Edgar Filing: MAGAL SECURITY SYSTEMS LTD

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 20-F

[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF
THE SECURITIES EXCHANGE ACT OF 1934

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004

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

For the transition period from __________ to __________

Commission file number 0-21388

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

Israel
(Jurisdiction of incorporation or organization)

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

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

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

Ordinary Shares, NIS 1.0 par value per share
(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d)
of the Act: None
(Title of Class)
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the period covered by the annual
report:

Ordinary Shares, NIS 1.0 par value per share
as of December 31, 2004 ..................... 8,672,448

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

[X] Yes [ ] No
Indicate by check mark which financial statement item the registrant has
elected to follow. [ ] Item 17 [X] Item 18

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

INTRODUCTION

Magal Security Systems Ltd. develops, manufactures, markets and sells
complex computerized security systems, including a line of perimeter security
systems, a video motion detection system, a hardware and software "all in one"
security solution which integrates Closed Circuit Television related
applications, security management and control systems, personal emergency
location systems, a pipeline security system, and provides video monitoring
services. Our predecessor commenced operations in 1969 as a department
specializing in perimeter security systems within the electronics division of
Israel Aircraft Industries Ltd., or IAI. Effective April 1984, we purchased from
IAI substantially all of the assets, and assumed substantially all of the
related liabilities, of that department. In March 1993, we completed an initial
public offering of 1,380,000 ordinary shares, in February 1997, we completed a
public offering of an additional 2,085,000 ordinary shares and in April 2005, we
completed an offering of an additional 1,700,000 ordinary shares. Our ordinary
shares are traded on the NASDAQ National Market and on the Tel Aviv Stock
Exchange under the symbol MAGS.

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

Statements which use the terms "believe," "do not believe," "expect,"
"plan," "intend," "estimate," "anticipate" and similar expressions are intended
to identify forward-looking statements. These statements reflect our current
views with respect to future events and are based on assumptions and are subject
to risks and uncertainties. Except as required by applicable law, including the
securities laws of the U.S., we do not intend to update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.

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

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

Our consolidated financial statements appearing in this annual report
are prepared in U.S. dollars and in accordance with U.S. generally accepted
accounting principles, or U.S. GAAP. All references in this annual report to
"dollars" or "$"are to U.S. dollars and all references in this annual report to
"NIS" are to New Israeli Shekels. The representative exchange rate between the
NIS and the dollar as published by the Bank of Israel on June 24, 2005 was NIS
4.538 per $1.00.

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

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

TABLE OF CONTENTS
Page No.
--------

PART I.........................................................................1
ITEM 1. Identity of Directors, Senior Management and Advisers.........1
ITEM 2. Offer Statistics and Expected Timetable.......................1
ITEM 3. Key Information...............................................1
A. Selected Consolidated Financial Data.........................1
B. Capitalization and Indebtedness..............................2
C. Reasons for the Offer and Use of Proceeds....................2
D. Risk Factors.................................................2
ITEM 4. Information on the Company...................................12
A. History and Development of the Company......................12
B. Business Overview...........................................12
C. Organizational Structure....................................28
D. Property, Plants and Equipment..............................28
ITEM 5. Operating and Financial Review and Prospects.................29
A. Operating Results...........................................29
B. Liquidity and Capital Resources.............................42
C. Research and Development, Patents and Licenses..............45
D. Trend Information...........................................45
E. Off-Balance Sheet Arrangements..............................45
F. Tabular Disclosure of Contractual Obligations...............46
ITEM 6. Directors, Senior Management and Employees...................46
A. Directors and Senior Management.............................46
B. Compensation................................................49
C. Board Practices.............................................49
D. Employees...................................................58
E. Share Ownership.............................................58
ITEM 7. Major Shareholders and Related Party Transactions............60
A. Major Shareholders..........................................60
B. Related Party Transactions..................................62
C. Interests of Experts and Counsel............................63
ITEM 8. Financial Information........................................63
A. Consolidated Statements and Other Financial Information.....63
B. Significant Changes........................................64
ITEM 9. The Offer and Listing........................................64
A. Offer and Listing Details ..................................64

B. Plan of Distribution........................................65
C. Markets.....................................................65
D. Selling Shareholders........................................65
E. Dilution....................................................65
F. Expenses of the Issue.......................................65
ITEM 10. Additional Information.......................................65
A. Share Capital...............................................65
B. Memorandum and Articles of Association......................65
C. Material Contracts..........................................70
D. Exchange Controls...........................................70
E. Taxation....................................................70
F. Dividends and Paying Agents.................................83
G. Statements by Experts.......................................83
H. Documents on Display........................................83
I. Subsidiary Information......................................84
ITEM 11. Quantitative and Qualitative Disclosures about Market Risk...84
ITEM 12. Description of Securities Other Than Equity Securities.......85

PART II.......................................................................85
ITEM 13. Defaults, Dividend Arrearages and Delinquencies..............85
ITEM 14. Material Modifications to the Rights of Security Holders
and Use of Proceeds..........................................85
ITEM 15. Controls and Procedures......................................86
ITEM 16. [Reserved]...................................................86
ITEM 16A. Audit Committee Financial Expert.............................86
ITEM 16B. Code of Ethics...............................................86
ITEM 16C. Principal Accounting Fees and Services.......................86
ITEM 16D. Exemptions from the Listing Requirements and Standards for
Audit Committee..............................................87
ITEM 16E. Purchase of Equity Securities by the Issuer and Affiliates
and Purchasers...............................................87

PART III......................................................................87
ITEM 17. Financial Statements.........................................87
ITEM 18. Financial Statements.........................................87
ITEM 19. Exhibits.....................................................88

SIGNATURE.....................................................................89

PART I

ITEM 1. Identity of Directors, Senior Management and Advisers

Not applicable.

ITEM 2. Offer Statistics and Expected Timetable

Not applicable.

ITEM 3. Key Information

A. Selected Consolidated Financial Data.

We have derived the following selected consolidated financial data as
of December 31, 2003 and 2004 and for each of the years ended December 31, 2002,
2003 and 2004 from our consolidated financial statements set forth elsewhere in
this annual report that have been prepared in accordance with U.S. GAAP. We have
derived the following selected consolidated financial data as of December 31,
2000, 2001 and 2002 and for each of the years ended December 31, 2000 and 2001
from our audited consolidated financial statements not included in this annual
report. You should read the following selected consolidated financial data
together with the section of this annual report entitled "Operating and
Financial Review and Prospects" and our consolidated financial statements and
notes thereto included elsewhere in this annual report.

Year Ended December 31,
------------------------------------------------------------
2000 2001 2002 2003 2004
--------- --------- --------- --------- --------
(in thousands except per share data)

Consolidated Statement of Income Data:

Revenues................................... $ 38,571 $ 41,020 $ 42,966 $ 59,361 $ 60,974
Cost of revenues........................... 20,523 21,505 23,924 33,378 33,725
--------- --------- --------- -------- --------
Gross profit............................... 18,048 19,515 19,042 25,983 27,249
--------- --------- --------- -------- --------
Operating expenses:
Research and development, net............ 2,975 3,054 3,128 4,773 4,683
Selling and marketing, net............... 7,129 7,933 8,642 11,585 12,679
General and administrative............... 4,661 4,949 4,938 5,305 5,771

Award granted by principal shareholders.... - - - - 1,200
Total operating expenses................... 14,765 15,936 16,708 21,663 24,333
--------- --------- --------- -------- --------
Operating income........................... 3,283 3,579 2,334 4,320 2,916
Financial income (expenses), net........... (214) 40 199 (1,003) (762)
---------- --------- --------- -------- -------
Income before taxes on income
and write-off of investment in
affiliate, net of taxes.................. 3,069 3,619 2,533 3,317 2,154
Taxes on income............................ 180 452 645 913 1,101
--------- --------- --------- -------- --------
Net income................................. 2,889 3,167 1,888 2,404 1,053
========= ========= ========= ======== ========
Basic net earnings per share............... $ 0.38 $ 0.41 $ 0.24 $ 0.30 $ 0.12
========= ========= ========= ======== ========
Diluted net earnings per share............. $ 0.37 $ 0.40 $ 0.23 $ 0.30 $ 0.12
========= ========= ========= ======== ========
Weighted average number of Ordinary shares used in
computing basic net earnings per share 7,663 7,738 7,866 7,948 8,581
Weighted average number of Ordinary shares used in
computing diluted net earnings per share... 7,750 7,925 8,069 8,029 8,636
Cash dividend per share.................... $ 0.10 $ 0.13 $ - $ 0.05 $ -
====== ======== ====== ======= ========

Our Board of Directors declared share dividend distributions of 3%, 3%
and 5% in May 2002, May 2003 and July 2004, respectively. All per share data in
the above table has been retroactively adjusted to reflect the stock dividends.

At the Annual General Meeting of Shareholders held on July 29, 2004,
our shareholders approved the payment of an interim cash dividend of $0.05 per
ordinary share, which dividend was declared by our Board of Directors in
December 2003.

As of December 31,
--------------------------------------------------------
2000 2001 2002 2003 2004
------- ------- ------- -------- --------
(in thousands)

Consolidated Balance Sheet Data:
Cash and cash equivalents.................. $ 3,579 $ 2,738 $ 2,519 $ 4,389 $11,964
Short and long-term bank deposits and structured
notes ..................................... 11,213 11,849 12,357 12,051 5,994
Working capital............................ 20,288 18,391 15,688 21,401 21,603
Total assets............................... 48,867 53,347 59,741 71,443 77,976
Short-term bank credit (including current
maturities of long-term loans)............. 2,765 6,264 10,357 16,438 17,467
Long-term loans............................ 6,302 5,038 4,698 1,873 3,500
Total shareholders' equity................. 30,899 32,700 35,031 38,984 43,548

B. Capitalization and Indebtedness.

Not applicable

C. Reasons for the Offer and Use of Proceeds.

Not applicable.

D. Risk Factors.

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

Risks Related to Our Business

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

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

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

As we receive large orders from a relatively small number of customers,
our revenues and operating results are subject to substantial periodic
variations. Individual orders from customers can

represent a substantial portion of our revenues in any one period and
significant orders by any customer during one period may not be followed by
further orders from the same customer in subsequent periods. Our revenues and
operating results for a specific quarter may not be indicative of our future
performance, making it difficult for investors to evaluate our future prospects
based on the results of any quarter. In addition, we have a limited order
backlog, which makes revenues in any quarter substantially dependent upon orders
we deliver in that quarter.

Our revenues and operating results are subject to very substantial variations,
including, among other things, because the loss of one or more of our key
customers, in particular the Israeli Ministry of Defense, would result in a loss
of a significant amount of our revenues.

Relatively few customers account for a large percentage of our
revenues. For the years ended December 31, 2002, 2003 and 2004, revenues
generated from sales to the Israeli Ministry of Defense, or MOD, accounted for
15.9%, 27.2% and 7.7% respectively, of our revenues.

The loss of MOD without replacement by a customer or customers of
similar volume would have a material adverse effect on our financial results.

Our quarterly performance may vary significantly. Consequently, the
results of our operations for any quarter are not necessarily indicative of the
results that we might achieve for any subsequent period. Consequently,
quarter-to-quarter comparisons of our operating results may not be meaningful.

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

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

o their requirements or budgetary constraints change;

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

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

o they adjust contract costs and fees on the basis of audits.

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

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

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

We can give no assurance that our wholly-owned subsidiary, Smart Interactive
Systems, Inc., will be successful in the future. If Smart is unsuccessful, our
future results of operations may be adversely affected.

In 2001, we established Smart Interactive Systems, Inc., or Smart, to
meet the growing demand for real-time video monitoring services for use in
industrial sites, commercial businesses and VIP residences. We have invested
$12.5 million in Smart through December 31, 2004. Its operations to date have
not been profitable and it has an accumulated deficit of $6.1 million as of
December 31, 2004. Smart's success will depend upon its ability to penetrate the
market for these services. If Smart is unable to market its services or if its
services fail to penetrate the market, we may lose our investment in this
company and our future results of operations may be adversely affected.

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

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

We cannot assure you that:

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

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

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

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

We face risks associated with doing business in international markets.

We make a large portion of our sales in markets outside of Israel (83%
in 2004 and 65% in 2003), and a key component of our strategy is to continue to
expand in such markets, the most significant of which currently are North
America, Europe, and Asia. Our international sales efforts are affected by costs
associated with the shipping of our products and risks inherent in doing
business in international markets, including:

o unexpected changes in regulatory requirements;

o currency fluctuations;

o export restrictions, tariffs and other trade barriers;

o unexpected difficulties in staffing and managing foreign
operations;

o longer payment cycles;

o difficulties in collecting accounts receivable;

o political instability; and

o seasonal reductions in business activities.

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

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

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

We may be adversely affected by long sales cycles.

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

We may not be able to implement our growth strategy.

As part of our growth strategy, we seek to acquire or invest in
complementary, including competitive, businesses, products and technologies.
Although we have identified potential acquisition candidates, we currently have
no commitments or agreements with respect to any such acquisitions or
investments and we cannot assure you that we will eventually be able to
consummate any acquisition or investment. Even if we do acquire or invest in
these businesses, products or technology, the process of integrating acquired
assets into our operations may result in unforeseen operating difficulties and
expenditures and may absorb significant management attention that would
otherwise be available for the ongoing development of our business.

In addition, we have limited experience in making acquisitions and
managing growth. We cannot assure you that we will realize the anticipated
benefits of any acquisition. In addition, future acquisitions by us could result
in potentially dilutive issuances of our equity securities, the incurrence of
debt and contingent liabilities and amortization expenses related to
identifiable intangible assets, any of which could materially adversely affect
our operating results and financial position. Acquisitions also involve other
risks, including risks inherent in entering markets in which we have no or
limited prior experience and the potential loss of key employees and the risk
that we may experience difficulty or delays in obtaining necessary permits.

We may not be successful in marketing and developing markets for our new
products.

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

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

Our success and ability to compete depend in large part upon protecting
our proprietary technology. We have approximately 45 patents and have patent
applications pending. We also rely on a combination of trade secret and
copyright law and confidentiality, non-disclosure and assignment-of-inventions
agreements to protect our proprietary technology. It is our policy to protect
our proprietary rights in our products and operations through contractual
obligations, including confidentiality and non-disclosure agreements with
certain employees, distributors and agents, suppliers and subcontractors. These
measures may not be adequate to protect our technology from third-party
infringement, and our competitors may independently develop technologies that
are substantially equivalent or superior to ours. Additionally, our products may
be sold in foreign countries that provide less protection to intellectual
property than that provided under U.S. or Israeli laws.

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

Third parties may in the future assert against us infringement claims
or claims asserting that we have violated a patent or infringed upon a
copyright, trademark or other proprietary right belonging to them.

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

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

We acquire most of the components utilized in our products, including,
but not limited to, our turnkey products and certain services from a limited
number of suppliers and subcontractors. We cannot assure you that we will
continue to be able to obtain such items from these suppliers and subcontractors
on satisfactory terms. Temporary disruptions of our manufacturing operations
would result if we were required to obtain materials from alternative sources,
which may have an adverse effect on our financial results. For example, our
subsidiary Senstar-Stellar Corporation, or Senstar, obtains triboelectric sensor
cable for its Intelli-FLEX product from a sole supplier. If this sole supplier
were to discontinue production of the triboelectric sensor cable, it would
adversely affect revenues of Senstar's Intelli-FLEX product.

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

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

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

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

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

Our products require sophisticated research and development, marketing
and sales and technical customer support. Our success depends on our ability to
attract, train and retain qualified research and development, marketing and
sales and technical customer support personnel. Competition for personnel in all
of these areas is intense and we may not be able to hire sufficient personnel to
achieve our goals or support the anticipated growth in our business. If we fail
to attract and retain qualified personnel, our business, operations and product
development efforts would suffer.

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

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

The implementation of SFAS No. 123R, which will require us to record
compensation expense in connection with equity share based compensation as of
the first quarter of 2006, may reduce our profitability.

On December 16, 2004, the Financial Accounting Standards Board (FASB)
issued Statement No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123R"),
which is a revision of SFAS No. 123.

Generally, the approach in SFAS 123(R) is similar to the approach described in
Statement 123. However, SFAS No. 123 permitted, but did not require, share-based
payments to employees to be recognized on the basis of their fair values while
SFAS No. 123(R) requires, as of the first quarter of 2006, all share-based
payments to employees to be recognized on the basis of their fair values. SFAS
No. 123R also revises, clarifies and expands guidance in several areas,
including measuring fair value, classifying an award as equity or as a liability
and attributing compensation cost to reporting periods. The adoption of SFAS No.
123R may have a significant effect on our results of operations in the future.
In addition, such adoption could limit our ability to use stock options as an
incentive and retention tool, which could, in turn, negatively impact our
ability to recruit employees and retain existing employees.

Compliance with the changing regulation of corporate governance and public
disclosure may result in additional expenses.

Changing laws, regulations and standards relating to corporate
governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new
Securities and Exchange Commission regulations and NASDAQ Marketplace Rules, are
creating uncertainty for companies such as ours. We are committed to maintaining
high standards of corporate governance and public disclosure. As a result, we
intend to invest reasonably necessary resources to comply with evolving
standards, and this investment may result in increased general and
administrative expenses and a diversion of management time and attention from
revenue-generating activities to compliance activities, which could harm our
operating results and business prospects.

Risks Relating to Our Ordinary Shares

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

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

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

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

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

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

o developments or disputes concerning proprietary rights;

o introduction and adoption of new industry standards;

o changes in financial estimates by securities analysts;

o market conditions or trends in our industry;

o changes in the market valuations of our competitors;

o announcements by us or our competitors of significant
acquisitions;

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

o additions or departures of key personnel.

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

Risks Relating to Our Location in Israel

Conducting business in Israel entails special risks.

We are incorporated under Israeli law and our principal offices and
manufacturing and research and development facilities are located in the State
of Israel. Accordingly, we are directly influenced by the political, economic
and military conditions affecting Israel. Specifically, we could be adversely
affected by any major hostilities involving Israel, a full or partial
mobilization of the reserve forces of the Israeli army, the interruption or
curtailment of trade between Israel and its present trading partners, and a
significant downturn in the economic or financial condition of Israel.

Since the establishment of the State of Israel in 1948, a number of
armed conflicts have taken place between Israel and its Arab neighbors, and a
state of hostility, varying from time to time in intensity and degree, has led
to security and economic problems for Israel. Since September 2000, there has
been a marked increase in violence, civil unrest and hostility, including armed
clashes, between the State of Israel and the Palestinians, and acts of terror
have been committed inside Israel and against Israeli targets in the West Bank
and Gaza. There is no indication as to how long the current hostilities will
last or whether there will be any further escalation. Any further escalation in
these hostilities or any future armed conflict, political instability or
violence in the region may have a negative effect on our business condition,
harm our results of operations and adversely affect our share price. In
addition, the Israeli Government has adopted a plan according to which the State
of Israel will disengage from territories in Gaza Strip and north Samaria, or
the Disengagement Plan. The Disengagement Plan has recently been approved by the
Israeli Parliament and is expected to be executed as of August 2005. However, at
this stage, it is not clear whether the Disengagement Plan will be implemented
at all, and if implemented, what implications, if any, will it entail.
Accordingly, we can not predict the effects of the implementation or
cancellation of such plan on the Israeli political and economical situation.
Furthermore, there are a number of countries that restrict business with Israel
or Israeli companies. Restrictive laws or policies of those countries directed
towards Israel or Israeli businesses had, and may in the future continue to
have, an adverse impact on our operations, our financial results or the
expansion of our business. No predictions can be made as to whether or when a
final resolution of the area's problems will be achieved or the nature thereof
and to what extent the situation will impact Israel's economic development or
our operations.

Political trade relations could limit our ability to sell or buy
internationally.

We could be affected adversely by the interruption or reduction of
trade between Israel and its trading partners. Some countries, companies and
organizations continue to participate in a boycott of Israeli firms and others
doing business with Israel or with Israeli companies. To date, these measures
have not had a material adverse affect on our business. However, there can be no
assurance that restrictive laws, policies or practices towards Israel or Israeli
businesses will not have an adverse impact on our business.

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

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

The economic conditions in Israel have not been stable in recent years.

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

Because exchange rates between the NIS and the dollar fluctuate
continuously, exchange rate fluctuations, particularly larger periodic
devaluations, may have an impact on our profitability and period-to-period
comparisons of our results. In 2001 and 2002, the rate of devaluation of the NIS
against the dollar was 9.3% and 7.3%, respectively, while in 2003 and 2004 the
NIS appreciated in value in relation to the dollar by 7.6% and 1.6%,
respectively. A portion of our expenses, primarily labor expenses, is incurred
in NIS and a part of our revenues are quoted in NIS. Additionally, certain
assets, as well as a portion of our liabilities, are denominated in NIS. Our
results may be adversely affected by the devaluation of the NIS in relation to
the dollar (or if such devaluation is on lagging basis), if our revenues in NIS
are higher than our expenses in NIS and/or the amount of our assets in NIS are
higher than our liabilities in NIS. Alternatively, our results may be adversely
affected by an appreciation of the NIS in relation to the dollar (or if such
appreciation is on a lagging basis), if the amount of our expenses in NIS are
higher than the amount of our revenues in NIS and/or the amount of our
liabilities in NIS are higher than our assets in NIS.

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

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

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

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

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

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

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

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

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

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

Additionally, it may be difficult for an investor, or any other person or
entity, to enforce civil liabilities under U.S. federal securities laws in
original actions filed in Israel.

ITEM 4. Information on the Company

A. History and Development of the Company.

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

We develop, manufacture, market and sell complex computerized security
systems, including a line of perimeter security systems, a video motion
detection system, a hardware and software "all in one" security solution which
integrates Closed Circuit Television, or CCTV, related applications, security
management and control systems, personal emergency location systems, a pipeline
security system and we also provide video monitoring services.

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

B. Business Overview.

General

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

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

o turnkey projects based on security management, command and
control systems, which integrate the management, control and
display of various security systems into a single, real-time
database and support real-time decision making and wide area
command and control; and

o video monitoring services.

We recently began to market two new products: DreamBox and PipeGuard.
DreamBox is a state-of-the-art embedded hardware and software product, which
integrates a number of Closed Circuit - TV related applications into one box.
The system is designed to be economical, as well as compact to save space, while
avoiding the use of complicated cable installation and network protocols
integration. PipeGuard utilizes an innovative technology to guard buried
pipelines, regardless of pipeline length, with the ability to detect potential
attack and alert authorities before potential harm or damage occurs. PipeGuard
provides a solution for securing buried assets, gas and oil pipelines and
infrastructure of buried

communication lines such as fiber optic cables. The target market for PipeGuard
includes oil and gas companies, owners and operators of pipelines or
communication cables and governmental agencies dealing with security and
environment.

Industry Background

Perimeter Security and Video Motion Detection Systems

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

DreamBox

The DreamBox is an embedded hardware and software product which
integrates a number of CCTV related applications into one box. The system is
designed to be economical, as well as compact to save space, by avoiding the use
of a complicated cable installation and network protocols integration.

