |        
|                                    |  | 
|Current Assets                      |  |  |                  |         |  |  |         | 
|Cash and cash equivalents           |  |  |                  | 1,358   |  |  | 25,831  | 
|Trade receivables                   |  |  |                  | 108,281 |  |  | 120,427 | 
|Other receivables                   |  |  |                  | 22,511  |  |  | 12,739  | 
|Inventories                         |  |  |                  | 93,867  |  |  | 76,840  | 
|                                    |  |  |                  |        
|                                    |  |  |                  | 226,017 |  |  | 235,837 | 
|                                    |  |  |                  |        
|Long-Term Investments               |  | 
|Capital note of shareholder         |  |  |                  | 32,770  |  |  | 32,770  | 
|Investments in Subsidiaries         |  |  |                  | 161,183 |  |  | 276,288 | 
|                                    |  |  |                  |        
|                                    |  |  |                  | 193,953 |  |  | 309,058 | 
|                                    |  |  |                  |        
|Fixed Assets, net                   |  |  |                  | 226,330 |  |  | 229,378 | 
|                                    |  |  |                  |        
|                                    |  |  |                  | 646,300 |  |  | 774,273 | 
|                                    |  |  |                  |        
|Current Liabilities                 |  | 
|Short-term bank credit              |  |  |                  | 43,800  |  |  | -       | 
|Trade payables                      |  |  |                  | 121,121 |  |  | 303,710 | 
|Other payables and accrued expenses |  |  |                  | 32,780  |  |  | 16,115  | 
|                                    |  |  |                  |        
|                                    |  |  |                  | 197,701 |  |  | 319,825 | 
|                                    |  |  |                  |        
|                                    |  | 
|Shareholders' Equity                |  |  |                  | 448,599 |  |  | 454,448 | 
|                                    |  |  |                  |        
|                                    |  |  |                  | 646,300 |  |  | 774,273 | 
|                                    |  |  |                  |        

-34-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 24  
COMPANYS FINANCIAL INFORMATION IN NOMINAL VALUES FOR TAX PURPOSES (cont.)

| | B. |  | Statement
of Operations
| | -- |  | -----------------------

|                                    | Year ended December 31, | 
|----------------------------------- | ----------------------- | 
|
|
|Net sales                           |                         | 
|                                    |                         | 
|Cost of sales                       |                         | 
|                                    |                         | 
|                                    |                         | 
|Gross profit                        |                         | 
|                                    |                         | 
|Selling expenses                    |                         | 
|                                    |                         | 
|General and administrative expenses |                         | 
|                                    |                         | 
|                                    |                         | 
|Operating profit                    |                         | 
|                                    |                         | 
|Financing income (expenses), net    |                         | 
|                                    |                         | 
|Other income                        |                         | 
|                                    |                         | 
|                                    |                         | 
|Income before income taxes          |                         | 
|                                    |                         | 
|Income taxes                        |                         | 
|                                    |                         | 
|                                    |                         | 
|Income after income taxes           |                         | 
|                                    |                         | 
|Equity in net earnings  (losses) of |                         | 
|Subsidiaries                        |                         | 
|                                    |                         | 
|                                    |                         | 
|Net income (loss) for the year      |                         | 
|                                    |                         | 

-35-



---

# HOGLA-KIMBERLY LTD.
NOTES TO FINANCIAL
STATEMENTS(REPORTED AMOUNTS)

# NOTE 24  
COMPANYS FINANCIAL INFORMATION IN NOMINAL VALUES FOR TAX PURPOSES (cont.)

| | C. |  | Statements
of Changes in Shareholders Equity
| | -- |  | ---------------------------------------------

|                             | Share
capital |  | Capital
reserves |       | Translation
adjustments
relating to
foreign held
autonomous
Subsidiary |  | Retained
earnings |  | Accumulate
other
comprehensive
income |         | Total | 
|---------------------------- | ------------- |  | ---------------- | ----- | ---------------------------------------------------------------------- |  | ----------------- |  | ------------------------------------- | ------- | ----- | 
|
|Balance - December 31, 2003  |               |  |                  | 8,263 |                                                                        |  | 132,127           |  |                                       | -       |       | 
|                             |               | 
|Changes during 2004:         |               | 
|Dividend paid                |               | 
|Distribution of bonus shares |               |  |                  | 250   |                                                                        |  | 23,615            |  |                                       | -       |       | 
|Translation adjustments      |               | 
|relating to foreign held     |               | 
|autonomous Subsidiary        |               |  |                  | -     |                                                                        |  | -                 |  |                                       | (3,377  | )     | 
|Net income for the year      |               |  |                  | -     |                                                                        |  | -                 |  |                                       | -       |       | 
|                             |               |  |                  |       |                                                                        |  |                   |  |                                       |         |       | 
|                             |               | 
|Balance - December 31, 2004  |               |  |                  | 8,513 |                                                                        |  | 155,742           |  |                                       | (3,377  | )     | 
|                             |               | 
|Changes during 2005:         |               | 
|Dividend paid                |               |  |                  |       |                                                                        |  |                   |  |                                       |         |       | 
|Translation adjustments      |               |  |                  | -     |                                                                        |  | -                 |  |                                       | -       |       | 
|relating to foreign held     |               | 
|autonomous Subsidiary        |               |  |                  | -     |                                                                        |  | -                 |  |                                       | 3,995   |       | 
|Net income for the year      |               |  |                  | -     |                                                                        |  | -                 |  |                                       | -       |       | 
|                             |               |  |                  |       |                                                                        |  |                   |  |                                       |         |       | 
|                             |               | 
|Balance - December 31, 2005  |               |  |                  | 8,513 |                                                                        |  | 155,742           |  |                                       | 618     |       | 
|                             |               |  |                  |       |                                                                        |  |                   |  |                                       |         |       | 
|                             |               | 
|Changes during 2006:         |               | 
|Shares issued                |               |  |                  | 600   |                                                                        |  | 49,097            |  |                                       |         |       | 
|Translation adjustments      |               | 
|relating to foreign held     |               | 
|autonomous Subsidiary        |               |  |                  | -     |                                                                        |  | -                 |  |                                       | (10,463 | )     | 
|Changes in fair value of     |               | 
|financial instruments        |               |  |                  | -     |                                                                        |  | -                 |  |                                       | -       |       | 
|Dividend paid                |               |  |                  | -     |                                                                        |  | -                 |  |                                       | -       |       | 
|Loss for the year            |               |  |                  | -     |                                                                        |  | -                 |  |                                       | -       |       | 
|                             |               |  |                  |       |                                                                        |  |                   |  |                                       |         |       | 
|                             |               | 
|Balance - December 31, 2006  |               |  |                  | 9,113 |                                                                        |  | 204,839           |  |                                       | (10,463 | )     | 
|                             |               |  |                  |       |                                                                        |  |                   |  |                                       |         |       | 

-36-



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| | Item 19(a)(iv)



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| | Item 19(a)(vi)



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