DreamBox contains twelve different applications, including a digital
video and audio recording, video and audio matrix switcher, outdoor and indoor
video motion detection system, or VMD, security management system, or SMS, and a
transmission system.

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

Security Management and Control Systems

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

Pipeline Security Systems

As of end of year 2004, there were an estimated three million miles of
unprotected oil and gas pipelines worldwide. Although the need for securing
these pipelines has been strongly recognized by the oil and gas industry for
years, and in spite of increasing threats since the events of 9/11 and current
instability in Iraq and elsewhere in the Middle East, there was no effective
solution for securing buried pipes against damage caused by terror, sabotage,
theft or other third party threats. We have identified the demand and have
implemented a technology aimed at meeting this challenge. PipeGuard, our
pipeline security system, provides a solution for securing buried assets and
infrastructure, including oil and gas pipelines and buried communication lines
such as fiber optic cables.

Personal Emergency Location Systems

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

Video Monitoring Services

The rapid consolidation of some of the largest companies in the
electronic security services industry combined with their overall emphasis on
residential security has led to fewer providers of high quality, innovative
commercial electronic security services. We believe that the potential market
for commercial real-time video monitoring security services is large and that
within a few years most of the security systems used at industrial and
commercial sites will adopt video monitoring systems as the preferred method of
surveillance and protection. Consequently, in 2001, we established Smart to
provide commercial real-time video monitoring security services.

Business and Marketing Strategy

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

Refine and Broaden Product Line. We have identified the security needs
of our customers and intend to enhance our current products and develop new
products to meet those needs. We intend to continue to focus on improving the
sensitivity, detection ability and reliability of our products. During 2003, we
invested 8% of our revenues in developing new products, expanding the
capabilities of existing products and making custom enhancements for specific
projects. Since the beginning of 2004 we have launched three new products that
significantly broaden the spectrum of security solutions we offer and
substantially expand our potential security markets.

Enter New Markets and Strengthen Presence in Existing Markets. In
2005 we intend to continue to penetrate new geographic markets by various means,
including the establishment of alliances with local distributors. We also intend
to increase our marketing efforts in our existing markets and to acquire or
invest in complementary, including competitive, businesses, products and
technologies.

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

Offer Comprehensive Turnkey Solutions. By broadening our product range
to include both indoor and outdoor security systems and by developing our
security management and control systems and Dreambox "all in one" CCTV security
solution, we now offer comprehensive turnkey security solutions that provide a
comprehensive security implementation process. This process entails:

o in-depth threat analysis;

o determination of the appropriate hardware and software solutions;

o training sessions for systems operators; and

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

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

Products and Services

Perimeter Security Systems

Our line of perimeter security systems consists of the following:

o taut wire perimeter intrusion detection systems;

o vibration detection systems; and

o field disturbance sensors.

Our line of perimeter security systems utilizes sophisticated sensor
devices to detect and locate intruders and identify the nature of intrusions.
Our perimeter security systems have been installed along thousands of kilometers
of borders and facility boundaries throughout the world, including more than 600
correctional institutions in the U.S. and correctional institutions in several
other countries. In addition, we have installed several hundred miles of high
security electronic perimeter systems along Israel's borders.

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

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

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

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

Vibration Detection Systems. We offer two types of vibration detection
systems. While less sensitive than taut wire installations, the adaptability of
these systems to a wide range of pre-existing barrier structures makes these
products viable alternatives for cost-conscious customers. Our vibration

detection devices are most effective when installed on common metal fabric
perimeter systems, such as chain link or welded mesh. In our BARRICADE 500
system, pairs of electro-mechanical sensors are attached to fence panels three
meters apart on any of several common types of fence structures. Once attached
to the fence, each sensor detects vibrations in the underlying structures. The
sensor system's built-in electro-mechanical filtering combines with system input
from a weather sensor to minimize the rate of false alarms from wind, hail or
other sources of nuisance vibrations.

Intelli-FLEX and FPS microprocessor-based triboelectric and
piezoelectric cable fence sensors are vibration sensitive transducers. Both
systems detect any attempt to cut, climb or penetrate the fence and both have
microphonic properties. The microphonic feature permits audio to be used for
low-cost alarm assessment, providing users with an additional tool for
determining the nature of an attempted intrusion. Our vibration detection
systems are sold for between $11-$26 per meter.

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

Video Motion Detection System

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

DTS is a detection and tracking system that combines our image
processing technology with input from ordinary video surveillance cameras to
detect, locate and track intruders without continuous human monitoring. Our DTS
image processing and graphics overlay cards and software, when installed in an
IBM-compatible personal computer, enable that computer to process video signals,
including signals from visible light, infrared and other camera types. Our image
processing software incorporates a learning cycle that permits the system to
analyze the protected area, including such variable features as changing weather
and lighting conditions, to reduce false alarms. A DTS user can program all the
parameters used to define an alarm condition, including, for example, intruder
speed, object size, threat direction and distance traveled. The user can also
designate specific areas within the camera's field of view to be protected. Each
camera in a multiple camera system can be monitored using different parameters.
Parameters can be switched manually, automatically or by external inputs, and
the cameras can be assigned relative priorities for computer monitoring. These
features enable the DTS to identify an intruder and then track the intruder in
real-time on screen and emit an alarm without the need for continuous human
monitoring. We have continued to improve our DTS system to make it more
user-friendly and to meet customer expectations.

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

DreamBox

DreamBox contains twelve different applications, including a digital
video and audio recording, video and audio matrix switcher, outdoor and indoor
VMD, SMS, and a transmission system.

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

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

Security Management System

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

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

Integrated Command and Control System

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

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

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

Pipeline Security System

PipeGuard, our pipeline security system, provides a solution for
securing buried assets, gas and oil pipelines and infrastructure of buried
communication lines such as fiber optic cables.

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

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

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

Personal Emergency Location Systems

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

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

Video Monitoring Services

Smart provides remote video verification services and remote video
surveillance services. Smart verification systems are activated by an event,
such as an illegal entry or tampering with property. Within seconds of an event
being triggered by an intrusion, Smart systems automatically store the video
images

which are then sent to a central control room. The use of audio response to an
event allows the control room operator to effectively stop a developing incident
by broadcasting a warning message directed at the intruder. In addition, the
control room operator can replay video images captured before and after the
event to verify a criminal intrusion. Smart operators are then able to respond
to the intrusion quickly and effectively by summoning police assistance or an
entity's appropriate internal security response team. Smart central monitoring
station is able to provide instantaneous security responses across the U.S.

Marketing, Sales and Distribution

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

Perimeter Intrusion Detection Systems. We generally sell our perimeter
intrusion detection systems to exclusive distributors for various geographic
territories or for specific projects. These exclusive distributors then resell
these products at prices negotiated with their respective customers. In some
cases, however, we pay commissions on these third-party sales either to the
distributor or to the sales representatives responsible for facilitating the
transaction. In addition to marketing activities, some of our distributors also
provide installation and maintenance services for our products. We currently
have over 50 distributors who resell these systems. We occasionally use agents
to find suitable distributors and pay finders' fees to these agents for their
services.

From 1988 until March 31, 2004, an unaffiliated third party held the
exclusive right to distribute our taut wire detection systems in the U.S. and
Canada. Since March 31, 2004, we distribute our taut wire detection systems in
the U.S. through our subsidiary Magal Senstar Inc., or MSI, and an unaffiliated
third party who was granted a non-exclusive right to distribute such systems in
the U.S., and in Canada.

DTS. We have continued to improve our DTS system to make it more
user-friendly and to meet customer expectations. Our marketing efforts for our
DTS system includes participation in exhibitions in Europe, South America and
the Far East. In the U.S., we distributed the DTS system through an unaffiliated
exclusive distributor who was subject to minimum purchase requirements. This
distribution agreement was terminated on March 31, 2004. Since March 31, 2004 we
distribute our DTS systems in the U.S. and Canada through our subsidiaries, MSI
and Senstar, respectively.

Security Management and Control Systems DreamBox and Turnkey Projects.
Our marketing efforts for our Security Management and Control Systems, DreamBox
and turnkey projects consists of direct contact with potential customers. We
offer the MagNet, the Fortis and the DreamBox primarily as part of comprehensive
turnkey project solutions or, at the customer's preference, as stand-alone
products.

Pipeline Security System. The target market for the pipeline security
system includes oil and gas companies, owners and operators of pipelines or
communication cables and governmental agencies engaged with security and
environment issues.

Personal Emergency Location Systems. Our marketing efforts for the
personal emergency location systems consist of direct contact with potential
customers, mainly correctional facilities in North America.

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

The following table shows the breakdown of our consolidated revenues
for the calendar years 2002, 2003 and 2004 by operating segment:

Year Ended December 31,
---------------------------------------
2002 2003 2004
------- ------- --------
(In thousands)
Perimeter products........ $36,435 $51,077 $46,341
Projects.................. 5,340 6,720 11,375
Video monitoring.......... 238 403 2,060
Other..................... 953 1,161 1,198
------- ----- -----
Total..................... $42,966 $59,361 $60,974
======= ======= =======

Seasonality

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

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

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

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

Customers

The following table shows the geographical breakdown of our
consolidated revenues for the calendar years 2002, 2003 and 2004:

Year Ended December 31,
---------------------------------
2002 2003 2004
------- ------ -------
(In thousands)
U.S.............................. $12,641 $13,292 $17,871
Europe (excluding Romania)....... 5,376 5,465 9,150
Israel........................... 11,350 20,503 10,123
Romania.......................... 1,023 5,151 9,521
Canada........................... 4,324 6,338 4,068
Others........................... 8,252 8,612 10,241
----- ----- ------
Total............................ $42,966 $59,361 $60,974
======= ======= =======

For the years ended December 31, 2002, 2003 and 2004, revenues
generated from sales to the MOD and the Israeli Defense Forces, or IDF,
accounted for 15.9%, 27.2% and 7.7%, respectively, of our revenues. We cannot
assure you that the MOD, IDF, or any of our other major customers will maintain
their volume of business with us or that, if such volume is reduced, other
customers generate similar revenues will replace the lost business. The loss of
one or more of these existing customers without replacement by a customer or
customers of similar volume would have a material adverse effect on our
financial results.

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

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

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

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

applications and configurations, and they will be supplied to the U.S.
Department of the Air Force through the major U.S. integrators.

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

In September 2002, we won 80% of the MOD bids for the installation of
intrusion detection systems along the seam line between Israel and the West
Bank. The MOD bids were for approximately 125 kilometers, or only one third of
the total project. We have won bids having a value of approximately $15 million
to install intrusion detection systems along approximately 100 kilometers. In
January 2004, we received follow on orders of approximately $4 million. This
project was completed in 2004. In March 2005, we signed a $6.1 million framework
agreement with the MOD to continue the installation of intrusion detection
systems along the seam line. This agreement is expected to be completed by the
end of the third quarter of 2005.

In January 2002, Senstar received a $1 million contract from Public
Works and Government Services Canada on behalf of Correctional Service Canada to
supply and install over 700 security cameras and video surveillance equipment to
27 correctional facilities across Canada. In April 2002, Senstar signed a second
contract worth approximately $2.2 million to supply and install Senstar's
Perimitrax sensor as part of Correctional Service Canada's overall perimeter
detection security system at nine of its facilities. Senstar will also provide
operational and maintenance training, as well as a quantity of spare parts and
test equipment and integration into the existing perimeter intrusion detection
system integration units. Installations at six sites, valued at approximately
$1.6 million, were completed during 2002 and the balance of the contract
($600,000) was completed during 2003. Since April 2002 approximately $500,000
was added to the value of the original contract for additional work with
$300,000 completed in 2003 and the balance of $200,000 has been completed in
2004.
In April 2002, we received orders of approximately $750,000 to protect
major sensitive installations in Israel. Revenues from the majority of these
orders was reflected in our 2002 financial results, with the reminder reflected
on our 2003 financials. The orders were for a number of our security systems,
including our vibration intrusion detection system, video motion detection
system, CCTV cameras and other security systems, all controlled by our MagNet
security management system.

In July 2002, we received a $850,000 order to protect a major
correctional facility in Southeast Asia. We are acting as a sub-contractor for
Megason Electronics and Tyco, which won the tender for the total protection of
this facility. Our part in this project includes providing the perimeter
security system, which includes taut wire intrusion detection systems, CCTV
cameras and video motion detection systems. This order was completed in the
first quarter of 2004.

In December 2002, Senstar-Stellar Inc. and Senstar signed contracts to
supply perimeter intrusion detection systems to correctional facilities in
Canada and to a prison in the state of Pennsylvania. The total amount of both
contracts is approximately $2.3 million, of which orders for $500,000 were
executed in 2002. Senstar will design, supply, install and test its Intelli-Flex
fence disturbance systems at twelve Correctional Service Canada institutions
located across Canada and will also provide operational and technical training.
The Intelli-FLEX sensors will be integrated into the existing perimeter
intrusion

detection system (PIDS) integration unit. This project has been completed and
the balance was completed in the first quarter of 2004.

In August 2003, Senstar Stellar Latin America, our wholly owned Mexican
subsidiary, received an order of approximately $1.5 million to install a
perimeter security system at sensitive installations in Mexico. As of December
31, 2003, 95% of this project had been completed and the balance was completed
in the first quarter 2004.

In January 2004, we received a $700,000 order from the Israeli Prisons
Authority, to install a perimeter intrusion detection system around one of the
largest prisons in Israel. The order was completed in the third quarter of 2004.
The order includes installation of our perimeter intrusion detection systems, as
well as cameras, digital video recording and other security systems, all
controlled by our MagNet security management system.

Our wholly owned U.S. based subsidiaries, Perimeter Products Inc., or
PPI, and Senstar Stellar Inc, or SSI, supplied $4.2 million of products to
Homeland Security contractors in 2003 and $7.7 million in 2004, respectively,
for the protection of various governmental and military sites throughout the
United States.

In October 2004, several of our wholly owned subsidiaries received
approximately $4.5 million in orders for a number of projects for perimeter
security systems that were installed at sensitive installations, mostly in
Mexico. The principal portions of these projects were completed in 2004 and the
balance is expected to be completed during the first half of 2005.

In November 2004, Senstar entered into a contract with Correctional
Service Canada to protect eight of its sites in Canada, for $3.4 million. This
agreement was amended in June 2005 to add deliverables and payments of $0.3
million. Perimitrax detection sensors will be delivered and installed at all of
the sites by the end of June 2006. Pursuant to the terms of the contract, the
deliverables and the payments will take place in two stages, the first stage,
worth $2.8 million, will be completed in 2005 and the balance of $0.9 million
will be delivered and paid for in 2006.

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

DreamBox In August 2004, we received a $0.5 million order for a project
based on the DreamBox, the new all-in-one CCTV security solution, to protect a
sensitive facility in Israel.

Security Management and Control Systems and Turnkey Projects. Since its
introduction, we have sold our security management system and provided turnkey
projects to several customers, including large international companies.

In December 1999, we signed an approximately $5.7 million agreement
(including interest) with Azal to protect its international airport in
Azerbaijan. As of June 2005 this agreement was paid in full.

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

Since May 2002 we have received orders to protect communication
facilities in India totaling $6 million. These orders constitute part of a
comprehensive security installation program and follows $3.5 million in orders
executed for a sister company of the same Indian concern.

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

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

Personal Emergency Location Systems. In 2003, a contract from the State
of Michigan, for eight correctional facilities, valued at approximately $0.6
million was assigned to PPI through our purchase of the business activity of
Dominion Wireless Inc. The project is expected to be completed by the third
quarter of 2005.

Recent Developments

In July 2003, PPI acquired the business activity of Dominion Wireless,
Inc., or Dominion, for approximately $902,000. Dominion develops, produces and
manufactures a product that delivers high reliability personal portable duress
alarm systems to protect personnel in correctional facilities. As of December
31, 2003, the total purchase price was fully paid in cash. Dominion Wireless,
Inc. will be entitled to an "earn out" of 50% of the operating income related to
the acquired activity conditioned upon the achievement of operating income
milestones during the periods ending December 31, 2003, 2004 and 2005. No
payments were due for the periods ending December 31, 2003 and 2004 since the
goals were not met. Should Dominion reach the earn out goal for 2005, any
additional consideration will be recorded as goodwill.

Support and Maintenance

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

We require distributors of our high-security perimeter systems to
purchase a demonstration kit that includes full-scale models of our perimeter
products, and to send technical personnel to Israel to participate in courses
given by us that focus on the marketing, installation and servicing of our
products.

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

During 2004, we derived less than 5% of our total revenues from
maintenance and services. We generally provide a warranty on most of our
products for defects for which we receive notice within 12 months of the
delivery date of the product.

Research and Development; Royalties

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

Our research and development expenses during 2002, 2003 and 2004 were
approximately $3,750,000, $5,128,000 and $5,088,000 respectively, of which
royalty bearing grants from the Office of the Chief Scientist of the Israel
Ministry of Industry, Trade and Labor, or the OCS, and investment tax credits,
constituted approximately 16.6% 6.9% and 8%. In addition to our own research and
development activities, we also acquire know-how from external sources. We
cannot assure you that any of our research and development projects will yield
profitable results.

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

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

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

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

We historically sought co-financing of our development projects from
the OCS. In 2004, we obtained grants from the OCS of $228,000 for certain of our
research and development projects. We are obligated to pay royalties to the OCS,
amounting to 3%-4.5% of revenues derived from sales of the products funded with
these grants, up to an amount equal to 100% of the grants received, linked to
the U.S. dollar. All grants received after January 1, 1999 also bear interest at
the rate of LIBOR. The obligation to pay these royalties is contingent on actual
sales of the products and in the absence of such sales no payment is required.
We paid royalties amounting to $131,000, $80,000 and $61,000 in the years ended
December 31, 2002, 2003 and 2004, respectively. As of December 31, 2004, our
aggregate contingent obligation to the OCS amounted to $1,868,000.

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

The Fund for the Encouragement of Marketing Activities

The Israeli Government, through the Fund for the Encouragement of
Marketing Activities, awarded us grants for overseas marketing expenses. We are
obligated to pay royalties to this fund at the rate of 3% of the increase in
export sales, up to the amount of the grants we received. To date, we have
received $253,000 in grants, and have paid royalties during 2002, 2003 and 2004
of $53,000, $0 and $0, respectively. As of December 31, 2004, our aggregate
contingent obligation amounted to $95,000.

Backlog

As of May 31, 2005, our backlog amounted to approximately $43 million
of which approximately $21 million is expected to be delivered by the end of
2005, $11 million is expected to be delivered by the end of 2006 and $11 million
is expected to be delivered thereafter.

Manufacturing and Supply

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

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

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

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

Competition

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

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

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

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

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

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

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

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

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

Intellectual Property Rights

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

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

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

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

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

protect our proprietary technology. The unauthorized use of our proprietary
technology by third parties may impair our ability to compete effectively. We
could become subject to litigation regarding intellectual property rights, which
could seriously harm our business.

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

Government Regulation of Certain Exports

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

C. Organizational Structure.

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

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

Name of Subsidiary Country of Incorporation
------------------ ------------------------
Senstar-Stellar Corporation Canada
Magal Senstar Inc. United States (Delaware)
Senstar GmbH Germany
Kobb Inc. United States (Delaware)
Magal B.V. The Netherlands
Senstar-Stellar Latin America S.A. de C.V. Mexico
Senstar-Stellar Limited United Kingdom
Smart Interactive Systems, Inc. United States (Delaware)
E.S.E. Ltd. Israel
Magal Security Sisteme S.R.L Romania

D. Property, Plants and Equipment.

Our two-story 2,533 square meter plant is located on a 4,352 square
meter parcel in the Yehud Industrial Zone. We purchased the rights to the land
in August 1988 from a third party, which had purchased them primarily from the
Israel Land Authority. In accordance with Israeli law, this parcel of

land is still registered in the name of the Israel Land Authority. We will be
entitled to have title to the property recorded in our name when Israeli
authorities subdivide the property into parcels. This procedure is a statutory
requirement for transferring land ownership in Israel. The products that we
manufacture at this facility include our taut-wire intrusion detection systems,
our vibration detection systems, our video-motion detection systems, MagNet,
Fortis, DreamBox, PipeGuard, and other perimeter systems.

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

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

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

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

ITEM 5. Operating and Financial Review and Prospects

A. Operating Results.

The following discussion of our results of operations and financial
condition should be read in conjunction with our consolidated financial
statements and the related notes thereto included elsewhere in this annual
report. This discussion contains forward-looking statements that involve risks
and uncertainties. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including, but not limited to, those set forth in Item 3.D. "Key
Information-Risk Factors."

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

o video monitoring services.

We recently began to market two new products: DreamBox and PipeGuard.
DreamBox is a state-of-the-art embedded hardware and software product, which
integrates a number of Closed Circuit - TV related applications, into one box.
The system is designed to be economical, as well as compact to save space, while
avoiding the use of complicated cable installation and network protocols
integration. PipeGuard utilizes an innovative technology to guard buried
pipelines, regardless of pipeline length, with the ability to detect potential
attack and alert authorities before potential harm or damage occurs. PipeGuard
provides a solution for securing buried assets, gas and oil pipelines and
infrastructure of buried communication lines such as fiber optic cables. The
target market for PipeGuard includes oil and gas companies, owners and operators
of pipelines or communication cables and governmental agencies dealing with
security and environment.

Economic and Other Factors

Following the terrorist attacks of September 11, 2001, heightened
global security concerns have increased the demand for products such as ours,
which protect aircraft, national borders and sensitive facilities from
terrorism, and we have experienced an increase in inquiries from prospective
customers regarding our products. Although we expect demand for our products to
increase, because our products are primarily sold to government agencies,
government authorities and government-owned companies, many of which have
complex and time-consuming procurement procedures, we do not expect to
experience a significant increase in our revenues until, at the earliest, the
end of 2005.

The continued state of hostility between the State of Israel and the
Palestinian Authority has caused the State of Israel to increase its efforts to
protect its facilities and installations from unauthorized intrusions. In 2002,
the Israeli Government announced the construction of a perimeter system to seal
off parts of the West Bank to prevent Palestinian terrorists from entering
Israel. In September 2002, we won 80% of the bids published by the Israeli
Ministry of Defense, or MOD, for the installation of intrusion detection systems
along the seam-line between Israel and the West Bank. We received orders having
a value of approximately $19 million to install intrusion detection systems
along approximately 150 kilometers. As of December 31, 2004, this project was
completed. In 2003, the Israeli Government resolved to extend the perimeter
system and to continue construction along most of the remaining parts of the
seam-line. However, following the UN resolution to refer the question of the
legality of the seam-line perimeter systems to the International Court of
Justice in Hague, an international opposition to the route selected by the
Israeli government arose, causing the Israeli Government to change and shorten
the route of the seam-line perimeter system. This opposition, as well as certain
resolutions of the Israeli Supreme Court, caused a halt in the building of the
seam-line fence during 2004. Recently, the Israeli government approved a new
seam-line fence route. Such resolution is expected to signal the renewal of work
on the southern parts of the seam-line. According to recent reports in the
Israeli press, the MOD is expected to shortly publish orders for the work on the
southern segments of the seam-line fence, and it is widely believed that the
majority of the remaining segments of the fence will be completed during 2005.
Although we believe that we will participate in the new construction, we cannot
assure you that Israel will follow through with its decision to build the
perimeter system along the seam-line, or if such perimeter system is constructed
or rebuilt, that our products will be utilized.

During 2004, we continued to incur losses relating to Smart's
operations.

Business Challenges/Areas of Focus

Our primary business challenges and areas of focus include:

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

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

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

o succeeding in selling our comprehensive turnkey solutions.

Discussion of Critical Accounting Policies

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

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

Revenue Recognition

We generate our revenues mainly from (1) installation of comprehensive
security systems for which revenues are generated from long-term fixed price
contracts; (2) sales of security products; and (3) services and maintenance,
which are performed either on a fixed-price basis or on a time-and-materials
basis.

Revenues from installation of comprehensive security systems and
turnkey projects are generated from fixed price contracts according to which the
time between the signing of the contract and the final customer acceptance is
over a period generally exceeding one year. Fees are payable upon completion of
agreed upon milestones, and subject to customer acceptance. Following customer
acceptance for certain milestones and only thereafter, services can be performed
for the next milestone. The amounts of revenues recognized are based on the
total fees under the agreement and the percentage to completion achieved.

Project costs include material purchased to produce the system, related
labor and overhead expenses and subcontractor's costs. The percentage to
completion is measured by monitoring costs and efforts devoted using records of
actual costs incurred to date in the project compared to the total estimated
project requirement, which corresponds to the costs related to earned revenues.
Estimates of total project requirements are based on prior experience of
installing and integrating security systems, a history of no collection issues,
delivery and acceptance of similar services and a history of no cancellation
problems, which are reviewed and updated regularly by us. Provisions for
estimated losses on uncompleted contracts are made in the period in which such
losses are first determined, in the amount of the estimated loss on the entire
contract.

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

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

Amounts recognized in advance of contractual billing are recorded as
unbilled receivables. At December 31, 2004 we recorded $ 13.2 million of such
unbilled receivables.

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

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

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

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

Inventories

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

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

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

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

During 2002, 2003 and 2004, we recorded inventories write-offs in the
amounts of $244,000, $601,000 and $224,000, respectively. A significant portion
of the 2003 write-off was attributable to discontinued products.

Income taxes

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

As part of the process of preparing our consolidated financial
statements, we are required to estimate our income taxes in each of the
jurisdictions in which we operate. This process involves estimating our actual
current tax exposure together with assessing temporary differences resulting
from differing treatment of items for tax and accounting purposes. These
differences result in deferred tax assets and liabilities, which are included
within our consolidated balance sheet. We must then assess the likelihood that
our deferred tax assets will be recovered from future taxable income and we must
establish a valuation allowance to reduce its deferred tax assets to the amount
that is more likely than not to be realized. Increases in the valuation
allowance result in additional expense to be reflected within the tax provision
in the consolidated statement of income. At December 31, 2004, our deferred tax
asset was $0.7 million. Our subsidiaries in the U.S. and the UK have estimated
total available carry-forward tax losses of $7,139,000 and $795,000
respectively, to be offset against future taxable profit for 16-20 years and an
indefinite period, respectively. As of December 31, 2004, we recorded a full
valuation allowance due to the uncertainty of our future realization of the tax
assets.

Goodwill

Goodwill represents the excess of the costs over the net fair value of
the assets of the businesses acquired. Goodwill acquired in a business
combination on or after July 1, 2001 may not be amortized and we ceased to
amortize goodwill acquired in prior periods beginning January 2002.

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

Significant estimates used in the methodologies include estimates of
future cash flows, future short-term and long-term growth rates and weighted
average cost of capital for each of the reportable units. During 2002, 2003 and
2004, no impairment losses were identified.

As of December 31, 2004, our goodwill amounted to $4,286,000, which
principally relates to our Perimeter security systems segment.

Impairment of long lived assets

Our long-lived assets and certain identifiable intangibles are reviewed
for impairment in whenever events or changes in circumstances indicate that the
carrying amount of a group of assets may not be recoverable. Recoverability of a
group of assets to be held and used is measured by a comparison of the carrying
amount of the group of asset to the future undiscounted cash flows expected to
be generated by the group of assets. If such group of assets is considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the group of assets exceeds their fair value. During 2002,
2003 and 2004, no impairment losses were identified.

Financial statements in U.S. dollars

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

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

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

Accordingly, we had accumulated foreign currency translation income of
approximately $1.3 million and $2.3 million that were included as part of
"accumulated other comprehensive income (loss)" within our balance sheets at
December 31, 2003 and 2004, respectively. During 2002, 2003 and 2004, foreign
currency translation income of $288,000, $2,292,000, and $1,057,000
respectively, were included under "accumulated other comprehensive income
(loss)." Had we determined that the functional currency of our subsidiaries (not
including our U.S. subsidiaries) was the dollar, these gains would have
increased our income for each of the years presented.

Concentrations of credit risk

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

Of our cash and cash equivalents and short-term and long-term bank
deposits at December 31, 2004, $12 million are invested in major Israeli and
U.S. banks, approximately $3 million is invested in other banks, mainly with
Deutsche Bank and RBC Royal Bank and we hold a structured note in the principal
amount of $3 million that was issued by the Royal Bank of Scotland. Cash and
cash equivalents in the United States may be in excess of insured limits and are
not insured in other jurisdictions. We believe that the financial institutions
that hold our investments are financially sound and, accordingly, minimal credit
risk exists with respect to these investments.

The short term and long term trade receivables and the unbilled
accounts receivable of our company and our subsidiaries are derived from sales
to large and solid organizations located mainly in Israel, the United States,
Canada and Europe. We perform ongoing credit evaluations of our customers and to
date have not experienced any material losses. An allowance for doubtful
accounts is determined with respect to those amounts that we have determined to
be doubtful of collection and by a general reserve. In certain circumstances, we
may require letters of credit, other collateral or additional guarantees. As of
December 31, 2004, the allowance for doubtful accounts amounted to $320,000.

Derivative instruments

We recognize our derivative instruments as either assets or liabilities
in our statement of financial position at fair value. The accounting for changes
in the fair value (i.e., gains or losses) of a derivative

instrument depends on whether it has been designated and qualifies as part of a
hedging relationship and further, on the type of hedging relationship. For those
derivative instruments that are designated and qualify as hedging instruments, a
company must designate the hedging instrument, based upon the exposure being
hedged, as a fair value hedge, cash flow hedge or a hedge of a net investment in
a foreign operation.

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

To protect against the reduction in value of forecasted foreign
currency cash flows resulting from certain sale arrangements, we entered into
forward contracts during 2003 and 2004 in order to hedge portions of our
forecasted revenue denominated in Euro. When the dollar strengthens
significantly against the Euro, the decline in value of future Euro revenue is
offset by gains in the value of the forward contracts designated as hedges.
Conversely, when the dollar weakens, the increase in the value of future Euro
cash flows is offset by losses in the value of the forward contracts.

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

We expect that during the next 12 months we will reclassify $649,000 of
net losses on derivative instruments from unrealized losses on forward contracts
to earnings due to actual sales and related payments.

Fair value of financial instruments

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

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

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

o The carrying amounts of our long-term debt are estimated by
discounting the future cash flows using current interest rates
for loans of similar terms and maturities. As of December 31,
2003, the fair value of our long-term borrowings was $ 5,564,000,
compared to the carrying amount of $ 5,714,000. As of December
31, 2004, the fair value of our long-term borrowings was $
5,318,000, compared to the carrying amount of $5,349,000.

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

Results of Operations

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

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

Year Ended December 31,
----------------------------------------------
2000 2001 2002 2003 2004
---- ---- ---- ---- ----

Revenues.................................. 100% 100% 100% 100% 100%
Cost of revenues.......................... 53 52 56 56 55
---- ---- ---- ---- ----
Gross profit.............................. 47 48 44 44 45
---- ---- ---- ---- ----
Operating expenses:
Research and development, net............. 8 8 7 8 8
Selling and marketing, net................ 18 19 20 20 21
General and administrative................ 12 12 11 9 9
Award granted by principal shareholders... - - - - 2
---- ---- ---- ---- ----
Operating income.......................... 9 9 6 7 5
Financial income (expenses), net.......... (1) - - (2) (1)
---- ---- ---- ---- ----
Income before taxes on income............. 8 9 6 5 4
Taxes on income........................... 1 1 2 1 2
---- ---- ---- ---- ----
Net income................................ 7% 8% 4% 4% 2%
---- ---- ---- ---- ----

Years ended December 31, 2004 and 2003

Revenues. Revenues increased by 2.7% to $61 million in the year ended
December 31, 2004, as compared with $59.4 million in the year ended December 31,
2003. Revenues from sales of perimeter systems were $46.3 million in 2004, as
compared with $51.1 million in 2003, a decrease of 9%, as a result of a decrease
of approximately $10.4 million in the seam-line project, which made a major
contribution to our revenues in 2003 and was halted in 2004 due to litigation in
Israel. Revenues from security turnkey projects increased by 69% to $11.4
million in 2004, as compared with $6.7 million in 2003. One of our main projects
in 2004 was the protection of the Otopeni International Airport in Romania.
Based on our backlog of approximately $25 million and our assessment of the
market, we anticipate that our rate of revenue growth will increase in 2005.

Cost of revenues. Cost of revenues reached $33.7 million in the year
ended December 31, 2004, as compared with $33.4 million in the year ended
December 31, 2003. Cost of revenues as a percentage of revenues was 55% in 2004,
as compared with 56% in 2003. We anticipate that our cost of revenues as a
percentage of revenues will remain at the same level in 2005.

Gross profit. Gross profit increased to $27.2 million in the year ended
December 31, 2004, as compared with $26.0 million for the year ended December
31, 2003, primarily as a result of our increased revenues.

Research and development expenses, net. Research and development
expenses, net for the year ended December 31, 2004 were $4.7 million, as
compared with $4.8 million for the year ended December 31, 2003, a decrease of
2%. Research and development expenses, net amounted to 7.7% of revenues in 2004,
as compared with 8% in 2003. Royalty bearing grants and investment tax credits
decreased to $405,000 in 2004 compared to $355,000 in 2003. We expect that our
net research and development expenditures will continue at the same level in
2005 as in 2004.

Selling and marketing expenses, net. Selling and marketing expenses,
net were $12.7 million for the year ended December 31, 2004, as compared with
$11.6 million for the year ended December 31, 2003, an increase of 9.4%. The
increase in selling and marketing expenses in 2004 was primarily due to
increased marketing and selling expenses for our newly developed products,
especially the DreamBox(R), and the increase in our revenues from projects,
mainly our project in Otopeni International Airport in Romania. Selling and
marketing expenses amounted to 20.8% of revenues in 2004, as compared with 19.5%
in 2003. We expect that our selling and marketing expenses will increase in 2005
at the same rate as any increase in revenues, but will not change materially as
a percentage of revenues.

General and administrative expenses. General and administrative
expenses were $5.8 million for the year ended December 31, 2004 compared to $5.3
million for the year ended December 31, 2003. General and administrative
expenses amounted to 9.5% of revenues in 2004, compared to 8.9% in 2003. The
increase in general and administrative expenses was due to an $0.2 million
increase in the amortization of deferred stock compensation and an increase in
expenses incurred by Smart due to a $0.2 million increase in rent and
depreciation expenses arising from its relocation to a new facility. We expect
that our general and administrative expenses will increase in 2005 due to the
costs associated with our implementation of the internal controls required under
Section 404 of the Sarbanes-Oxley Act.

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

Financial income (expenses), net. Financial expenses, net for the year
ended December 31, 2004 were $762,000, as compared with $1 million for the year
ended December 31, 2003. This decrease in financial expenses was due to the
decrease in the rate of devaluation of the U.S. dollar against the Canadian
Dollar and the NIS. Our major operations are located in Canada and Israel.

Years ended December 31, 2003 and 2002

Revenues. Revenues increased by 38% to $59.4 million in the year ended
December 31, 2003, as compared with $43 million in the year ended December 31,
2002. Revenues from sales of perimeter systems were $51.1 million in 2003, as
compared with $36.4 million in 2002, an increase of 40%. Revenues from security
turnkey projects increased by 26% to $6.7 million in 2003, as compared with $5.3
million in 2002. Our main projects in 2003 included the installation of
intrusion detection systems along the seam-line between Israel and the West Bank
and the protection of the Otopeni International Airport in Romania. The
devaluation of the U.S. dollar against the Canadian dollar and the NIS increased
by approximately $2 million the revenues that are linked to those currencies in
terms of U.S. dollars.

Cost of revenues. Cost of revenues reached $33.4 million in the year
ended December 31, 2003, as compared with $23.9 million in the year ended
December 31, 2002. Cost of revenues as a percentage of revenues was 56% in 2003,
remaining at the same level as in 2002.

Gross profit. Gross profit increased to $26.0 million in the year ended
December 31, 2003, as compared with $19.0 million for the year ended December
31, 2002, primarily as a result of our increased revenues.

Research and development expenses, net. Research and development
expenses, net were $4.8 million in the year ended December 31, 2003, as compared
with $3.1 million for the year ended December 31, 2002, an increase of 53%.
Research and development expenses, net amounted to 8% of revenues in 2003, as
compared with 7% of revenues in 2002. Royalty bearing grants and investment tax
credits decreased to $355,000 in 2003, as compared with $622,000 in 2002 due to
the decrease of royalty bearing grants received from the OCS. The increase in
our research and development expenses was attributable to our development of
three new products that were launched in the beginning of 2004.

Selling and marketing expenses, net. Selling and marketing expenses,
net were $11.6 million in the year ended December 31, 2003, as compared with
$8.6 million in the year ended December 31, 2002, an increase of 34%. The
increase in selling and marketing expenses in 2003 was primarily due to the
increase in our revenues. Selling and marketing expenses amounted to 20% of
revenues in both 2003 and 2002.

General and administrative expenses. General and administrative
expenses were $5.3 million in the year ended December 31, 2003, as compared with
$4.9 million in the year ended December 31, 2002. General and administrative
expenses amounted to 9% of revenues in 2003, compared to 11% in 2002.

Financial income (expenses), net. Financial expenses, net were $1.0
million in the year ended December 31, 2003, as compared with financial income
of $199,000 in the year ended December 31, 2002. This increase in financial
expenses was due to the devaluation of the U.S. dollar against the Canadian
Dollar and the NIS Our major operations are located in Canada and Israel.

Seasonality

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

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

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

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

Exchange rate fluctuations between the NIS and the dollar, particularly
larger periodic devaluations, may have an impact on our profitability and
period-to-period comparison of our results. In 2001 and 2002, the rate of
devaluation of the NIS against the dollar was 9.3% and 7.3%, respectively, while
in 2003 and 2004 the NIS appreciated in value in relation to the dollar by 7.6%
and 1.6%, respectively. A portion of our expenses, primarily labor expenses, is
incurred in NIS and a part of our revenues are quoted in NIS. Additionally,
certain assets, as well as a portion of our liabilities, are denominated in NIS.
Our results may be adversely affected by the devaluation of the NIS in relation
to the dollar (or if such devaluation is on lagging basis), if our revenues in
NIS are higher than our expenses in NIS and/or the amount of our assets in NIS
are higher than our liabilities in NIS. Alternatively, our results may be
adversely affected by an appreciation of the NIS in relation to the dollar (or
if such appreciation is on a lagging basis), if the amount of our expenses in
NIS are higher than the amount of our revenues in NIS and/or the amount of our
liabilities in NIS are higher than our assets in NIS.

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

Israeli inflation
Year ended Israeli inflation NIS devaluation adjusted for
December 31, rate % rate % devaluation %
------------ ----------------- --------------- -----------------
2000 0 (2.7) 2.7
2001 1.4 9.3 (7.9)
2002 6.5 7.3 (0.8)
2003 (1.9) (7.6) 5.7
2004 1.2 (1.6) 2.8

Because exchange rates between the NIS and the dollar fluctuate
continuously, exchange rate fluctuations, particularly larger periodic
devaluations, may have an impact on our profitability and period-to-period
comparisons of our results. We are also subject to exchange rate fluctuations
related to our activities in Canada. During the three years ended December 31,
2004, foreign currency fluctuations had an adverse impact on our results of
operations, and our foreign exchange gains (losses), net were $478,000,
($569,000) and ($120,000), respectively. We cannot assure you that in the future
our results of operations may not be materially adversely affected by currency
fluctuations.

We periodically enter into foreign exchange contracts to offset the
risk of currency exchange rate fluctuations in connection with certain revenues.
During 2003 and 2004, we entered into forward contracts in order to hedge a
portion of our forecasted revenues denominated in euro. These forward contracts
are designated as cash flows hedges, as defined by SFAS No. 133, as amended, and
we believe are effective as a hedge for these revenues when the revenues are
recorded. The effective portion of the derivative instruments is included in
revenues and in financial expenses in the statements of operations.

Political Conditions

Since 1993, several agreements have been signed between Israel and the
Palestinian representatives concerning conditions in the West Bank and Gaza and
outlining several interim Palestinian self-government arrangements. The
implementation of these agreements have been subject to difficulties and delays.

Since September 2000, relations between Israel and the Palestinian
Authority have deteriorated and there has been a marked increase in violence,
civil unrest and hostility, including armed clashes, between the State of Israel
and the Palestinians, and acts of terror have been committed inside Israel and

against Israeli targets in the West Bank and Gaza. Recently, the Israeli
government has resolved to unilaterally evacuate all the Jewish settlements in
Gaza Strip, and a few settlements in the West Bank. In addition, following the
death of Yasser Arafat, the Palestinian Authority has established a new regime
which vowed to take active actions against terrorism and caused all Palestinian
terror organizations to commit to halt the execution of acts of terror in
Israel. Such commitment has not been completely observed. However, there is no
indication as to how long the current hostilities will last or whether there
will be any further escalation. Any further escalation in these hostilities or
any future armed conflict, political instability or violence in the region may
have a negative effect on our business condition, harm our results of operations
and adversely affect our share price.

Furthermore, there are a number of countries that restrict business
with Israel or Israeli companies. Restrictive laws or policies of those
countries directed towards Israel or Israeli businesses may have an adverse
impact on our operations, our financial results or the expansion of our
business.

In addition, some of our employees in Israel are subject to being
called upon to perform military service in Israel, and their absence may have an
adverse effect upon our operations. Generally, unless exempt, male adult
citizens and permanent residents of Israel under the age of 40 are obligated to
perform up to 36 days of military reserve duty annually and all such residents
are subject to being called to active duty at any time under emergency
circumstances. While we have operated effectively under these requirements since
we began operations, we cannot assess the full impact of these requirements on
our workforce or business if conditions should change, and we cannot predict the
effect on us of any expansion or reduction of these obligations.

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

Economic Conditions

In recent years Israel has been going through a period of recession in
economic activity, resulting in low growth rates and growing unemployment. Our
operations could be adversely affected if the economic conditions in Israel
continue to deteriorate. In addition, due to significant economic measures
proposed by the Israeli Government, there have been several general strikes and
work stoppages in 2003 and 2004, affecting all banks, airports and ports. These
strikes have had an adverse effect on the Israeli economy and on business,
including our ability to deliver products to our customers.

The domestic security situation in Israel and the global slowdown in
demand for high-tech imports continued to be the main factors affecting economic
activity in Israel in 2002 and 2003. Nevertheless, in the second half of 2003,
the business sector's activity showed signs of recovery, based on the rise in
export and private consumption. Toward the end of 2003, budgetary restraint was
exercised as a result of the economic program. The economic program placed much
emphasis on immediately reducing the deficit and on measures expected to lead to
its permanent reduction, and it therefore boosted the credibility of the fiscal
policy and placed the economy on a declining budget deficit path.

During 2004, the expansion of the economic activity and growth that the
Israeli economy experienced since the second half of 2003 continued and
unemployment decreased slightly. During this period inflation reached a rate of
1.2%, and the level expected by the Bank of Israel for the next 12 months is
between 1% and 3%. Interest rates have remained level throughout the year at
approximately 4.1%.

The Israeli government's monetary policy contributed to relative price
and exchange rate stability in recent years, despite fluctuating rates of
economic growth and a high rate of unemployment. There can

be no assurance that the Israeli government will be successful in its attempts
to keep prices and exchange rates stable.

Trade Agreements

Israel is a member of the United Nations, the International Monetary
Fund, the International Bank for Reconstruction and Development and the
International Finance Corporation. Israel is a signatory to the General
Agreement on Tariffs and Trade, which provides for reciprocal lowering of trade
barriers among its members. In addition, Israel has been granted preferences
under the Generalized System of Preferences from the U.S., Australia, Canada and
Japan. These preferences allow Israel to export products covered by such
programs either duty-free or at reduced tariffs.

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

Israel receives significant amounts of economic assistance from the
United States, averaging approximately $3 billion annually over the last several
years. We cannot assure you that U.S. economic assistance will continue at or
near amounts received in the past. If U.S. economic assistance is eliminated or
reduced significantly, the Israeli economy could suffer material adverse
consequences which could have a material adverse impact on our financial
condition and results of operations.

Effective Corporate Tax Rate

The general Israeli corporate tax rate was reduced in June 2004 from
36% to 35% for the 2004 tax year, 34% for the 2005 tax year, 32% for the 2006
tax year and 30% for the 2007 tax year and thereafter. However, certain of our
manufacturing facilities have been granted "Approved Enterprise" status under
the Law for the Encouragement of Capital Investments, 1959, as amended, commonly
referred to as the Investment Law, and, consequently, are eligible, subject to
compliance with specified requirements, for tax benefits beginning when such
facilities first generate taxable income. The tax benefits under the Investment
Law are not available with respect to income derived from products manufactured
outside of Israel. We have derived, and expect to continue to derive, a
substantial portion of our income from our Approved Enterprise facilities.
Subject to certain restrictions, we are entitled to a tax exemption in respect
of income derived from our approved facilities for a period of two years,
commencing in the first year in which such income is earned, and will be
entitled to a reduced tax rate of 15% to 25% for an additional three to eight
years if we qualify as a foreign investors' company. If we do not qualify as a
foreign investors' company, we will instead be entitled to a reduced rate of 25%
for an additional five years, rather than eight years. A foreign investors'
company is defined in the Investment Law as a company in which more than 25% of
its shareholders are non-Israeli residents. Pursuant to the Investment Law, a
foreign investors' company may enjoy benefits for a period of up to ten years,
or twelve years if it meets certain export criteria stipulated in the Investment
Law (the actual length of the benefits period is graduated based on the
percentage of foreign ownership).

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

As of December 31, 2004, our subsidiaries in the U.S. and the United
Kingdom had total net available carry forward tax losses of approximately $8
million. A full valuation allowance was recorded due to the uncertainty of the
tax assets' future realization. Utilization of U.S. net operating losses may be
subject to a substantial annual limitation due to the "change in ownership"
provisions of the Internal Revenue Code of 1986 and similar state tax law
provisions. The annual limitation may result in the expiration of net operating
losses before utilization.

B. Liquidity and Capital Resources.

General

Our ongoing liquidity requirements arise primarily from our need to
service debt and provide working capital. From our inception until our initial
public offering in March 1993, we financed our activities mainly through cash
flow from operations and bank loans. In March 1993, we received proceeds of
$9,837,000 from an initial public offering of 1,380,000 ordinary shares. In
February 1997, we raised $9,440,000 from a follow-on offering of 2,085,000
ordinary shares. The proceeds from these offerings together with cash flow from
operations and our credit facilities are our main sources of working capital.

On April 19, 2005, we completed a registered direct offering of
1,700,000 of our ordinary shares. The ordinary shares were sold to unaffiliated
institutional investors at a purchase price of $9.50 per share and to affiliated
investors at a purchase price of $9.92 per share (the closing price of the
ordinary shares on the Nasdaq National Market on April 14, 2005) for aggregate
gross proceeds of approximately $16.3 million.

Our working capital at December 31, 2004 was $21.6 million compared to
$21.4 million at December 31, 2003. Cash and cash equivalents amounted to $12
million at December 31, 2004 compared to $4.4 million at December 31, 2003. On a
proforma basis our working capital at March 31, 2005 including proceeds of the
April registered direct offering was $36.5 million. Short-term and long-term
bank deposits and structured notes amounted to $6 million at December 31, 2004
compared to $12.1 million at December 31, 2003. Our cash and cash equivalents,
short and long-term bank deposits and a structured note are held mainly in U.S.
dollars.

We expect to fund our short-term liquidity needs, including our
obligations under our credit facilities, other contractual agreements and any
other working capital requirements, from cash and cash equivalents, operating
cash flow and our credit facilities. We believe that our current cash and cash
equivalents, including bank deposits, structured note and our expected cash flow
from operations in 2005 will be sufficient to meet our planned and potential
cash requirements through 2006.

Net cash provided from operating activities was $3.7 million for the
year ended December 31, 2004 compared to $1.7 million for the years ended
December 31, 2003 and net cash used from operating activities of $1.9 million
for the year ended December 31, 2002. The increase in cash from operations was
primarily due to interest received on short and long term bank deposits,
payments received from trade receivable mainly from the MOD and a customer in
Azerbaijan and a decrease in inventories. Purchases of property and equipment in
2002, 2003 and 2004 were $1.5 million, $3.2 million and $4.9 million,
respectively. Capital expenditures in 2001, 2002 and 2003 were principally for
equipment for Smart, computers and other machinery and equipment. We estimate
that our capital expenditures for 2005 will

total approximately $5.5 million, of which 8% will be spent in Israel, 90% in
the U.S. and Canada and 2% in other countries. We expect to finance these
expenditures primarily from our cash and cash equivalents, operating cash flow
and our credit facilities. However, the actual amount of our capital
expenditures for 2005 will depend on a variety of factors, including general
economic conditions, changes in the demand for our products and the risks and
uncertainties involved in doing business in Israel.

Credit Lines and Other Debt

We currently have credit lines with Bank Leumi Le-Israel B.M., or BLL,
Union Bank of Israel Ltd., or Union Bank, United Mizrahi Bank Ltd., or UMB, and
Bank Hapoalim B.M. totaling $24 million in the aggregate. There are no
restrictions as to our use of each of these credit lines. We agreed not to
pledge any of our assets without the consent of these banks. In addition, in
connection with two of these credit lines, a fixed charge was placed on our
physical plant in Israel by each of BLL and Union Bank, each of which ranks
pari-passu with the other.

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

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

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

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

As of December 31, 2004, we were in compliance with these ratios and
terms. If we fail to fulfill our undertakings and covenants as aforesaid, these
three banks will be entitled to demand the immediate repayment of any of our
outstanding indebtedness to them and may terminate our credit lines with them.
Our loans under these credit lines are generally denominated in dollars.
However, we may occasionally have short-term NIS-denominated loans.

In addition, our subsidiaries currently have credit lines with Bank
Leumi USA, Royal Bank of Canada and Deutsche Bank totaling $9.2 million in the
aggregate.

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

o A quick ratio of not less than 1.25;

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

o Tangible net worth of at least $9 million.

As of December 31, 2004, Senstar was in compliance with these ratios
and terms.

As of December 31, 2004, we had approximately $5 million available
under our credit lines. In addition, our subsidiaries had approximately $1.4
million available under their credit lines.

As of December 31, 2004, we had outstanding under our used credit
lines:

o short-term NIS-denominated loans of approximately $5.6 million,
bearing an average interest at a rate of 5.47%;

o short-term dollar-denominated loans of approximately $8.6
million, bearing an average interest at a rate of 4.08%;

o several bank performance and advance payment guarantees totaling
approximately $2.8 million, at an annual cost of 0.5 %-1.0 %; and

o forward contracts of approximately $2.1 million.

As of December 31, 2004, Senstar, had outstanding, in the aggregate,
short-term Canadian dollar denominated loans of US$1.5 million, bearing interest
at a rate of Canadian Prime plus 0.5% (4.75% at December 31, 2004). This loan is
collateralized by a general security agreement.

As of December 31, 2004, our subsidiaries had outstanding, in the
aggregate, $5.3 million in long-term loans as follows:

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

o $500,000, bearing interest at an annual rate of 3.5% and
collateralized by the assets of our US subsidiary, Perimeter
Products Inc., or PPI. The interest on the outstanding balance
under this borrowing is due quarterly, with the principal due in
one installment in April 2006;

o $500,000, bearing interest at an annual rate of 3.05% and
collateralized by PPI's assets. This loan is due in one
installment in April 2006; and

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

In connection with our non-mortgage related loans listed immediately
above, Bank Leumi USA placed a $3 million fixed charge on our deposits with that
bank.

The two $500,000 promissory notes issued to Bank Leumi USA both have
covenants that require us to maintain $1 million in deposits at all times,
otherwise the interest rate on the notes become the bank's rate plus 0.25% until
the minimum deposit is maintained. We are also required to maintain tangible net
worth and subordinated debt in an amount of not less than $170,000 for one note
and not less than $100,000 for the second note.

As of December 31, 2004, Senstar GmbH obtained bank performance
guarantees in the amount of $136,000.

As of December 31, 2004, Senstar issued a letter of credit in the
amount of $902,000 in connection with the purchase of supplies.

On May 5, 2005, we repaid a short term loan of $1.7 million from Bank
Hapoalim from the proceeds of the April ordinary shares offering.

C. Research and Development, Patents and Licenses.

Government Grants

We participate in programs sponsored by the Israeli Government for the
support of research and development activities. In 2004, we obtained $228,000 of
royalty-bearing grants from the OCS for certain of our research and development
projects. We are obligated to pay royalties to the OCS, amounting to 3%-4.5% of
revenues derived from sales of the products funded with these grants, up to 100%
of the grants received, linked to the U.S. dollar. All grants received after
January 1, 1999 will also bear interest at the rate of LIBOR. The obligation to
pay these royalties is contingent on actual sales of the products, and in the
absence of such sales no payment is required.

Royalties paid to the OCS amounted to $131,000, $80,000 and $61,000 in
the years ended December 31, 2002, 2003 and 2004, respectively.

As of December 31, 2004, we had a remaining contingent obligation to
pay royalties of approximately $1.9 million to the OCS upon the successful sale
of products developed using such research and development programs sponsored by
the OCS.

The Israeli Government, through the Fund for the Encouragement of
Marketing Activities, awarded us grants for overseas marketing expenses. We are
obligated to pay royalties to this fund at the rate of 3% of the increase in
export sales, up to the amount of the grants we received. To date, we have
received $253,000 in grants from the Fund and, during 2002, 2003 and 2004, we
paid the Fund $53,000, $0 and $0, respectively, in royalties. As of December 31,
2004, we had a remaining contingent obligation to the Fund of $95,000.

Investment Tax Credit

Senstar is eligible for investment tax credits on its research and
development activities and on certain current and capital expenditures. During
2002, 2003 and 2004, Senstar recognized $304,000, $216,000 and $176,000,
respectively, of investment tax credits as a reduction of research and
development expenses. Senstar has available investment tax credits of
approximately $436,000 to reduce future federal income taxes payable. These
credits will expire at various dates from 2012 through 2014. See also Item 4.B.
"Information on the Company-Business Overview-Research and Development;
Royalties."

D. Trend Information.

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

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

E. Off-Balance Sheet Arrangements.

At December 31, 2004, we have guaranteed the advance payments and the
performance of our work to certain of our customers (usually government
entities). Such guarantees are required by contract for our performance during
the installation and operational period of projects throughout Israel and the
rest of the world. The guarantees for installation typically expire soon after
certain milestones are met and

guarantees for operations typically expire proportionally over the contract
period. Our maximum potential amount of future payments we could be required to
make under our guarantees at December 31, 2004 was $2.9 million. We have not
recorded any liability for such amounts, as we expect that our performance will
be acceptable and to date, no guarantees have been exercised against us.

F. Tabular Disclosure of Contractual Obligations.

The following table summarizes our minimum contractual obligations and
commercial commitments as of December 31, 2004 and the effect we expect them to
have on our liquidity and cash flow in future periods.

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

Long-term debt obligations.............. $5,349,000 $1,849,000 $3,500,000 $ - $-
Capital (finance) lease obligations..... - - - - -
Operating lease obligations............. 986,000 441,000 446,000 99,000 -
Purchase obligations.................... 300,000 - 300,000 - -
Other long-term liabilities reflected on
the company's balance sheet under U.S.
GAAP ................................ - - - - -
Total................................... $6,635,000 $2,290,000 $4,246,000 $99,000 $-

ITEM 6. Directors, Senior Management and Employees

A. Directors and Senior Management.

Our directors and executive officers are as follows:

Name Age Position
---- --- --------

Jacob Even-Ezra......................... 74 Chairman of the Board and Chief Executive Officer
Izhar Dekel............................. 53 President and Director
Chaim Porat............................. 69 Vice President - Far East and Australia Marketing
Yehezkel Farber......................... 64 Vice President - Operations
Zvi Dank................................ 55 Vice President - Research and Development
Raya Asher.............................. 37 Vice President - Finance, Chief Financial Officer and Secretary
Asaf Even-Ezra.......................... 39 Vice President - Israel and West European Marketing
Dany Pizen.............................. 53 Vice President - East European and CIS Marketing
Ofer Katz............................... 56 Vice President - Aviation Security
Raffi Netzer............................ 42 Vice President - Africa and Latin America Marketing
Nathan Kirsh............................ 73 Director
Jacob Nuss.............................. 57 Director
Jacob Perry ............................ 61 Director
Zeev Livne.............................. 60 Director
Shaul Kobrinsky......................... 53 Outside Director
Anat Winner............................. 46 Outside Director

Our articles of association provide for a board of directors of not
less than three and not more than eleven members as may be determined from time
to time at our annual general meeting. All questions that arise at meetings of
the board of directors are decided by majority vote. In the event of a tie, the
chairman of the board casts the deciding vote. All directors, other than outside
directors who

serve for three years, hold office until the next annual general meeting of
shareholders and until their successors have been elected. Officers serve at the
discretion of the board of directors, subject to the terms of any agreement
between them and us and the provisions of the Israeli Companies Law, 5739-1999.

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

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

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

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

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

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

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

Dany Pizen has served as our vice president - East European and CIS
marketing since 1995. Before joining us, Mr. Pizen served as vice president of
business development of Eldor Electronics Ltd., before which he served for 20
years in the IDF and retired as a Lieutenant Colonel. Mr. Pizan holds a B.A. in
Social Science from Bar Ilan University.

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

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

Nathan Kirsh has served as our director since 1984. Mr. Kirsh is an
independent investor. Mr. Kirsh serves as one of the trustees of the Eurona
Foundation, the beneficial owner of 81.5% of the

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

Jacob Nuss has served as our director since 1993. Mr. Nuss currently
serves as the vice president - internal auditing of IAI, and served as IAI's
deputy vice president - internal auditing from 1999 to 2003. From 1993 to 1999,
Mr. Nuss served as the director of finance of IAI's electronics group. From 1991
to 1993, Mr. Nuss served as assistant to the chairman of the board of IAI. Since
1975, Mr. Nuss has served in various financial management capacities at IAI. IAI
is a former shareholder in our company. Mr. Nuss holds an M.B.A. in Business
from Recanati Business School and a B.A. in Economics and Business Management
from Bar Ilan University. Mr. Nuss holds a certificate in internal auditing.

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

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

Shaul Kobrinsky was appointed to serve as an outside director in July
2004. Mr. Kobrinsky has served as the President and Chief Executive Officer of
Urdan Industries Ltd., an investment and holding company since 1997. From 1989
to 1997, Mr. Kobrinsky served a Chief Executive Officer of Cargal Ltd., an
Israeli company that manufactures corrugates. Previously, and since 1984, Mr.
Kobrinsky served as deputy Managing Director of Clal Industries Ltd., a holding
and investment company. Mr. Kobrinsky serves as a director of various public
companies, including: Mendelson Israel Technical and Engineering Supplies Ltd.
and Aloni Marble Ltd. Mr. Kobrinsky holds a B.A in Economics from Tel Aviv
University.

Anat Winner was appointed to serve as an outside directors in July
2004. Mrs. Winner has served as Chief Executive Officer and Chief Financial
Officer of Israel News Ltd. since October 2001. From 1999 to October 2001, Mrs.
Winner served as Chief Financial Officer of DBS. Satellite Services (1998) Ltd.
(YES), an Israeli company that is engaged in setting up and operating DBS
television systems. Previously, and since 1995, Mrs. Winner served as chief
financial officer of Eurocom Cellular Communications Ltd., an Israeli company
that is engaged in the importing and marketing of cellular phones as well as
supplying cellular service. Since 1996, Mrs. Winner has also served as corporate
secretary of Eurocom Cellular Communications Ltd. Mrs. Winner holds a B.A.
degree in Accounting and Economics from Haifa University and has been a
certified public accountant for 15 years.

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

Itzhak Hoffi and Menachem Meron, who served as our outside directors
since June 2001 and as directors since 1996, vacated office in July 2004 as
their terms of office concluded in accordance with the provisions of the Israeli
Companies Law. Brigadier-General (Ret.) Emanuel Shaked who acted as our vice
president - Africa and Latin America marketing since 1986, retired effective
December 31, 2004.

B. Compensation.

During the fiscal year ended December 31, 2004, we paid aggregate
compensation to all of our officers and directors as a group (consisting then of
16 persons) of approximately $1.5 million. In addition, we have provided
automobiles to our executive officers at our expense. We have two key-man life
insurance policies for Izhar Dekel. We are the beneficiary of one of these
policies and certain of Mr. Dekel's family members are the beneficiaries of the
other policy. We bear the cost of each of these insurance policies. We also have
a key-man life insurance policy for Jacob Even-Ezra, for which we are the
beneficiary.

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

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

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

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

C. Board Practices.

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

Election of Directors and Officers

Our directors, other than our outside directors as described below, are
elected by our shareholders at our annual general meeting and hold office until
the next annual general meeting. All the members of our board of directors
(except the outside directors as detailed below) may be reelected upon
completion of their term of office. Our annual general meetings are held at
least once every calendar year, but not more than fifteen months after the last
preceding annual general meeting. In the intervals between our annual general
meetings, the board of directors may appoint new directors to fill vacancies.

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

Our officers serve at the discretion of the board of directors, subject
to the terms of any agreement between them and us and the provisions of the
Israeli Companies Law.

Directors' Service Contracts

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

Alternate Directors

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

Independent and Outside Directors

Under the Israeli Companies Law, companies incorporated under the laws
of Israel whose shares have been offered to the public in Israel or outside of
Israel are required to appoint two outside directors. The Israeli Companies Law
requires that the outside directors be residents of Israel. However, the
Minister of Justice of the State of Israel has promulgated regulations exempting
certain qualifying dual listed companies, such as us, from the applicability of
certain provisions of the Israeli Companies Law. The Companies Regulations
(Concessions for Public Companies Whose Shares are Registered in a Stock
Exchange outside Israel), 5760-2000, as amended, provides that a public company
whose shares have been offered to the public outside of Israel or were
registered on a stock exchange out of Israel prior to February 1, 2000; and were
registered on a stock exchange in Israel after such date, may appoint an outside
director who is not an Israeli resident.

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

o an employment relationship;

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

o control; and

o service as an office holder, excluding service as an outside
director of a company that is offering its shares to the public
for the first time.

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

No person may serve as an outside director if the person's position or
other business creates, or may create, conflicts of interest with such person's
responsibilities as an outside director. Until the lapse of two years from
termination of office, a company may not engage an outside director to serve as
an office holder and cannot employ or receive services from that person, either
directly or indirectly, including through a corporation controlled by that
person.

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

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

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

The initial term of an outside director is three years and may be
extended for an additional three years. Outside directors can be removed from
office only by the same special percentage of shareholders as can elect them, or
by a court, and then only if the outside directors cease to meet the statutory
qualifications with respect to their appointment or if they violate their duty
of loyalty to the company. Each of the outside directors is required to serve on
the company's audit committee. Each other committee of a company's board of
directors must include at least one outside director. An outside director is
entitled to compensation as provided in regulations under the Israeli Companies
Law and is prohibited from receiving any other compensation, directly or
indirectly, in connection with such service.

In addition, under the NASDAQ Marketplace Rules promulgated pursuant to
the Sarbanes-Oxley Act of 2002, effective as of July 31, 2005, a majority of our
board of directors must qualify as independent directors within the meaning of
the NASDAQ Marketplace Rules and our audit committee must have at least three
members and be comprised only of independent directors each of whom satisfies
the respective "independence" requirements of the Securities and Exchange
Commission and NASDAQ. Out of the eight directors serving on our board of
directors, five directors qualify as independent directors within the meaning of
the NASDAQ Marketplace Rules. Our board of directors has determined that Ms.
Winner and Mr. Kobrinsky qualify both as independent directors under the
Securities and Exchange Commission and NASDAQ requirements and as outside
directors under the Israeli Companies Law requirements. Our board of directors
has further determined that Messrs. Nuss, Perry, and Livne qualify as
independent directors under the Securities and Exchange Commission and NASDAQ
requirements.

NASDAQ Exemptions and Home Country Practices

NASDAQ Marketplace Rule 4350, or Rule 4350, was recently amended to
permit foreign private issuers, such as our company, to follow certain home
country corporate governance practices without the need to seek individual
exemptions from NASDAQ. Instead, a foreign private issuer must provide NASDAQ
with a letter from outside counsel in its home country certifying that the
issuer's corporate governance practices are not prohibited by home country law.
On June 29, 2005, we provided NASDAQ

with a notice of non-compliance with Rule 4350. We do not comply with the
following requirements of Rule 4350, and instead follow Israeli law and practice
in respect of such requirements:

o the requirement regarding the process of nominating directors.
Instead, we follow Israeli law and practice in accordance with
which our board of directors recommends the director nominees for
election by our shareholders. See above in this Item 6.C.
"Directors, Senior Management and Employees - Board Practices -
Election of Directors."

o the requirement regarding the compensation of our chief executive
officer and all other executive officers. Instead, we follow
Israeli law and practice in accordance with which our board of
directors must approve all compensation arrangements for our
chief executive officer and all compensation arrangements for
officers are subject to the chief executive officer's approval.
See above in this Item 6.B. "Directors, Senior Management and
Employees - Compensation."

o the requirement that our independent directors have regularly
scheduled meetings at which only independent directors are
present.

o the requirement that we distribute to shareholders (and file with
NASDAQ) copies of an annual report containing audited financial
statements of our company and its subsidiaries within a
reasonable period of time prior to our annual meeting of
shareholders. We will make our financial statements available on
our website, and will send it to shareholders upon written
request.

Audit Committee

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

Our audit committee consists of three board members who satisfy the
respective "independence" requirements of the Securities and Exchange
Commission, NASDAQ and Israeli Law for audit committee members. Our audit
committee is currently composed of Ms. Anat Winner and Messrs. Shaul Kobrinsky,
and Jacob Nuss. The audit committee meets at least once each quarter. Our audit
committee charter is available on our website at www.magal-ssl.com.

Under Israeli law, an audit committee may not approve an action or a
transaction with a controlling shareholder, or with an office holder, unless at
the time of approval two outside directors are serving as members of the audit
committee and at least one of the outside directors was present at the meeting
in which an approval was granted.

Our audit committee reviewed our audited financial statements for the
year ended December 31, 2004 and members of the committee met with both
management and our external auditors to discuss those financial statements.
Management and the external auditors have represented to the audit committee
that the financial statements were prepared in accordance with U.S. GAAP.
Members of the audit committee

have received from and discussed with the external auditors their written
disclosure and letter regarding their independence from our company as required
by Independence Standards Board Standard No. 1. Members of the audit committee
also discussed with the external auditors any matters required to be discussed
by Statement on Auditing Standards No. 61. Based upon these reviews and
discussions, the audit committee has recommended to the board of directors that
the audited financial statements be included in our Annual Report on Form 20-F
for the year ended December 31, 2004.

Internal Auditor

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

Approval of Specific Related-Party Transactions

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

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

o all other important information pertaining to these actions.

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

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

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

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

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

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

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

transaction other than in the ordinary course of business, other than on market
terms, or likely to have a material impact on the company's profitability,
assets or liabilities, the office holder must also disclose any personal
interest held by:

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

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

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

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

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

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

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

o the extension of the term of an existing related-party
transaction; provided that the original transaction was duly
approved in accordance with the applicable provisions of

the Israeli Companies Law or the Israeli Securities Law and
regulations promulgated thereunder;

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Indemnification of Directors and Officers and Limitations of Liability

The Israeli Companies Law provides that a company may not exonerate
office holders from liability for a breach of their duty of loyalty, but may
exonerate in advance office holders from their liability to the company, in
whole or in part, for a breach of his duty of care. However, a company may not
exculpate in advance a director from his liability to the company with respect
to a breach of his duty of care in the event of distributions. Our articles of
association allow us to exculpate any office holder from his or her liability to
us for breach of duty of care, to the maximum extent permitted by law, before
the occurrence giving rise to such liability.

o Additionally, the Israeli Companies Law provides that a company
may, if permitted by its articles of association, enter into a
contract for the insurance of the liability of any of its office
holders with respect to an act performed by him in his capacity
as an office holder, for: a breach of their duty of care to us or
to another person;

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

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

Our articles of association provide that, subject to any restrictions
imposed by the Israeli Companies Law, we may enter into an insurance contract
providing coverage for the liability of any of our office holders for a breach
of his duty of care to us or to another person; breach of his duty of loyalty to
us, provided that the office holder acted in good faith and had reasonable cause
to assume that his act would not prejudice our interests; or a financial
liability imposed upon him in favor of another person.

Further, the Israeli Companies Law permits a company, if its articles
of association so provide, to indemnify an office holder for acts or omissions
committed in his or her capacity as an office holder of the company; for:

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

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

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

o a provision authorizing the company to grant in advance an
undertaking to indemnify an office holder, provided that the
undertaking is limited to specified classes of events that the
board of directors deem foreseeable at the time of grant and is
limited to an amount determined by the board of directors to be
reasonable under the circumstances; or

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

Our articles of association provide that we may undertake to indemnify
in advance an office holder, against financial liability imposed on them in
favor of another person by any judgment, including a settlement or an
arbitrator's award approved by a court, and, reasonable litigation expenses,
including attorneys' fees, incurred by such office holders or imposed upon them
by a court, in connection with proceedings instigated by us against them or that
are instigated on our behalf or by another person, or as a result of a criminal
charge from which they were acquitted or a criminal charge in which they were
convicted for a criminal offense that does not require proof of intent, provided
that such undertaking is limited to events of a kind that can be expected as
determined by our board of directors when authorizing such undertaking, and with
respect to such amounts determined by our board of directors as reasonable in
the circumstances. Furthermore, under our articles of association, we may
indemnify any office holder, with respect to any past occurrence.

Pursuant to a recent amendment to the Israeli Companies Law, a company
may indemnify any of its office holders for reasonable litigation costs incurred
by such office holder in connection with any investigation or other legal
proceeding instituted against him by a competent authority, provided that such
investigation or proceeding concluded without the filing of an indictment
against him or the imposition of any financial liability in lieu of criminal
proceedings, or concluded without the filing of an indictment against him and a
financial liability was imposed on him in lieu of criminal proceedings with
respect to a criminal offense that does not require proof of criminal intent.

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

o a breach by the office holder of his duty of loyalty unless, with
respect to insurance coverage or indemnification, the office
holder acted in good faith and had a reasonable basis to believe
that the act would not prejudice the company;

o a breach by the office holder of his duty of care if such breach
was committed intentionally or recklessly, unless the breach was
committed only negligently;

o any act or omission done with the intent to unlawfully yield a
personal benefit; or

o any fine imposed on the office holder.

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

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

D. Employees.

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

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

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

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

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

E. Share Ownership.

The following table sets forth certain information regarding the
ownership of our ordinary shares by our directors and executive officers as of
June 20, 2005.

Percentage of
Number of Ordinary Outstanding
Name Shares Owned(1) Ordinary Shares(2)
---------------------------------- ------------------ ------------------
Jacob Even-Ezra(3)(7)(8).......... 633,730 6.11%
Izhar Dekel(4)(8)................. - -
Raffi Netzer...................... - -
Chaim Porat....................... - -
Yehezkel Farber................... - -
Zvi Dank.......................... - -
Raya Asher........................ - -
Asaf Even-Ezra(5)(7).............. 112,426 1.08%
Dany Pizen........................ - -
Ofer Katz......................... - -
Nathan Kirsh(6)................... 1,832,227 17.66%
Jacob Nuss........................ - -
Zeev Livne........................ - -
Jacob Perry....................... - -
Shaul Kobrinsky................... - -
Anat Winner....................... - -
All directors and executive
officers as a group persons)(16). 2,465,957 23.77%

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

(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Ordinary shares relating
to options or convertible debenture notes currently exercisable or
exercisable within 60 days of the date of this table are deemed
outstanding for computing the percentage of the person holding such
securities but are not deemed outstanding for computing the percentage
of any other person. Except as indicated by footnote, the persons named
in the table above have sole voting and investment power with respect
to all shares shown as beneficially owned by them.
(2) The percentages shown are based on 10,372,448 ordinary shares issued
and outstanding as of June 20, 2005. (3) Includes Mr. Even-Ezra's
beneficial ownership of 337,279 ordinary shares held by Mira Mag, an
additional
219,554 ordinary shares, and 76,897 ordinary shares held by a trustee.
(4) Does not include any of the ordinary shares held by Mira Mag in which
Mr. Dekel's wife, Ornit Dekel, has an interest.
(5) Includes one-third, or 337,279 of the ordinary shares held by
Mira Mag in which Mr. Even-Ezra has an interest.
(6) Includes Mr. Kirsh's beneficial ownership of 1,485,852 ordinary shares
held by Mira Mag. Mr. Kirsh is a trustee of the Eurona Foundation,
which owns an 81.5% interest in Mira Mag. Mr. Kirsh is the beneficial
owner of an additional 346,375 ordinary shares.
(7) Jacob Even-Ezra and Asaf Even-Ezra are father and son.
(8) Izhar Dekel is Jacob Even-Ezra's son-in-law and Asaf Even Ezra's
brother-in-law.

As of June 20, 2005, the directors and executive officers listed above,
as a group, held options to purchase 94,500 of our ordinary shares at a weighted
average exercise price of $7.66 per share, expiring in January 2009.

Stock Option Plan

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

Under the 2003 Plan, stock options will be periodically granted to our
employees, directors, officers and consultants, in accordance with the decision
of our board of directors. Our board of directors has the authority to determine
the number of options, if any, which will be granted to each of the recipients,
the dates of the grant of such options, the date of their exercise as well as
their rate of conversion into shares in respect of each stock option, and the
purchase price thereof. Subject to shareholder approval, the 2003 Plan will be
effective for ten years and shall terminate in October 2013.

Under the 2003 Plan, no option may be exercised before the second
anniversary of the date on which it was granted, and each option expires on or
before the fifth anniversary of the date on which it was granted. Pursuant to
the plan, any options that are cancelled or not exercised within the option
period will become available for future grants.

Pursuant to the provisions of the 2003 Plan, if we issue a stock
dividend, the number of shares purchasable by any grantee upon the exercise of
options that were granted prior to the issuance of the stock dividend will be
correspondingly increased.

As of December 31, 2004, options to purchase 105,000 shares were
outstanding and additional options to purchase 537,606 shares were available for
grant.

Grants of stock options under the 2003 Plan are accounted for by us
over the exercise periods thereof as a compensation expense with a corresponding
credit to our contributed capital. Ordinary shares subject to options under the
2003 Plan are to be valued for this purpose at their market value at the time
the options are granted.

ITEM 7. Major Shareholders and Related Party Transactions

A. Major Shareholders.

The following table sets forth certain information regarding the
beneficial ownership of our ordinary shares as of June 20, 2005, by each person
or entity known to own beneficially more than 5% of our outstanding ordinary
shares based on the information provided to us by the holders or disclosed in
public filings with the Securities and Exchange Commission. The voting rights of
the shareholders listed below are not different from the voting rights of our
other shareholders.

Number of
Ordinary Shares Percentage of
Beneficially Outstanding
Name Owned(1) Ordinary Shares(2)
--------------------------------- --------------- ------------------
Mira Mag Inc.(3)................. 1,823,131 17.58%
Jacob Even-Ezra(4)............... 633,730 6.11%
Nathan Kirsh (5)................. 1,832,227 17.66%

------------------

(2) The percentages shown are based on 10,372,448 ordinary shares issued
and outstanding as of June 20, 2005.

(3) Mira Mag is the holder of 1,823,131 ordinary shares. The beneficial
owners and their percentage interest in these shares are: The Eurona
Foundation 81.5%, or 1,485,852 ordinary shares, and Jacob Even-Ezra's
three children 18.5%, or 337,279 ordinary shares. Jacob Even-Ezra
beneficially owns all of the 337,279 shares held by Mira Mag in which
his children, Ornit Dekel and Guy and Asaf Even-Ezra, have an interest.
The Eurona Foundation is an entity controlled by Nathan Kirsh, the
trustees of which are Prinz Michael von Liechtenstein, Altenbach 8,
P.O. Box 339, FL-9490 Vaduz, Liechtenstein, and Nathan Kirsh, Spintex
Village, Ezulwini, Swaziland.

(4) Includes Mr. Even-Ezra's beneficial ownership of 337,279 ordinary
shares held by Mira Mag (see footnote (3) above) and Mr. Even-Ezra's
beneficial ownership of an additional 219,554 ordinary shares and
76,897 ordinary shares held by a trustee.

(5) Includes Mr. Kirsh's beneficial ownership of 1,485,852 ordinary shares
held by Mira Mag (see footnote (3) above). Mr. Kirsh, a trustee of the
Eurona Foundation, which owns an 81.5% interest in Mira Mag, is also
the beneficial owner of an additional 346,375 ordinary shares.

Significant Changes in the Ownership of Major Shareholders

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

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

Major Shareholders Voting Rights

Our major shareholders do not have different voting rights.

Record Holders

Based on a review of the information provided to us by our transfer
agent, as of June 8, 2005, there were 59 holders of record of our ordinary
shares, of which 53 record holders holding approximately 76.6% of our ordinary
shares had registered addresses in the United States. These numbers are not
representative of the number of beneficial holders of our shares nor is it
representative of where such beneficial holders reside since many of these
ordinary shares were held of record by brokers or other

nominees, including CEDE & Co., the nominee for the Depositary Company (the
central depositary for the U.S. brokerage community), which held approximately
76.5% of our outstanding ordinary shares as of said date.

B. Related Party Transactions.

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

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

Registration Rights Agreement

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

Sales to a Former Principal Shareholder

We sell our perimeter systems to IAI, which was a principal
shareholders until July 2003. Jacob Nuss, one of our directors, is currently the
deputy vice-president-internal auditing of IAI, and since 1975, has served in
various financial management capacities at IAI. The terms of the contracts under
which we make sales to IAI were negotiated on an arms'-length basis and the
terms of such contracts are no more favorable to IAI than those it could have
obtained from an unaffiliated third party. Our sales to IAI during the years
ended December 31, 2002, 2003 and 2004 were $111,000, $88,000 and $541,000,
respectively.

Sales to a Principal Shareholder

Our U.S. subsidiary Smart provides video monitoring services to
companies controlled by Mr. Kirsh. The terms of the contracts under which we
make sales to these companies were negotiated on an arms'-length basis and the
terms of such contracts are no more favorable to these companies than those it
could have obtained from an unaffiliated third party. Our sales to these
companies during the years ended December 31, 2002, 2003 and 2004 were $77,000
$108,000 and $386,000, respectively.

Employment Contracts

Jacob Even-Ezra and Izhar Dekel entered into substantially similar
employment agreements with us, effective January 1993. These agreements contain
certain non-competition and confidentiality provisions. In addition, each
agreement establishes a base salary and a package of benefits with an aggregate
value of approximately 20% of the base salary, as well as a possible bonus. In
April 2000, we extended the term of Mr. Even-Ezra's employment agreement until
January 2004. In October 2003, the appointment of Mr. Even-Ezra as chairman of
the board was extended until January 2006 and as CEO for such period until a new
CEO is appointed. Under the Israeli Companies Law, such dual positions require

shareholders, approval which must be renewed every three years. Our shareholders
approved this dual position in July 2004. In December 2000, our board of
directors amended the term of Mr. Dekel's employment agreement. Under the
amended agreement, the term of Mr. Dekel's employment will continue until such
time as it is terminated by us or by Mr. Dekel pursuant to the terms of the
agreement. Under the Israeli Companies Law, the terms of employment of Mr.
Dekel, who is also a member of our board of directors requires shareholders'
approval. Our shareholders approved Mr. Dekel's terms in July 2004. See also
Item 6.B. "Directors, Senior Management and Employees-Compensation" above.

C. Interests of Experts and Counsel.

Not applicable.

ITEM 8. Financial Information

A. Consolidated Statements and Other Financial Information.

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

In 2004, the total amount of our revenues from our facilities located
outside of Israel to customers outside of Israel was approximately $35 million,
or 57% of our total revenues. The total amount of our export revenues from our
Israeli facilities to countries outside of Israel was approximately $15.8
million, or 26% of our total revenues.

Legal Proceedings

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

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

Dividend Policy

In each of 1999 and 2000, we paid a cash dividend to our shareholders
of $0.10 per ordinary share, representing approximately 32% of our net income
before writing off the investment in our affiliate in each of 1998 and 1999. In
2001, we paid a cash dividend to our shareholders of $0.13 per ordinary share,
representing approximately 33% of our net income in 2000. In each of August 2002
and 2003, we paid a 3% stock dividend, as a final dividend for the years ended
December 31, 2001 and 2002, respectively.

On January 27, 2004 we paid a cash dividend to our shareholders of
$0.05 per ordinary share, representing approximately 17% of our net income in
2003. In August 2004, we paid a 5% stock dividend to our shareholders as a final
dividend for 2003.

B. Significant Changes.

Except as otherwise disclosed in this annual report, there has been no
material change in our financial position since December 31, 2004.

ITEM 9. The Offer and Listing

A. Offer and Listing Details.

Annual Stock Information

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

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

NASDAQ National Market Tel Aviv Stock Exchange
---------------------- -----------------------
High Low High Low
---- --- ---- ---
Year
----
2000............. $5.12 $2.37 -- --
2001............. 15.20 2.87 NIS 64.00 NIS 20.50
2002............. 13.49 4.57 59.60 22.24
2003............. 9.97 4.74 42.68 22.69
2004............. 40.35 6.75 156.68 32.25

Quarterly Stock Information

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

NASDAQ National Market Tel Aviv Stock Exchange
---------------------- -----------------------
High Low High Low
---- --- ---- ---
2003
----
First Quarter... $6.28 $4.84 NIS 29.66 NIS 4.15
Second Quarter.. 6.81 4.74 28.23 22.69
Third Quarter... 9.97 5.55 42.68 25.62
Fourth Quarter.. 9.50 7.55 42.23 33.74

2004
----
First Quarter... $23.22 $6.75 NIS 88.10 NIS 32.25
Second Quarter.. 40.35 12.35 156.68 56.77
Third Quarter... 19.45 12.60 84.77 57.12
Fourth Quarter.. 17.05 10.60 74.70 47.20

Monthly Stock Information

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

NASDAQ National Market Tel Aviv Stock Exchange
---------------------- -----------------------
High Low High Low
---- --- ---- ---
2004
----
December $13.89 $10.6 NIS 59.75 NIS 47.2
2005
----
January $12.51 $ 9.41 NIS 53.74 NIS 42.5
February 11.50 9.46 50.99 41.61
March 12.47 10.08 52.5 44.57
April 11.90 9.00 50.91 40.28
May 10.09 8.51 43.7 37.8

B. Plan of Distribution.

Not applicable.

C. Markets.

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

D. Selling Shareholders.

Not applicable.

E. Dilution.

Not applicable.

F. Expenses of the Issue.

Not applicable.

ITEM 10. Additional Information

A. Share Capital.

Not applicable.

B. Memorandum and Articles of Association.

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

Board of Directors

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

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

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

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

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

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

Share Capital

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

may, subject to certain provisions detailed below, create different classes of
shares, each class bearing different rights, preferences and restrictions.

Dividends

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

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

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

Voting Rights

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

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

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

o amend the memorandum or the articles of association;

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

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

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

Rights in the Company's Profits

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

Liquidation

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

Redemption

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

Transfer of shares

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

Substantial limitations on shareholders

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

Capital Calls

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

Modifications of Share Rights

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

General Meetings of Shareholders

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

The Israeli Companies Law provides that a company whose shares are
traded on a stock exchange must give notice of a general meeting of shareholders
to its shareholders of record at least twenty-one days prior to the meeting. A
shareholder present, in person or by proxy, at the commencement of a general
meeting of shareholders may not seek the cancellation of any proceedings or
resolutions adopted at such general meeting of shareholders on account of any
defect in the notice of such meeting relating to

the time or the place thereof. Shareholders who are registered in our register
of shareholders at the record date may vote at the general meeting of
shareholders. The record date is set in the resolution to convene the general
meeting of shareholders, provided, however, that such record date must be
between four to twenty-one days or, in the event of a vote by ballots, between
four to forty days prior the date the general meeting of shareholders is held.

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

Limitations on the Right to Own Our Securities

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

Provisions Restricting a Change in Control of Our Company

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

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

However, under the Companies Law, if as a result of any acquisition
of shares the acquirer would hold more than 90% of the company's outstanding
shares, the acquisition must be made by means of a tender offer for all of the
outstanding shares. If less than 5% of the outstanding shares are not

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

Disclosure of Shareholders' Ownership

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

C. Material Contracts.

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

D. Exchange Controls.

Israeli law and regulations do not impose any material foreign exchange
restrictions on non-Israeli holders of our ordinary shares. In May 1998, a new
"general permit" was issued under the Israeli Currency Control Law, 1978, which
removed most of the restrictions that previously existed under such law, and
enabled Israeli citizens to freely invest outside of Israel and freely convert
Israeli currency into non-Israeli currencies.

Non-residents of Israel who purchase our ordinary shares will be able
to convert dividends, if any, thereon, and any amounts payable upon our
dissolution, liquidation or winding up, as well as the proceeds of any sale in
Israel of our ordinary shares to an Israeli resident, into freely repatriable
dollars, at the exchange rate prevailing at the time of conversion, provided
that the Israeli income tax has been withheld (or paid) with respect to such
amounts or an exemption has been obtained.

E. Taxation.

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

Tax Reform

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

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

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

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

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

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

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

General Corporate Tax Structure

In 2004, Israeli companies were generally subject to corporate tax at
the rate of 35% of taxable income. This tax rate is expected to decrease
gradually to 34% in 2005, 32% in 2006 and 30% beginning in 2007. However, the
effective tax rate payable by a company that derives income from an approved
enterprise, discussed further below, may be considerably less. See "-Law for the
Encouragement of Capital Investments, 1959." Subject to relevant tax treaties,
dividends or interest received by an Israeli company from its foreign
subsidiaries are generally subject to tax regardless of such company's status as
an approved enterprise.

Law for the Encouragement of Industry (Taxes), 1969

According to the Law for the Encouragement of Industry (Taxes), 1969,
generally referred to as the Industry Encouragement Law, an industrial company
is a company resident in Israel, at least 90% of the income of which, in a given
tax year, determined in Israeli currency exclusive of income from

specified government loans, capital gains, interest and dividends, is derived
from an industrial enterprise owned by it. An industrial enterprise is defined
as an enterprise whose major activity in a given tax year is industrial
production activity.

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

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

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

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

o accelerated depreciation rates on equipment and buildings.

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

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

Law for the Encouragement of Capital Investments, 1959

General

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

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

Tax Benefits

Taxable income of a company derived from an approved enterprise is
generally subject to company tax at the maximum rate of 25%, rather than 35%,
for the benefit period. This period is ordinarily seven years, or ten years if
the company qualifies as a foreign investors' company as described below,
commencing with the year in which the approved enterprise first generates
taxable income. However, this period is limited to the earlier of twelve years
from commencement of production or fourteen years from the date of approval.

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

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

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

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

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

On April 1, 2005, an amendment to the Investments Law came into force.
Pursuant to the amendment, a company's facility will be granted the status of
"Approved Enterprise" only if it is proven to be an industrial facility (as
defined in the Investments Law) that contributes to the economic independence of
the Israeli economy and is a competitive facility that contributes to the
Israeli gross domestic product. The amendment provides that the Israeli Tax
Authority and not the Investment Center will be responsible for an Approved
Enterprise under the alternative package of benefits, referred to as a
Benefiting Facility. A company wishing to receive the tax benefits afforded to a
Benefiting Facility is required to select the tax year from which the period of
benefits under the Investment Law are to commence by simply notifying the
Israeli Tax Authority within 12 months of the end of that year. In order to be
recognized as owning a Benefiting Facility, a company is required to meet a
number of

conditions set forth in the amendment, including making a minimal investment in
manufacturing assets for the Benefiting Facility and having completed a
cooling-off period of no less than two to four years from the company's previous
year of commencement of benefits under the Investments Law.

Facility is required to select the tax year from which the period of
benefits under the Investment Law are to commence by simply notifying the
Israeli Tax Authority within 12 months of the end of that year. In order to be
recognized as owning a Benefiting Facility, a company is required to meet a
number of conditions set forth in the amendment, including making a minimal
investment in manufacturing assets for the Benefiting Facility and having
completed a cooling-off period of no less than two to four years from the
company's previous year of commencement of benefits under the Investments Law.

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

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

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

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

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

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

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

Financial Benefits

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

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

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

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

We currently have two approved enterprise expansion programs which were
approved in 1997 and 2001, and under which we are entitled to tax benefits. The
periods of benefits for two of our approved enterprise programs will expire in
2007 and in 2012, respectively. The benefits we receive in connection with our
approved enterprise programs are conditioned upon the fulfillment of a marketing
plan filed by us with the Investment Center.

Law for the Encouragement of Industrial Research and Development, 1984

Under the Law for the Encouragement of Industrial Research and
Development, 1984, or the Research Law, research and development programs that
meet specified criteria and are approved by a governmental committee of the OCS
are eligible for grants of up to 50% of certain of the project's expenditures,
as determined by the research committee, in exchange for the payment of
royalties from the sale of products developed under the program. Regulations
under the Research Law generally provide for the payment of royalties to the OCS
of 3%-5% on sales of products and services derived from technology developed
using these grants until 100% of the dollar-linked grant is repaid. Upon full
repayment of the grant, there is no further liability for royalties.

The terms of the Israeli government participation also require that
products developed with government grants be manufactured in Israel. However,
under the regulations of the Research Law, upon the approval of the Chief
Scientist, some of the manufacturing volume may be performed outside Israel,
provided that the we pay royalties at an increased rate and the aggregate
repayment amount is increased. The increase in royalties depends upon the
manufacturing volume that is performed outside of Israel, as follows:

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

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

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

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

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

The Research Law imposes reporting requirements with respect to certain
changes in the ownership of a grant recipient. The law requires the grant
recipient and its controlling shareholders and interested parties to notify the
Office of the Chief Scientist of any change in control of the recipient or a
change in the holdings of the means of control of the recipient that results in
a non-Israeli becoming an interested party directly in the recipient and
requires the new interested party to undertake to the Office of the Chief
Scientist to comply with the Research Law. In addition, the rules of the Office
of the Chief Scientist may require prior approval of the Office of the Chief
Scientist or additional information or representations in respect of certain of
such events. For this purpose, "control" is defined as the ability to direct the
activities of a company other than any ability arising solely from serving as an
officer or director of the company. A person is presumed to have control if such
person holds 50% or more of the

means of control of a company. "Means of control" refers to voting rights or the
right to appoint directors or the chief executive officer. An "interested party"
of a company includes a holder of 5% or more of its outstanding share capital or
voting rights, its chief executive officer and directors, someone who has the
right to appoint its chief executive officer or at least one director, and a
company with respect to which any of the foregoing interested parties owns 25%
or more of the outstanding share capital or voting rights or has the right to
appoint 25% or more of the directors. Accordingly, any non-Israeli who acquires
5% or more of our ordinary shares will be required to notify the Office of the
Chief Scientist that it has become an interested party and to sign an
undertaking to comply with the Research Law.

Taxation Under Inflationary Conditions

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

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

A. Where a company's equity, as calculated under the
Inflationary Adjustments Law, exceeds the depreciated
cost of fixed assets, a deduction from taxable income
is permitted equal to the excess multiplied by the
applicable annual rate of inflation. The maximum
deduction permitted in any single tax year is 70% of
taxable income, with the unused portion permitted to
be carried forward.

B. Where a company's depreciated cost of fixed assets
exceeds its equity, then the excess multiplied by the
applicable annual rate of inflation is added to
taxable income.

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

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

Pursuant to the Inflationary Adjustments Law, results for tax purposes
are measured in real terms in accordance with changes in the Israeli CPI. The
discrepancy between the change in the Israeli CPI and the change in the exchange
rate of the NIS to the dollar, each year and cumulatively, may result in a
significant difference between taxable income and the income denominated in
dollars as reflected in our financial statements (see note 14 of the notes to
our consolidated financial statements). A foreign investors' company may,
subject to certain conditions, elect to measure results, for tax purposes, in
dollar terms.

Until 2002, we measured the results for tax purposes in terms of
earnings in NIS, after certain adjustments for increases in Israel's CPI.
Commencing January 1, 2003, the basis for remeasurement is the changes in the
exchange rate of the U.S. dollar.

For the years 2001 and 2002, the differences between the change in
Israel's CPI and in the NIS/U.S. dollar exchange rate caused a difference
between taxable income or loss and the income or loss before taxes reflected in
the consolidated financial statements. In accordance with paragraph 9(f) of SFAS
No. 109, we have not provided deferred income taxes on this difference between
the reporting currency and the tax bases of assets and liabilities.

Stamp Tax

Under Israel's Stamp Tax on Documents Law, certain documents are
subject to stamp tax. Recently promulgated regulations provide for a gradual
phase-out of the stamp tax by 2008. However, in 2004, the tax authorities began
an enforcement campaign involving extensive audits of companies' compliance with
the stamp tax obligation with respect to all agreements that had been signed
since June 2003.

We have received legal advice that there are a variety of defenses
relating to the obligation to pay stamp tax and as to the amount to be paid. In
addition, the Israeli Forum of Chief Financial Officers' has filed a petition
with the Israeli Supreme Court against enforcement of this law, which petition
is currently pending. If the petition is rejected and the tax authorities do not
accept the available defenses, we may be liable to pay stamp tax with respect to
the period beginning June 1, 2003. Our management believes that the potential
costs arising from this matter are not material.

Capital Gains Tax

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

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

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

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

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

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

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

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

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

Taxation of Non-Resident Holders of Shares

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

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

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

United States Federal Income Tax Consequences

The following is a summary of certain material U.S. federal income tax
consequences that apply to U.S. Holders who hold ordinary shares as capital
assets. This summary is based on the United States Internal Revenue Code of
1986, as amended (the "Code"), Treasury regulations promulgated thereunder,
judicial and administrative interpretations thereof, and the U.S.-Israel Tax
Treaty, all as in effect on the date hereof and all of which are subject to
change either prospectively or retroactively. This summary does not address all
tax considerations that may be relevant with respect to an investment in
ordinary shares. This summary does not discuss all the tax consequences that may
be relevant to a U.S. Holder in light of such holder's particular circumstances
or to U.S. Holders subject to special rules, including

persons that are non-U.S. Holders, broker-dealers, financial institutions,
certain insurance companies, investors liable for alternative minimum tax,
tax-exempt organizations, regulated investment companies, non-resident aliens of
the U.S. or taxpayers whose functional currency is not the U.S. dollar, persons
who hold the ordinary shares through partnerships or other pass-through
entities, persons who acquired their ordinary shares through the exercise or
cancellation of employee stock options or otherwise as compensation for
services, investors that actually or constructively own 10 percent or more of
our voting shares, and investors holding ordinary shares as part of a straddle
or appreciated financial position or as part of a hedging or conversion
transaction.

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

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

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

Taxation of Dividends

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

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

Subject to complex limitations, any Israeli withholding tax imposed on
such dividends will be a foreign income tax eligible for credit against a U.S.
Holder's U.S. federal income tax liability (or, alternatively, for deduction
against income in determining such tax liability). The limitations set out in
the Code include computational rules under which foreign tax credits allowable
with respect to specific classes of income cannot exceed the U.S. federal income
taxes otherwise payable with respect to each such class of income. Dividends
generally will be treated as foreign source passive income or, in the case of
certain U.S. Holders, financial services income for United States foreign tax
credit purposes. U.S. Holders should note that recently enacted legislation
eliminates the "financial services income" category with respect to taxable
years beginning after December 31, 2006. Under this legislation, the foreign tax

credit limitation categories will be limited to "passive category income" and
"general category income." Further, there are special rules for computing the
foreign tax credit limitation of a taxpayer who receives dividends subject to a
reduced rate of tax, see discussion below. A U.S. Holder will be denied a
foreign tax credit with respect to Israeli income tax withheld from dividends
received on the ordinary shares to the extent such U.S. Holder has not held the
ordinary shares for at least 16 days of the 31-day period beginning on the date
which is 15 days before the ex-dividend date or to the extent such U.S. Holder
is under an obligation to make related payments with respect to substantially
similar or related property. Any days during which a U.S. Holder has
substantially diminished its risk of loss on the ordinary shares are not counted
toward meeting the 16-day holding period required by the statute. The rules
relating to the determination of the foreign tax credit are complex, and you
should consult with your personal tax advisors to determine whether and to what
extent you would be entitled to this credit.

Subject to certain limitations, "qualified dividend income" received by
a noncorporate U.S. Holder in tax years beginning on or before December 31, 2008
will be subject to tax at a reduced maximum tax rate of 15 percent.
Distributions taxable as dividends paid on the ordinary shares should qualify
for the 15 percent rate provided that either: (i) we are entitled to benefits
under the income tax treaty between the United States and Israel (the "Treaty")
or (ii) the ordinary shares are readily tradable on an established securities
market in the United States and certain other requirements are met. We believe
that we are entitled to benefits under the Treaty and that the ordinary shares
currently are readily tradable on an established securities market in the United
States. However, no assurance can be given that the ordinary shares will remain
readily tradable. The rate reduction does not apply unless certain holding
period requirements are satisfied. With respect to the ordinary shares, the U.S.
Holder must have held such shares for at least 61 days during the 121-day period
beginning 60 days before the ex-dividend date. The rate reduction also does not
apply to dividends received from passive foreign investment companies, see
discussion below, or in respect of certain hedged positions or in certain other
situations. The legislation enacting the reduced tax rate contains special rules
for computing the foreign tax credit limitation of a taxpayer who receives
dividends subject to the reduced tax rate. U.S. Holders of ordinary shares
should consult their own tax advisors regarding the effect of these rules in
their particular circumstances.

Disposition of Ordinary Shares

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

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

An accrual basis U.S. Holder may elect the same treatment required of
cash basis taxpayers with respect to a sale or disposition of ordinary shares,
provided that the election is applied consistently from year to year. Such
election may not be changed without the consent of the Internal Revenue Service
(the

"IRS"). In the event that an accrual basis U.S. Holder does not elect to be
treated as a cash basis taxpayer (pursuant to the Treasury regulations
applicable to foreign currency transactions), such U.S. Holder may have a
foreign currency gain or loss for U.S. federal income tax purposes because of
differences between the U.S. dollar value of the currency received prevailing on
the trade date and the settlement date. Any such currency gain or loss would be
treated as ordinary income or loss and would be in addition to gain or loss, if
any, recognized by such U.S. Holder on the sale or disposition of such ordinary
shares.

Passive Foreign Investment Companies

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

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

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

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

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

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

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

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

Alternatively, if the ordinary shares are considered "marketable stock"
and if you elect to "mark-to-market" your ordinary shares, you will generally
include in income any excess of the fair market value of the ordinary shares at
the close of each tax year over your adjusted basis in the ordinary shares. If
the fair market value of the ordinary shares had depreciated below your adjusted
basis at the close of the tax year, you may generally deduct the excess of the
adjusted basis of the ordinary shares over its fair market value at that time.
However, such deductions generally would be limited to the net mark-to-market
gains, if any, that you included in income with respect to such ordinary shares
in prior years. Income recognized and deductions allowed under the
mark-to-market provisions, as well as any gain or loss on the disposition of
ordinary shares with respect to which the mark-to-market election is made, is
treated as ordinary income or loss.

Backup Withholding and Information Reporting

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

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

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

U.S. Gift and Estate Tax

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

F. Dividends and Paying Agents.

Not applicable.

G. Statements by Experts.

Not applicable.

H. Documents on Display.

We are subject to the informational requirements of the Securities
Exchange Act of 1934, as amended, applicable to foreign private issuers and
fulfill the obligations with respect to such requirements by filing reports with
the Securities and Exchange Commission. You may read and copy any document we
file with the Securities and Exchange Commission without charge at the
Securities and Exchange Commission's public reference room at 450 Fifth Street,
N.W., Washington, D.C. 20549, and on the Securities and Exchange Commission
Internet site (http://www.sec.gov) and on our website www.magal-ssl.com. Copies
of such material may be obtained by mail from the Public Reference Branch of the
Securities and Exchange Commission at such address, at prescribed rates. Please
call the Securities and Exchange Commission at l-800-SEC-0330 for further
information on the public reference room.

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

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

I. Subsidiary Information.

Not applicable.

ITEM 11. Quantitative and Qualitative Disclosures about Market Risk

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

Interest Rate Risk

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

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

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

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

Fair
Value at
2004 2005 2006 2007 Total 12/31/04
---- ---- ---- ---- ----- --------

Liabilities:
Short Term Loans....................... $15,618 - - - $15,618 $15,618
Weighted Average Interest Rate......... 4.64% - - - - -
Long Term Loans........................ $3,500 $1,849 - - $5,349 $5,318
Weighted Average Interest Rate ........ 3.15% 8.25% - - - -

Foreign Currency Exchange Risk

We sell most of our products in North America, Europe and Israel. The
majority of our revenues and expenditures are denominated in dollars. A portion
of our revenues in Israel are made in NIS, and we expect to make NIS denominated
revenues in 2005 as well. Our foreign currency exposure with respect to our
revenues is mitigated, and we expect it will continue to be mitigated, through
salaries, materials and support operations, in which part of these costs are
denominated in NIS. Since the beginning of

2005, the NIS has decreased by approximately 5.3% against the dollar. We are
also subject to exchange rate fluctuations related to our activities in Canada.

Because exchange rates between the NIS and the dollar fluctuate
continuously, exchange rate fluctuations, particularly larger periodic
devaluations, may have an impact on our profitability and period-to-period
comparisons of our results. In 2001 and 2002, the rate of devaluation of the NIS
against the dollar was 9.3% and 7.3%, respectively, while in 2003 and 2004 the
NIS was revaluated in relation to the dollar by 7.6% and 1.6%, respectively. A
portion of our expenses, primarily labor expenses, is incurred in NIS and a part
of our revenues are quoted in NIS. Additionally, certain assets especially trade
receivables, as well as part of our liabilities are denominated in NIS. Our
results may be adversely affected by devaluation of the NIS in relation to the
dollar (or if such devaluation is on lagging basis), if our revenues in NIS are
higher than our expenses in NIS and/or the amount of our assets in NIS are
higher than our liabilities in NIS. On the contrary, our results may be
adversely affected by the revaluation of the NIS in relation to the dollar (or
if such revaluation is on a lagging basis), if the amount of our expenses in NIS
are higher than the amount of our revenues in NIS and/or the amount of our
liabilities in NIS are higher than our assets in NIS.

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

During the three years ended December 31, 2004, foreign currency
fluctuations had an adverse impact on our results of operations, and our foreign
exchange gains (losses), net were $478,000, ($569,000) and ($120,000),
respectively. We cannot assure you that in the future our results of operations
may not be materially adversely affected by currency fluctuations.

We periodically enter into foreign exchange contracts to offset the
risk of currency exchange rate fluctuations in connection with certain revenues.
During 2003 and 2004, we entered into forward contracts in order to hedge
portions of our forecasted revenues and unbilled accounts receivables
denominated in euro. These forward contracts are designated as cash flows
hedges, as defined by SFAS No. 133, as amended, and we believe are effective as
a hedge for these revenues when the revenues are recorded. The effective portion
of the derivative instruments is included in revenues.

As of the December 31, 2004, we expect to reclassify $649,000 of net
losses on derivative instruments from unrealized losses on forward contracts to
earnings due to actual sales and related payments.

ITEM 12. Description of Securities Other Than Equity Securities

Not applicable.

PART II

ITEM 13. Defaults, Dividend Arrearages and Delinquencies

Not applicable.

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

Not applicable.

ITEM 15. Controls and Procedures

Our management, including our chief executive officer and chief
financial officer, evaluated the effectiveness of our disclosure controls and
procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the
period covered by this annual report on Form 20-F. Based upon that evaluation,
our chief executive officer and chief financial officer have concluded that, as
of such date, our disclosure controls and procedures were effective to ensure
that information required to be disclosed by our company in reports that we file
or submit under the U.S. Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms and that such
information was made known to them by others within the company, as appropriate
to allow timely decisions regarding required disclosure.

There were no changes to our internal control over financial reporting
that occurred during the period covered by this annual report on Form 20-F that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting

All internal control systems, no matter how well designed, have
inherent limitations. Therefore, even those systems determined to be effective
may not prevent or detect misstatements and can provide only reasonable
assurance with respect to financial statement preparation and presentation.
Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may
deteriorate.

ITEM 16. [Reserved]

ITEM 16A. Audit Committee Financial Expert

Our board of directors has determined that Anat Winner meet the
definition of an audit committee financial expert, as defined in Item 401 of
Regulation S-K.

ITEM 16B. Code of Ethics

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

ITEM 16C. Principal Accounting Fees and Services

Fees Paid to Independent Public Accountants

The following table sets forth, for each of the years indicated, the
fees paid to our independent public accountants and the percentage of each of
the fees out of the total amount paid to the accountants.

Year Ended December 31,
----------------------------------------------
2003 2004
---------------------- ----------------------
Services Rendered Fees Percentages Fees Percentages
-------------------------- -------- ----------- -------- -----------
Audit (1)................. $197,043 71.3% $275,311 83.4%
Audit-related (2)......... 14,695 5.3 17,404 5.3

Tax (3)................... 64,738 23.4 18,183 5.5
Other .................... - - 19,380 5.8
-------- ------ -------- ------
Total .................... $276,476 100.0% $330,278 100.0%

--------------
(1) Audit fees consist of services that would normally be provided in
connection with statutory and regulatory filings or engagements.

(2) Audit-related fees relate to assurance and associated services that
traditionally are performed by the independent accountant, including:
attest services that are not required by statute or regulation;
accounting consultation and audits in connection with mergers,
acquisitions and divestitures; employee benefit plans audits; and
consultation concerning financial accounting and reporting standards.

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

Pre-Approval Policies and Procedures

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

ITEM 16D. Exemptions from the Listing Requirements and Standards for
Audit Committee

Not applicable.

ITEM 16E. Purchase of Equity Securities by the Issuer and Affiliates and
Purchasers

Issuer Purchase of Equity Securities

Not applicable.

PART III

ITEM 17. Financial Statements

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

ITEM 18. Financial Statements

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

ITEM 19. Exhibits

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

Exhibit
No. Description
--------- ---------------------------------------------------------------
1.1* Memorandum of Association of the Registrant
1.2** Articles of Association of the Registrant
2.1*** Specimen Share Certificate for Ordinary Share
2.2**** The Registrant's Stock Option Plan (1993), as amended
2.4***** Form of Underwriters' Warrant Agreement
2.5***** Registration Rights Agreement, dated as of November 18, 1996,
by and among the Registrant, Mira Mag Inc., Israel Aircraft
Industries Ltd. and Jacob Even-Ezra
4.1***** Form of Underwriting Agreement
8 List of Subsidiaries of the Registrant

12.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act,
as amended
12.2 Certification of Chief Financial Officer pursuant to
Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange
Act, as amended
13.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
13.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
15.1 Schedule of Valuation and Qualifying Accounts
15.2 Consent of Kost Forer Gabbay & Kasierer

---------------

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

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

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

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

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

MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2004

IN U.S. DOLLARS

INDEX

Page
---------

Report of Independent Registered Public Accounting Firm F-2

Consolidated Balance Sheets F-3 - F-4

Consolidated Statements of Income F-5

Statements of Changes in Shareholders' Equity F-6

Consolidated Statements of Cash Flows F-7 - F-8

Notes to Consolidated Financial Statements F-9 - F-38

- - - - - - - -

F-1

ERNST & YOUNG

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of

MAGAL SECURITY SYSTEMS LTD.

We have audited the accompanying consolidated balance sheets of Magal
Security Systems Ltd. (the "Company") and its subsidiaries as of December 31,
2003 and 2004, and the related consolidated statements of income, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 2004. Our audits included the financial statement schedule listed in the
Index at Item 2. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.

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

In our opinion, based on our audits, the consolidated financial statements
referred to above present fairly, in all material respects, the consolidated
financial position of the Company and its subsidiaries as of December 31, 2003
and 2004, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 2004, in conformity
with U.S. generally accepted accounting principles.

Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.

/s/Kost Forer Gabbay and Kasierier
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
February 13, 2005 A Member of Ernst & Young Global

F-2

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

December 31,
------------------
2003 2004
-------- -------

ASSETS

CURRENT ASSETS:
Cash and cash equivalents $ 4,389 $11,964
Short-term bank deposits 9,000 -
Trade receivables (net of allowance for doubtful accounts of
$187 and $320 as of December 31, 2003 and 2004, respectively) 14,885 13,232
Unbilled accounts receivable 5,072 7,465
Other accounts receivable and prepaid expenses 3,857 3,858
Deferred income taxes 454 488
Inventories 11,777 12,702
------- -------
Total current assets 49,434 49,709
------- -------
LONG-TERM INVESTMENTS AND TRADE RECEIVABLES:
Long-term trade receivables 300 344
Long-term bank deposits - 2,994
Structured notes 3,051 3,000
Severance pay fund 1,960 2,142
------- -------
Total long-term investments and trade receivables 5,311 8,480
------- -------
PROPERTY AND EQUIPMENT, NET 11,505 14,659
------- -------
DEFERRED INCOME TAXES 335 186
------- -------
INTANGIBLE ASSETS, NET 713 656
------- -------
GOODWILL 4,145 4,286
------- -------
Total assets $71,443 $77,976
======= =======

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

F-3

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

December 31,
-------------------
2003 2004
-------- --------

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
Short-term bank credit $ 12,597 $ 15,618
Current maturities of long-term debt 3,841 1,849
Trade payables 5,077 3,189
Other accounts payable and accrued expenses 6,518 7,450
-------- --------
Total current liabilities 28,033 28,106
-------- --------
LONG-TERM LIABILITIES:
Unrealized losses on hedging forward contracts 561 650
Long-term debt 1,873 3,500
Accrued severance pay 1,992 2,172
-------- --------
Total long-term liabilities 4,426 6,322
-------- --------
COMMITMENTS AND CONTINGENT LIABILITIES

SHAREHOLDERS' EQUITY:
Share capital:
Ordinary shares of NIS 1 par value:
Authorized: 19,748,000 shares at December 31, 2003 and 2004;
Issued and outstanding: 8,035,779 and 8,672,448 shares at
December 31, 2003 and 2004, respectively 2,683 2,825
Additional paid-in capital 24,098 32,526
Deferred stock compensation - (477)
Accumulated other comprehensive income 479 1,639
Retained earnings 11,724 7,035
-------- --------
Total shareholders' equity 38,984 43,548
-------- --------
Total liabilities and shareholders' equity $ 71,443 $ 77,976
======== ========

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

F-4

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

Year ended December 31,
-------------------------------
2002 2003 2004
-------- -------- --------

Revenues $ 42,966 $ 59,361 $ 60,974
Cost of revenues 23,924 33,378 33,725
-------- -------- --------
Gross profit 19,042 25,983 27,249
-------- -------- --------
Operating expenses:
Research and development, net 3,128 4,773 4,683
Selling and marketing, net 8,642 11,585 12,679
General and administrative 4,938 5,305 5,771
Award granted by principal shareholders - - 1,200
-------- -------- --------
Total operating expenses 16,708 21,663 24,333
-------- -------- --------
Operating income 2,334 4,320 2,916
Financial income (expenses), net 199 (1,003) (762)
-------- -------- --------
Income before taxes on income 2,533 3,317 2,154
Taxes on income 645 913 1,101
-------- -------- --------
Net income $ 1,888 $ 2,404 $ 1,053
======== ======== ========
Basic net earnings per share $ 0.24 $ 0.30 $ 0.12
======== ======== ========
Diluted net earnings per share $ 0.23 $ 0.30 $ 0.12
======== ======== ========

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

F-5

MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
U.S. dollars in thousands

Accumulated
Additional Deferred other Total Total
Ordinary paid-in stock comprehensive Retained comprehensive shareholders'
shares capital compensation income (loss) earnings income equity
-------- ----------------------- ------------- -------- ------------- -------------

Balance as of January 1, 2002 $ 2,583 $ 21,670 $ (20) $ (1,294) $ 9,761 $ 32,700
Exercise of stock options 13 125 - - - 138
Exercise of warrants 4 (4) - - - -
Amortization of deferred stock compensation - - 17 - - 17
Comprehensive income:
Net income - - - - 1,888 $ 1,888 1,888
Foreign currency translation adjustments - - - 288 - 288 288
-------- ----------------------- ------------- -------- ------------- -------------
Total comprehensive income $ 2,176
=============

Balance as of December 31, 2002 2,600 21,791 (3) (1,006) 11,649 35,031
Declared dividend - - - - (401) (401)
Exercise of stock options 30 432 - - - 462
Amortization of deferred stock compensation - - 3 - - 3
Stock dividend 53 1,875 - - (1,928) -
Comprehensive income:
Net income - - - - 2,404 $ 2,404 2,404
Unrealized losses on forward contracts, net - - - (807) - (807) (807)
Foreign currency translation adjustments - - - 2,292 - 2,292 2,292
-------- ----------------------- ------------- -------- ------------- ------------
Total comprehensive income $ 3,889
=============

Balance as of December 31, 2003 $ 2,683 $ 24,098 $ - $ 479 $ 11,724 $ 38,984
Exercise of stock options 51 916 - - - 967
Deferred stock compensation related to
officers' options grant - 661 (661) - - -
Amortization of deferred stock compensation
related to officers' options grant - - 184 - - 184
Award granted by principal shareholders 1,200 - - 1,200
Stock dividend 91 5,651 - - (5,742) -
Comprehensive income:
Net income - - - - 1,053 $ 1,053 1,053
Unrealized gains on forward contracts, net - - - 103 - 103 103
Foreign currency translation adjustments - - - 1,057 - 1,057 1,057
-------- ----------------------- ------------- -------- ------------ ------------
Total comprehensive income $ 2,213
=============
Balance as of December 31, 2004 $ 2,825 $ 32,526 $ (477) $ 1,639 $ 7,035 $ 43,548
======== ======================= ============= ======== ============
Accumulated unrealized losses on forward
contracts, net $ (704)
Accumulated foreign currency translation
adjustments 2,343
-------------
Accumulated other comprehensive income as of
December 31, 2004 $ 1,639
==============

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

F-6

MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. dollars in thousands

Year ended December 31,
-----------------------------
2002 2003 2004
-------- -------- -------

Cash flows from operating activities:
-------------------------------------
Net income $ 1,888 $ 2,404 $ 1,053
Adjustments required to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 1,096 1,378 1,966
Gain on sale of property and equipment (15) (9) (18)
Decrease (increase) in accrued interest on
short-term and long-term bank deposits 133 (199) 657
Amortization of deferred stock compensation 17 3 184
Decrease (increase) in trade receivables (2,861) (4,103) 2,049
Decrease in related parties receivables 1 28 -
Decrease (increase) in unbilled accounts receivable (2,101) 2,708 (2,373)
Decrease (increase) in other accounts receivable and
prepaid expenses (1,822) (836) 16
Decrease (increase) in deferred income taxes 444 (88) 178
Decrease (increase) in inventories 468 (2,586) (588)
Decrease (increase) in long-term trade receivables 705 1,210 (44)
Increase (decrease) in trade payables 786 10 (1,956)
Increase (decrease) in other payables and accrued
expenses (532) 1,727 880
Accrued severance pay, net (72) 77 (2)
Award granted by principal shareholders - - 1,200
Realized losses on hedging forward contract - - 476
------- ------- -------
Net cash provided by (used in) operating activities (1,865) 1,724 3,678
------- ------- -------
Cash flows from investing activities:
-------------------------------------
Purchase of long-term bank deposits (8,389) - (3,000)
Purchase of structured notes - (3,000) -
Proceeds from sale of short-term bank deposits 7,748 3,505 8,400
Proceeds from sale of property and equipment 35 33 59
Purchase of property and equipment (1,527) (3,194) (4,858)
Purchase of know-how and patents (14) (48) (89)
Acquisition of the business activity of Dominion
Wireless Inc.(a) - (902) -
------- ------- -------
Net cash used in investing activities (2,147) (3,606) 512
------- ------- -------

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

F-7

MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. dollars in thousands

Year ended December 31,
--------------------------------
2002 2003 2004
-------- -------- --------

Cash flows from financing activities:
-------------------------------------
Short-term bank credit, net $ 3,911 $ 3,098 $ 2,895
Proceeds from long-term bank loans - 43 -
Principal payment of long-term bank loans (158) (103) (365)
Proceeds from exercise of employee stock options 138 462 967
Dividend paid - - (401)
-------- -------- --------
Net cash provided by financing activities 3,891 3,500 3,096
-------- -------- --------
Effect of exchange rate changes on cash and cash
equivalents (98) 252 289
-------- -------- --------
Increase (decrease) in cash and cash equivalents (219) 1,870 7,575
Cash and cash equivalents at the beginning of the year 2,738 2,519 4,389
-------- -------- --------
Cash and cash equivalents at the end of the year $ 2,519 $ 4,389 $ 11,964
======== ======== ========
Supplemental disclosures of cash flows activities:
--------------------------------------------------

(i) Cash paid during the year for:

Interest $ 932 $ 1,099 $ 1,093
======== ======== ========
Taxes $ 1,415 $ 1,544 $ 1,164
======== ======== ========
(ii) Non-cash activities:

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

(a) Acquisition of the business activity of Dominion Wireless Inc.:

Net fair value of the assets acquired at the
acquisition date was as follows:
Inventory $ 376
Property and equipment 90
Technology 436
---------
$ 902
=========

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

F-8

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

NOTE 1:- GENERAL

a. Magal Security Systems Ltd. (the "Company") and its subsidiaries
(together "the Group") are engaged in the development,
manufacturing, marketing and sales of compleHx computerized
security systems used to automatically detect and deter human
intrusion for both civilian and military markets. A majority of
the Group's sales is generated in the U.S.A., Canada, Europe and
Israel.

As for major customer data, see Note 14b.

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

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

The Asset Purchase Agreement with DW, stipulated for additional
payments to be made conditioned upon the achievement of operating
income milestones during the periods ending on December 31, 2003,
2004 and 2005. Since such goals have not been met, no additional
payments were due for the periods ending December 31, 2003 and
2004. Should DW reach the earn out goals as of December 31, 2005,
an additional payment will become due. Such payment will be
recorded as additional goodwill in accordance with the provisions
of Statement of Financial Accounting Standards ("SFAS") No. 141
"Business Combinations".

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

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

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

At July 1,
2003
---------------
Unaudited
---------------

Inventories $ 376
Property and equipment 90
Technology 436
---------------
$ 902
===============

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

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

F-9

NOTE 1:- GENERAL (Cont.)

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

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

The following unaudited pro forma information does not purport
to represent what the Group's results of operations would have
been had the acquisition been consummated on January 1, 2002
and 2003, nor does it purport to represent the Group's results
of operations for any future period. Pro forma results of
operations for the period:

Year ended
December 31,
-------------------------
2002 2003
----------- -----------
Revenues $ 47,474 $ 59,933
=========== ===========
Net income $ 680 $ 1,910
=========== ===========
Basic net earnings per share $ 0.09 $ 0.24
=========== ===========
Diluted net earnings per share $ 0.08 $ 0.24
=========== ===========

c. Award granted by principal shareholders:

In June 2004, two principal shareholders awarded the Group's
employees an amount of net $1.2 million. The award was allocated
among the employees according to their position and seniority.
The Group recorded the award expense against additional paid in
capital in accordance with Staff Accounting Bulletin ("SAB")
Topic 5T "Accounting for Expenses or Liabilities Paid by
Principal Stockholder".

F-10

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES

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

a. Use of estimates:

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

b. Financial statements in U.S. dollars:

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

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

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

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

c. Principles of consolidation:

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

d. Cash equivalents:

Cash equivalents are short-term highly liquid investments that
are readily convertible into cash with original maturities of
three months or less at the date acquired.

F-11

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

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

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

Bank deposits with maturities of more than one year are included
in long-term bank deposits, and presented at their cost. The
deposits are in U.S. dollars and bear interest at an average rate
of 2.3% and mature in 2006.

f. Structured Notes:

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

The Company accounts for investment in structured notes in
accordance with SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities" and FASB Emerging Issues Task
Force Issue ("EITF") No. 96-12, "Recognition of Interest Income
and Balance Sheet Classification of Structured Notes". Management
determines the appropriate classification of its investments in
debt securities at the time of purchase and reevaluates such
determinations at each balance sheet date. Structured notes
securities are classified as held-to-maturity since management
believes the Company has the intent and ability to hold these
securities to maturity and are stated at amortized cost. As of
December 31, 2003 and 2004, the investments in the Notes
approximate their fair market value.

g. Inventories:

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

Cost is determined as follows:

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

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

F-12

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

During 2002, 2003 and 2004, the Group recorded inventories
write-offs in the amount of $244, $601 and $224, respectively. A
significant portion of the 2003 write-off was attributed to
discontinued products.

h. Long-term trade receivables:

Long-term trade receivables derive from operating lease
arrangements and from long-term payment arrangements.

i. Property and equipment:

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

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

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

j. Intangible assets:

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

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

F-13

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

k. Impairment of long-lived assets:

The Group's long-lived assets and certain identifiable
intangibles are reviewed for impairment in accordance with SFAS
No. 144 "Accounting for the Impairment or Disposal of Long- Lived
Assets" whenever events or changes in circumstances indicate that
the carrying amount of a group of assets may not be recoverable.
Recoverability of a group of assets to be held and used is
measured by a comparison of the carrying amount of the group to
the future undiscounted cash flows expected to be generated by
the group. If such group of assets is considered to be impaired,
the impairment to be recognized is measured by the amount by
which the carrying amount of the assets exceeds their fair value.
During 2002, 2003 and 2004, no impairment losses have been
identified.

l. Goodwill:

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

SFAS No. 142 requires goodwill to be tested for impairment on
adoption and at least annually thereafter or between annual tests
in certain circumstances, and written down when impaired, rather
than being amortized as previous accounting standards required.
Goodwill attributable to each of the reporting units is tested
for impairment by comparing the fair value of each reporting unit
with its carrying value. Fair value is determined using
discounted cash flows. Significant estimates used in the
methodologies include estimates of future cash flows, future
short-term and long-term growth rates and weighted average cost
of capital for each of the reportable units. During 2002, 2003
and 2004, no impairment losses have been identified.

Differences between the balance of goodwill as of December 31,
2003 and 2004 derive from functional currency translation
adjustments. The entire goodwill balance relates to the Perimeter
segment.

m. Revenue recognition:

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

Revenues from installation of comprehensive security systems are
generated from fixed price contracts according to which the time
between the signing of the contract and the final customer
acceptance is over a period generally exceeding one year.

F-14

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

Fees are payable upon completion of agreed upon milestones, and
subject to customer acceptance. Following customer acceptance for
certain milestone and only thereafter, services could be
performed for the next milestone. Such revenues are recognized in
accordance with Statement of Position ("SOP") No. 81-1
"Accounting for Performance of Construction-Type and Certain
Production-Type Contracts," using contract accounting on a
percentage of completion method, in accordance with the "Input
Method". The amounts of revenues recognized are based on the
total fees under the agreement and the percentage to completion
achieved.

Project costs include material purchased to produce the system,
related labor and overhead expenses and subcontractor's costs.
The percentage to completion is measured by monitoring costs and
efforts devoted using records of actual costs incurred to date in
the project compared to the total estimated project requirement,
which corresponds to the costs related to earned revenues.
Estimates of total project requirements are based on prior
experience of installing and integrating security systems, a
history of no collection issues, delivery and acceptance of
similar services and a history of no cancellation problems, which
are reviewed and updated regularly by management. Provisions for
estimated losses on uncompleted contracts are made in the period
in which such losses are first determined, in the amount of the
estimated loss on the entire contract.

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

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

Amounts recognized in advance of contractual billing are recorded
as unbilled accounts receivable.

The Group sells security products to customers according to
customers' orders without installation work. The customers are
not entitled to return the products. Revenues from security
product sales are recognized in accordance with SAB No. 104
"Revenue Recognition in Financial Statements", when delivery has
occurred, persuasive evidence of an agreement exists, the
vendor's fee is fixed or determinable, no further obligation
exists and collectability is probable.

Services and maintenance are performed under either fixed-price
basis or time-and-materials basis contracts. Under fixed-price
contracts, the Group agrees to perform certain work for a fixed
price. Under time-and-materials contracts, the Group is
reimbursed for labor hours

F-15

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

at negotiated hourly billing rates and for materials. Such
service contracts are not in the scope of SOP No. 81-1, and
accordingly, related revenues are recognized in accordance with
SAB No. 104, as those services are performed or over the term of
the related agreements provided that, an evidence of an
arrangement has been obtained, fees are fixed and determinable
and collectibillity is reasonably assured.

One of the Company's subsidiaries provides security video
monitoring services. The majority of contracts executed are for a
five year term and do not include terms that result in the
transfer of title of the equipment to the customer. Under the
contracts service is not dependent on specific equipment. The
subsidiary's obligation is related to the provision of monitoring
services. In accordance with EITF No. 01-08 "Determining Whether
an Arrangement Contains a Lease" and SFAS No. 13 "Accounting for
Leases," the service contract does not meet the definition of a
lease and as such the subsidiary recognizes monthly service fees
over the term of the agreement.

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

n. Accounting for stock-based compensation:

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

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

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

The fair value for options granted in 2004 is amortized over
their vesting period and estimated at the grant date using the
Black and Scholes option pricing model with the following
weighted-average assumptions for 2004: risk-free interest rate of
2.46%, dividend yields of 0%, a volatility factor of the expected
market price of the Company's Ordinary shares of 0.979, and a
weighted average life of the option of 1.5 years.

F-16

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

Proforma information under SFAS No. 123:

Year ended December 31,
-----------------------------------------
2002 2003 2004
------------ ------------ -----------

Net income as reported: $ 1,888 $ 2,404 $ 1,053
Add: stock based compensation
expenses determined under the
intrinsic value based method
included in the reported net income 17 3 184
Deduct: stock based compensation
expenses determined under fair
value based method for all awards (246) (111) (198)
------------ ------------ -----------
Proforma net income $ 1,659 $ 2,296 $ 1,039
============ ============ ===========
Basic net earnings per share-as reported $ 0.24 $ 0.30 $ 0.12
============ ============ ===========
Diluted net earnings per share-as
reported $ 0.23 $ 0.30 $ 0.12
============ ============ ===========
Proforma basic net earnings per share $ 0.21 $ 0.29 $ 0.12
============ ============ ===========
Proforma diluted net earnings per share $ 0.21 $ 0.29 $ 0.12
============ ============ ===========

o. Research and development costs:

Research and development costs incurred in the process of
developing product improvements or new products, are charged to
expenses as incurred, net of grants received and investment tax
credit.

p. Warranty costs:

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

F-17

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

q. Royalty-bearing grants:

Royalty-bearing grants from the Government of Israel for funding
research and development projects are recognized at the time the
Company is entitled to such grants on the basis of the related
costs incurred and recorded as a reduction of research and
development costs. Research and development grants recognized
amounted to $318, $128 and $228 in 2002, 2003 and 2004,
respectively.

The Company also received royalty-bearing grants from the Fund
for Encouragement of Marketing Activity. These grants are
recognized at the time the Company is entitled to such grants on
the basis of the costs incurred and included as a deduction of
selling and marketing expenses. Total grants recognized amounted
to $82, $0 and $0 in 2002, 2003 and 2004, respectively.

r. Net earnings per share:

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

s. Concentrations of credit risk:

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

Cash and cash equivalents, short-term and long-term bank deposits
and structured notes are mainly invested in major Israeli and
U.S. banks. Cash and cash equivalents in the United States may be
in excess of insured limits and are not insured in other
jurisdictions. Management believes that the financial
institutions that hold the Group's investments are financially
sound and, accordingly, minimal credit risk exists with respect
to these investments.

The short-term and long-term trade receivables of the Group, as
well as the unbilled accounts receivable, are derived from sales
to large and solid organizations and government authorities
located mainly in Israel, the United States, Canada and Europe.
The Group performs ongoing credit evaluations of its customers
and to date have not experienced any material losses. An
allowance for doubtful accounts is determined with respect to
those amounts that the Group has determined to be doubtful of
collection and in accordance with an aging key. In certain
circumstances, the Group may require letters of credit, other
collateral or additional guarantees.

The Group has no significant off-balance sheet concentration of
credit risks, such as foreign exchange contracts or foreign
hedging arrangements, except derivative instruments, which are
detailed in Note 2x.

F-18

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

t. Income taxes:

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

u. Severance pay:

The Company's liability for its Israeli employees severance pay
is calculated pursuant to Israel's Severance Pay Law based on the
most recent salary of the employees multiplied by the number of
years of employment, as of the balance sheet date. Employees are
entitled to one month's salary for each year of employment or a
portion thereof. The Company's liability for its employees in
Israel is fully provided by monthly deposits with insurance
policies and by an accrual. The value of these policies is
recorded as an asset in the Company's balance sheet.

The deposited funds include profits accumulated up to balance
sheet date. The deposited funds may be withdrawn only upon the
fulfillment of the obligation pursuant to Israel's Severance Pay
Law or labor agreements. The value of the deposited funds is
based on the cash surrendered value of these policies, and
includes immaterial profits.

Severance expenses for the years ended December 31, 2002, 2003
and 2004, amounted to approximately $60, $313 and $306,
respectively.

v. Fair value of financial instruments:

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

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

(ii) The carrying amount of the Group's long-term trade
receivables, long-term bank deposits and structured notes
approximate their fair value. The fair value was estimated
using discounted cash flows analyses, based on the Group's
investment rates for similar type of investment
arrangements.

F-19

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

(iii)The carrying amounts of the Group's long-term debt are
estimated by discounting the future cash flows using current
interest rates for loans of similar terms and maturities. As
of December 31, 2003, the fair value of the Group's
long-term borrowing was $5,564, compared to the carrying
amount of $5,714. As of December 31, 2004, the fair value of
the Company's long-term borrowing was $5,318, compared to
the carrying amount of $5,349.

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

w. Advertising expenses:

Advertising costs are charged to the statement of income as
incurred. Advertising expenses for the years ended December 31,
2002, 2003 and 2004, were $372, $422 and $495, respectively.

x. Derivative instruments:

SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", requires a company to recognize all of its
derivative instruments as either assets or liabilities in the
statement of financial position at fair value. The accounting for
changes in the fair value (i.e., gains or losses) of a derivative
instrument depends on whether it has been designated and
qualifies as part of a hedging relationship and further, on the
type of hedging relationship. For those derivative instruments
that are designated and qualify as hedging instruments, a company
must designate the hedging instrument, based upon the exposure
being hedged.

To protect against the change in value of forecasted foreign
currency cash flows resulting from certain sale arrangements, the
Company has entered during 2003 and 2004 into forward contracts
in order to hedge portions of its forecasted revenue and unbilled
accounts receivable denominated in euro.

For derivative instruments designated as cash flow hedge (i.e.,
hedging the exposure to variability in expected future cash flows
that is attributable to a particular risk). The effective portion
of the gain or loss on the derivative instrument is reported as a
component of other comprehensive income and reclassified into
earnings in the same line item associated with the forecasted
transaction in the same period or periods during which the hedged
transaction affects earnings. For derivative instruments that are
designated and qualify as a fair value hedge (i.e., hedging the
exposure to changes in the fair value of an asset or a liability
or an identified portion thereof that is attributable to a
particular risk), the gain or loss on the derivative instrument
as well as the offsetting loss or gain on the hedged item
attributable to the hedged risk are recognized in the same line
item associated with the hedged item in current earnings during
the period of the change in fair values.

F-20

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

As of December 31, 2004, the Company expects to reclassify $649
of net losses on derivative instruments from unrealized losses on
forward contracts to earnings during the next 12 months due to
actual sales and related payments.

y. Reclassification:

Certain amounts from prior years have been reclassified to
conform to the previous year's presentation. The reclassification
had no effect on previously reported net loss, shareholders'
equity or cash flows.

z. Impact of recently issued accounting standards:

In November 2004, the FASB issued SFAS No. 151, "Inventory Costs,
an amendment of ARB No. 43, Chapter 4." SFAS No. 151 amends
Accounting Research Bulletin ("ARB") No. 43, Chapter 4, to
clarify that abnormal amounts of idle facility expense, freight
handling costs and wasted materials (spoilage) should be
recognized as current-period charges. In addition, SFAS No. 151
requires that allocation of fixed production overheads to the
costs of conversion be based on normal capacity of the production
facilities. SAFS No. 151 is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. The
Company does not expect that the adoption of SFAS No. 151 will
have a material effect on its financial position or results of
operations.

On December 16, 2004, the FASB issued SFAS No. 123(R) (revised
2004), "Share-Based Payment," which is a revision of SFAS No.
123, "Accounting for Stock-Based Compensation." Generally, the
approach in Statement 123(R) is similar to the approach described
in SFAS No. 123. However, SFAS No. 123 permitted, but not
required, share-based payments to employees to be recognized
based on their fair values while SFAS 123(R) requires all
share-based payments to employees to be recognized based on their
fair values. SFAS 123(R) also revises, clarifies and expands
guidance in several areas, including measuring fair value,
classifying an award as equity or as a liability and attributing
compensation cost to reporting periods. The new standard will be
effective for the Company in the first interim period beginning
after June 15, 2005. The adoption of SFAS 123(R) will not have a
significant effect on the Company's results of operations.

F-21

NOTE 3:- INVENTORIES

December 31,
-------------------------------
2003 2004
-------------- --------------

Raw materials $ 6,843 $ 6,806
Work in progress 2,513 2,320
Finished products 2,421 3,576
------------- -------------
$ 11,777 $ 12,702
============= =============

NOTE 4:- PROPERTY AND EQUIPMENT, NET

a. Composition:

December 31,
--------------------------------
2003 2004
--------------- ---------------

Cost:
Land and buildings $ 8,215 $ 8,790
Machinery and equipment 4,170 4,411
Machinery and equipment leased to customers
under operating leases 2,083 4,952
Motor vehicles 1,414 1,341
Promotional display 3,659 4,236
Office furniture and equipment 2,609 2,924
Leasehold improvements 23 784
-------------- --------------
22,173 27,438
-------------- --------------
Accumulated depreciation:
Buildings 2,098 2,404
Machinery and equipment 2,648 2,958
Machinery and equipment leased to customers
under operating leases 292 845
Motor vehicles 738 833
Promotional display 2,891 3,322
Office furniture and equipment 1,980 2,356
Leasehold improvements 21 61
-------------- --------------
10,668 12,779
-------------- --------------
Depreciated cost $ 11,505 $ 14,659
============== ==============

b. Depreciation expenses amounted to $1,014, $1,241 and $1,822 for
the years ended December 31, 2002, 2003 and 2004, respectively.

c. As for charges, see Note 9g.

F-22

NOTE 5:- OTHER INTANGIBLE ASSETS, NET

a. Composition:

December 31,
------------------------------
2003 2004
------------- -------------
Cost:
Know-how $ 1,502 $ 502
Patents 2,381 2,639
Technology 436 436
------------- -------------
4,319 3,577
------------- -------------
Accumulated amortization:
Know-how 1,342 396
Patents 2,237 2,443
Technology 27 82
------------- -------------
3,606 2,921
------------- -------------
Amortized cost $ 713 $ 656
============= =============

b. Amortization expenses related to intangible assets amounted to
$82, $137 and $144 for the years ended December 31, 2002, 2003
and 2004, respectively.

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

December 31,
----------------
2005 148
2006 139
2007 77
2008 74
2009 73
----------------
511
================

NOTE 6:- SHORT-TERM BANK CREDIT

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

Interest rate December 31,
--------------------- -----------------------------
2003 2004 2003 2004
--------- --------- ------------ --------------
%
---------------------

In or linked to U.S. Dollars (1) 3.02 4.08 $ 4,300 $ 8,600
In or linked to NIS (1) 6.83 5.47 6,613 5,556
In or linked to Canadian
Dollars (2) 5.01 4.75 1,684 1,462
------------ --------------
$ 12,597 $ 15,618
============ ==============
Weighted average interest
rates at the end of the year 5.28% 4.64%
============ ==============
Total authorized credit lines
approximate $ 33,245
==============
Unutilized credit lines
approximate $ 6,352
==============

F-23

NOTE 6:- SHORT-TERM BANK CREDIT (Cont.)

(1) The Company has undertaken to maintain the following financial
ratios and terms in respect of its used credit line:

1. A ratio of at least 40% of consolidated shareholders' equity
out of the consolidated total assets.

2. Minimal annual consolidated net income in the amount of $
1,000.

3. The same shareholders maintain the core of control in the
Company.

As of December 31, 2004, management believes that the Company was
in compliance with these ratios and terms.

(2) The loan to a subsidiary is collateralized by a general security
agreement and has undertaken to maintain general covenants and
the following financial ratios, with respect to the subsidiary's
financial statements, and terms in respect of its used credit
lines:

1. A quick ratio of not less than 1.25.

2. A ratio of total liabilities to tangible net worth of not
greater than 0.75.

3. Tangible net worth of at least $9 million.

As of December 31, 2004, management believes that the subsidiary
was in compliance with these ratios and terms.

b. As for charges, see Note 9g.

NOTE 7:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES

December 31,
------------------------------
2003 2004
-------------- --------------

Employees and payroll accruals $ 1,951 $ 1,380
Accrued expenses 2,116 3,911
Deferred revenues 324 81
Unrealized losses on hedging forward contracts 489 781
Government authorities - 308
Declared dividend 401 -
Income tax payable 641 3
Others 596 986
-------------- -------------
$ 6,518 $ 7,450
============== =============

F-24

NOTE 8:- LONG-TERM DEBT

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

Interest rate December 31,
Linkage ----------------------- ---------------------------
terms 2003 2004 2003 2004
----------- ----------- ----------- ------------- -------------
%
-----------------------

Bank loan U.S. $ 4.60 3.10 $ 2,500 $ 2,500
Bank loan U.S. $ 4.60 - 250 -
Bank promissory note (1) U.S. $ 2.87 3.05 500 500
Bank promissory note (1) U.S. $ 5.66 3.50 500 500
------------- -------------
3,750 3,500
Mortgage payable U.S. $ 8.25 8.25 1,964 1,849
------------- -------------
5,714 5,349
Less - current
maturities 3,841 1,849
------------- -------------
$ 1,873 $ 3,500
============= =============
Weighted average
interest rates at the
end of the year 5.80% 4.91%
============= =============

(1) As for financial ratios and terms in respect of long-term loans,
the two $500 promissory notes both have covenants that require the
Group to maintain $1 million in deposits at all times otherwise the
interest rate on the notes become the bank's rate plus 0.25% until the
minimum deposit is maintained. The Group is also required to maintain
tangible net worth and subordinated debt of not less than $170 for one
note and not less than $100 for the second note.

As of December 31, 2004, management believes that the Group was in
compliance with these ratios and terms.

b. As of December 31, 2004, the aggregate annual maturities of the
long-term loans are as follows:

2005 $ 1,849
2006 3,500
------------
$ 5,349
============

c. As for charges, see Note 9g.

F-25

NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES

a. Royalty commitments to the Office of the Chief Scientist of the
Israeli Ministry of Industry and Trade ("OCS"):

Under the research and development agreements of the Company with
the OCS and pursuant to applicable laws, the Company is required
to pay royalties at the rate of 3%-4.5% of sales of products
developed with funds provided by the OCS, up to an amount equal
to 100% of the OCS research and development grants received,
linked to the U.S. dollars plus interest on the unpaid amount
received based on the 12-month LIBOR rate applicable to dollar
deposits. The Company is obligated to repay the Israeli
Government for the grants received only to the extent that there
are sales of the funded products.

Royalties paid amounted to $131, $80 and $61 for the years ended
December 31, 2002, 2003 and 2004, respectively. As of December
31, 2004, the Company had remaining contingent obligations to pay
royalties in the amount of approximately $1,868.

b. Royalty commitments to the Fund of Encouragement of Marketing
Activities:

The Israeli Government, through the Fund for the Encouragement of
Marketing Activities, awarded the Company grants for
participation in expenses for foreign marketing. The Company is
committed to pay royalties at the rate of 3% of the increase in
export sales, up to the amount of the grants received.

Royalties paid during the years ended December 31, 2002, 2003 and
2004, amounted to $53, $0 and $0, respectively. As of December
31, 2004, the aggregate contingent obligation amounted to $95.

c. Royalty commitments to third party:

During 2002, the Company entered into a development agreement for
planning, developing and manufacturing a security system with a
third party. Under the agreement, the Company agreed to pay the
third party royalty fees, based on a formula as defined in the
agreement. Under this agreement the Company has also committed to
purchase a certain volume of products at a minimum amount of
approximately $300 over 2.5 years after achievement of certain
milestones. As of December 31, 2004, no royalty commitment, under
the agreement, exists.

d. Lease commitments:

The Group rents its facilities and some of its motor vehicles
under various operating lease agreements, which expire on various
dates, the latest of which is in 2008.

F-26

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

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

2005 $ 441
2006 290
2007 156
2008 99
-----------
$ 986
===========

Total rent expenses for the years ended December 31, 2002,
2003 and 2004, were approximately $183, $368 and $671,
respectively.

e. Guarantees:

1. As of December 31, 2004, the Group obtained bank performance
guarantees and advance payment guarantees from several banks
mainly in Israel in the amount of $2,935.

2. As of December 31, 2004, the Company obtained bank
guarantees in an amount of $1,849 in order to secure
mortgage payable by a subsidiary.

3. As of December 31, 2004, the Group issued a letter of credit
in the amount of $902, as per suppliers' demand.

f. Legal proceedings:

1. In April 2003, a competitor filed a civil action suit
against the Company and others. The plaintiff alleged that
the failure of its perimeter systems in field trials
executed by the Ministry of Defense during 1996 and 1997,
resulted from intentional damage to the fence and diversion
of the results of certain tests by a former employee of the
Company, who was then a soldier in the Israeli Defense
Force. The plaintiff alleged that the Company, which was the
employer of this employee during 1995, still employed him as
an agent during the field trials, and directed the actions
of the former employee. The plaintiff requested the courts
to annul the field trial and sought, approximately $760 in
damages. The Company denied all of the above allegations and
claimed that the plaintiff's perimeter system failure was
not the result of the former employee's actions. The
Company's legal counsel believes that, the Company has valid
defenses against the aforementioned claims and, therefore,
no provision was recorded in the financial statements. The
action is in the preliminary stage.

2. In June 2000, Rapiscan Security Products Inc. ("Rapiscan")
filed a lawsuit against the Company claiming $1,600 was due
it in the context of an agreement between Rapiscan and the
Company. The Company filed a counter-claim in the amount of
approximately $1,350. The financial statements as of
December 31, 2003 included a reserve computed by management
for this litigation of approximately $1,000. On February 18,
2004, the court approved a settlement agreement between the
Company and Rapiscan, according to which, the Company paid
Rapiscan approximately $653. The reduction of $347 of the
$1,000 estimated reserve was recorded in operations during
the first quarter of 2004.

F-27

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

g. Charges:

As collateral for all of the Group liabilities to banks:

1. A fixed charge has been placed on the Company's property.

2. The Company agreed not to pledge any of its assets without
the consent of several banks.

3. A fixed charge in the amount of $3,000 has been placed on
the Company's bank deposits.

4. The Company's subsidiary has two bank promissory notes in
the aggregate amount of $1,000 due on April 15, 2006,
collateralized by substantially all of the subsidiary's
assets, and a $1,849 mortgage note payable, collateralized
by a first mortgage on its land and building.

NOTE 10:- SHAREHOLDERS' EQUITY

a. Pertinent rights and privileges conferred by Ordinary shares:

The Ordinary shares of the Company are listed for trade on NASDAQ
National Market and in Israel, on the Tel-Aviv Stock Exchange.
The Ordinary shares confer upon their holders the right to
receive notice to participate and vote in the General Meetings of
the Company and the right to receive dividends, if declared.

b. Stock Option Plan:

On October 27, 2003, the Company's Board of Directors approved
the 2003 Israeli Share Option Plan ("the 2003 Plan"). Under the
2003 Plan, stock options will be periodically granted to
employees, directors, officers and consultants of the Company or
its subsidiaries, in accordance with the decision of the Board of
Directors of the Company (or a committee appointed by it). The
Board of Directors has the authority to determine the number of
options, if any, which will be granted to each of the
aforementioned, the dates of the grant of such options, the date
of their exercise as well as their rate of conversion into shares
in respect of each stock option, and the purchase price thereof.
The 2003 Plan is effective for ten years and shall terminate on
October 2013. Any options that are cancelled or forfeited before
expiration become available for future grant.

As of December 31, 2004, there were 537,606 options available for
future grant.

F-28

NOTE 10:- SHAREHOLDERS' EQUITY (Cont.)

A summary of the Company's stock options activities in 2002, 2003
and 2004, is as follows:

Year ended December 31,
-------------------------------------------------------------
2002 2003 2004
------------------ ------------------ ----------------------
Weighted Weighted Weighted
Number average Number average Number average
of exercise of exercise of exercise
options price options price Options price
------- ----- ------- ----- ------- -----

Outstanding
at the
beginning
of the year 412,400 $ 3.93 358,234 $ 4.23 223,216 $ 4.61

Granted - $ - - $ - 100,000 $ 7.66

Adjustment as
a result of
stock
dividend 11,232 $ - 10,256 $ - 7,652 $ -
Exercised (63,750) $ 2.17 (137,446) $ 3.55 (225,338) 4.61
Forfeited (1,648) $ - (7,828) - (530) $ -
-------- -------- --------
Outstanding
at the
end of the
year 358,234 $ 4.23 223,216 $ 4.61 105,000 $ 7.66
======== ====== ======== ====== ======== =======
Exercisable
options
at the end
of the year 118,450 $ 2.14 223,216 $ 4.61 - $ -
======== ====== ======== ====== ======== =======

All options outstanding as of December 31, 2004 have an exercise
price of $7.66 and a weighted average remaining contractual life
of 1.5 years.

Where the Company has recorded deferred stock compensation for
options issued with an exercise price below the fair market value
of the Ordinary shares, the deferred stock compensation has been
amortized and recorded as compensation expense ratably over the
vesting period of the options. Compensation expense of
approximately $17, $3 and $184 were recognized during the years
ended December 31, 2002, 2003 and 2004, respectively.

c. Dividends:

1. Dividends, if any, will be declared and paid in U.S.
dollars. Dividends paid to shareholders in Israel will be
converted into NIS on the basis of the exchange rate
prevailing at the date of payment. The Company has
determined that it will not distribute dividends out of
tax-exempt profits.

2. The Company's Board of Directors decided on a distribution
of stock dividends of 3%, 3% and 5% in May 2002, May 2003
and July 2004, respectively. All shares, options and net
earnings per share data have been retroactively adjusted to
reflect the stock dividend.

3. At the Annual General Meeting of Shareholders held on July
29, 2004, the shareholders approved the payment of an
interim cash dividend in the amount of $0.05 per Ordinary
Share of NIS 1 par value each, which was declared in
December 2003.

F-29

NOTE 10:- SHAREHOLDERS' EQUITY (Cont.)

d. Warrants to underwriters:

In connection with the 1997 follow-on Offering, the Company
issued to the underwriters, 200,000 warrants to purchase 200,000
Ordinary shares of the Company. The warrants were initially
exercisable at an exercise price of 120% of the 1997 offering
price per share ($5.50) for a period of four years, commencing
one year from the date of the 1997 offering. As of December 31,
2002, all 200,000 warrants were exercised on a net cash basis and
60,703 Ordinary shares of NIS 1 par value were issued.

e. In May 2002, the Company's Board of Directors approved an
increase in the authorized Ordinary share capital to 19,748,000
shares of NIS 1 par value.

NOTE 11:- BASIC AND DILUTED NET EARNINGS PER SHARE

Year ended December 31,
------------------------------------------
2002 2003 2004
------------- ------------- ------------

Numerator:

Net income $ 1,888 $ 2,404 $ 1,053
============= ============= ============
Denominator:

Denominator for basic net earnings per share
- weighted-average number of shares
outstanding 7,866,477 7,947,778 8,581,348
Effect of diluting securities:
Employee stock options and warrants to
underwriters 202,661 80,848 55,031
------------- ------------- ------------
Denominator for diluted net earnings per
share - adjusted weighted average shares
and assumed exercises 8,069,138 8,028,626 8,636,379
============= ============= ============

NOTE 12:- TAXES ON INCOME

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

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

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

F-30

NOTE 12:- TAXES ON INCOME (Cont.)

2. On March 18, 1997, a program of the Company was granted the
status of an "Approved Enterprise". The Company elected to
enjoy the "alternative benefits" track - waiver of grants in
return for tax exemption and accordingly, the Company's
income from this program was tax-exempt for a period of four
years, and is subject to a reduced tax rate of 15%-25% for a
period ranging between three to six years (depending on the
percentage of foreign ownership of the Company). The period
of benefits under this program began in 1998 and will
terminate in 2007.

3. On August 13, 2002, a program of the Company was granted the
status of an "Approved Enterprise". The Company elected to
enjoy the "alternative benefits" track - waiver of grants in
return for tax exemption - and, accordingly, the Company's
income from this program is tax-exempt for a period of two
years, and is subject to a reduced tax rate of 15%-25% for a
period of five to eight years (depending upon the percentage
of foreign ownership of the Company). The benefit period for
this program began in 2003 and will terminate in 2012.

The entitlement to the above benefits is conditional upon the
Company fulfilling the conditions stipulated by the Law,
regulations published there under and the letters of approval for
the specific investments in "approved enterprises". In the event
of failure to comply with these conditions, the benefits may be
canceled and the Company may be required to refund the amount of
the benefits, in whole or in part, including interest. As of
December 31, 2004, management believes that the Company is in
compliance with all of the aforementioned conditions.

The period of tax benefits detailed above is subject to limits of
the earlier of 12 years from the commencement of production or 14
years from receiving the approval.

Income from sources other than "Approved Enterprise", during the
benefit period will be subject to tax at regular rate of 35%.

By virtue of the Law, the Company is entitled to claim
accelerated depreciation on equipment used by the "Approved
Enterprise" during five tax years.

Since the Company is operating under more than one approval and
since part of its taxable income is not entitled to tax benefits
under the aforementioned law and is taxed at regular rates
(currently 35%), its effective tax rate is the result of a
weighted combination of the various applicable rates and
tax-exemptions. The computation is made for income derived from
each program on the basis of formulas determined in the law and
in the approvals.

The tax-exempt income attributable to the "Approved Enterprises"
can be distributed to shareholders without subjecting the Company
to taxes only upon the complete liquidation of the Company. If
the retained tax-exempt income is distributed in a manner other
than in the complete liquidation of the Company, it would be
taxed at the corporate tax rate applicable to such profits as if
the Company had not chosen the alternative tax benefits
(currently - 15%).

F-31

NOTE 12:- TAXES ON INCOME (Cont.)

b. Measurement of taxable income under the Income Tax (Inflationary
Adjustments) Law, 1985:

Under the Income Tax (Inflationary Adjustments) Law, 1985,
results for tax purposes are measured in real terms, in
accordance with the changes in the Israeli Consumer Price Index
("Israeli CPI"). Accordingly, until 2002, results for tax
purposes were measured in terms of earnings in NIS after certain
adjustments for increases in the Israeli CPI. Commencing in
taxable year 2003, the Company has elected to measure its taxable
income and file its tax return under the Israeli Income Tax
Regulations (Principles Regarding the Management of Books of
Account of Foreign Invested Companies and Certain Partnerships
and the Determination of Their Taxable Income), 1986. Such an
elective obligates the Company for three years. Accordingly,
commencing taxable year 2003, results for tax purposes are
measured in terms of earnings in dollar.

c. Tax benefits (in Israel) under the Law for the Encouragement of
Industry (Taxes), 1969:

The Company is an "industrial company" as defined by this law
and, as such, is entitled to certain tax benefits including
accelerated depreciation, deduction of the purchase price of
patents and know-how and deduction of public offering expenses.

d. Tax rates:

1. On June 29, 2004, the Israeli Government passed the
Amendment to the Income Tax Ordinance (No. 140 and Temporary
Provision), 2004, which progressively reduces the tax rates
applicable to companies from 36% to 35% in 2004 to a rate of
30% in 2007. The amendment had no impact on the Company's
financial statements.

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

e. Investment tax credit:

One of the Company's subsidiaries is eligible for investment tax
credits on its research and development activities and on certain
current and capital expenditures. During fiscal year 2004, the
subsidiary recognized $176 of investment tax credits as a
reduction of research and development expenses. In total, the
subsidiary has investment tax credits available to reduce future
federal income taxes payable, amounting to $436, which will
expire at various dates from 2012 through 2014.

F-32

NOTE 12:- TAXES ON INCOME (Cont.)

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

Year ended December 31,
------------------------------------
2002 2003 2004
----------- ----------- ----------

Income before taxes as reported in the $ 2,533 $ 3,317 $ 2,154
statements of income
=========== =========== ==========
Tax rate 36% 36% 35%
=========== =========== ==========
Theoretical tax expense $ 912 $ 1,194 $ 754
Increase (decrease) in taxes:
Tax adjustments in respect of
inflation in Israel 11 - -
Non-deductible items, net (24) 17 (400)
Deferred taxes on losses for which
valuation allowance was provided 442 298 1,163
Tax exemption applicable to "Approved
Enterprises" and exempted income (293) (443) (281)
Taxes in respect of prior years (279) (107) (23)
Other (124) (46) (112)
----------- ----------- ----------
Taxes on income in the statements of
income $ 645 $ 913 $ 1,101
=========== =========== ==========
Per share amounts (basic and diluted)
of the tax benefit resulting from
"Approved Enterprises" $ 0.04 $ 0.06 $ 0.03
=========== =========== ==========

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

Year ended December 31,
------------------------------------
2002 2003 2004
----------- ----------- ----------

Current taxes:
Domestic $ 269 $ 398 $ 428
Foreign 211 534 518
Deferred income taxes:
Domestic (30) - (70)
Foreign 474 88 248
Taxes in respect of prior years:
Domestic (279) (107) -
Foreign - - (23)
----------- ----------- ----------
Taxes on income $ 645 $ 913 $ 1,101
=========== =========== ==========

F-33

NOTE 12:- TAXES ON INCOME (Cont.)

h. Deferred income taxes:

Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used
for income tax purposes. Significant components of the Group
deferred tax assets are as follows:

December 31,
----------------------------
2003 2004
------------ ------------

Operating loss carryforward $ 1,813 $ 2,992
Reserves and tax allowances 658 (26)
------------ ------------
Total deferred assets before valuation allowance 2,471 2,966
Valuation allowance (1,682) (2,292)
------------ ------------
Net deferred tax assets $ 789 $ 674
============ ============
Domestic $ 212 $ 288
Foreign 577 386
------------ ------------
$ 789 $ 674
============ ============

During 2004, the Company's subsidiaries have increased the
valuation allowance in the amount of approximately $300, as a
result of change in circumstances that caused a change in
judgment about the certainty of realization of related deferred
tax assets in future years. The total net change in valuation
allowance during 2004 amounted to $610.

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

Year ended December 31,
------------------------------------
2002 2003 2004
----------- ----------- ----------

Domestic $ 2,217 $ 2,217 $ 2,137
Foreign 316 1,100 17
----------- ----------- ----------

$ 2,533 $ 3,317 $ 2,154
=========== =========== ==========

F-34

NOTE 12:- TAXES ON INCOME (Cont.)

j. Net operating losses carryforward:

The Company's subsidiaries in the U.S. and the U.K. have
estimated total available carryforward tax losses of $7,139 and
$795, respectively, to offset against future taxable profit for
16 to 20 years, and an indefinite period, respectively. As of
December 31, 2004, the Company recorded a full valuation
allowance due to the uncertainty of the tax assets future
realization.

Utilization of U.S. net operating losses may be subject to a
substantial annual limitation due to the "change in ownership"
provisions of the Internal Revenue Code of 1986 and similar state
provisions. The annual limitation may result in the expiration of
net operating losses before utilization.

NOTE 13:- RELATED PARTIES TRANSACTIONS

Year ended December 31,
----------------------------------
2002 2003 2004
---------- ---------- ----------
Sales to related parties (1) $ 188 $ 196 $ 386
========== ========== ==========

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

NOTE 14:- SEGMENTS INFORMATION

The Group adopted SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information". The Group operates in three major
reportable segments, which represent the Group's operating segments as
follows:

1. Perimeter security systems - The Group's line of perimeter
security systems consists of the following: Microprocessor-based
central control units, taut wire perimeter intrusion detection
systems, INNO Fences, vibration detection systems, field
disturbance sensors, and other.

2. Security turnkey projects - The Group is executing turnkey
projects based on the Company's security management system and
acting as an integrator.

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

F-35

NOTE 14:- SEGMENTS INFORMATION (Cont.)

a. The following data present the revenues, expenditures, assets and
other operating data of the Group's operating segments:

Year ended December 31,
----------------------------------------------------------------------------------------------------------------
2002 2003
---------------------------------------------------- ---------------------------------------------------------
Video Video
Perimeter Projects monitoring Other Total Perimeter Projects monitoring Other Total
--------- -------- ---------- ----- ----- --------- -------- ---------- ----- -----

Revenues $ 36,435 $ 5,340 $ 238 $ 953 $42,966 $ 51,077 $ 6,720 $ 403 $ 1,161 $59,361
======== ========= ======= ======= ======= ========= ======== ======== ======== =======
Depreciation
and
amortization $ 927 $ 9 $ 149 $ 11 $ 1,096 $ 1,056 $ 20 $ 292 $ 10 $1,378
======== ========= ======= ======= ======= ========= ======== ======== ======== ======
Operating
income,
before
financial
expenses and
taxes on
income $ 4,045 $ 794 $(1,556) $ (949) $ 2,334 $ 5,803 $ 936 $ (1,870) $ (549) $4,320
======== ========= ======= ======= ========= ========= ======== ========
Financial
income
(expenses),
net 199 (1,003)
Taxes on income 645 913
--- ---
Net income $ 1,888 $2,404
======= ======

Year ended December 31,
---------------------------------------------------
2004
---------------------------------------------------
Video
Perimeter Projects monitoring Other Total
--------- -------- ---------- ----- -----

Revenues $ 46,341 $11,375 $ 2,060 $ 1,198 $60,974
======== ======= ======= ======= =======
Depreciation
and
amortization $ 1,252 $ 11 $ 698 $ 5 $1,966
======== ======= ======= ======= ======
Operating
income,
before
financial
expenses and
taxes on
income $ 4,978 $ 1,430 $(2,262) $(1,230) $2,916
======== ======= ======= =======
Financial
income
(expenses),
net (762)
Taxes on income 1,101
-----
Net income $1,053
======

December 31,
----------------------------------------------------------------------------------------------------------------
2002 2003
---------------------------------------------------- ---------------------------------------------------------
Video Video
Perimeter Projects monitoring Other Total Perimeter Projects monitoring Other Total
--------- -------- ---------- ----- ----- --------- -------- ---------- ----- -----

Total
long-lived
assets $ 12,408 $ 30 $ 867 $ 21 $ 13,326 $ 13,476 $ 88 $ 2,787 $ 12 $ 16,363
======== ======= ====== ====== ======== ======== ======= ======== ===== ========

December 31,
----------------------------------------------------
2004
---------------------------------------------------
Video
Perimeter Projects monitoring Other Total
--------- -------- ---------- ----- -----

Total
long-lived
assets $ 13,576 $ 192 $ 5,814 $ 19 $19,601
======== ======= ======= ===== =======

F-36

NOTE 14:- SEGMENTS INFORMATION (Cont.)

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

Year ended December 31,
-----------------------------------------
2002 2003 2004
------------- ------------- -----------

Israel's Ministry of Defense and
Israel's Defense Forces 15.9% 27.2% *) -%
============= ============= ===========
C.N. Aeroportul international Bucuresti
Otopeni *) -% *) -% 15.6%
============= ============= ===========

*) Less then 10% of total revenues.

c. Geographical information:

The following is a summary of revenues within geographic areas
based on end customer's location and long-lived assets:

Year ended December 31,
------------------------------------------
2002 2003 2004
------------- ------------- ------------

1. Revenues:

Israel $ 11,350 $ 20,503 $ 10,123
Romania 1,023 5,151 9,521
Europe (excluding Romania) 5,376 5,465 9,150
USA 12,641 13,292 17,871
Canada 4,324 6,338 4,068
Others 8,252 8,612 10,241
------------- ------------- ------------
$ 42,966 $ 59,361 $ 60,974
============= ============= ============

December 31,
------------------------------------------
2002 2003 2004
------------- ------------- ------------

2. Long-lived assets:

Israel $ 3,802 $ 3,626 $ 3,211
Europe 786 980 1,069
USA 6,299 8,655 11,518
Canada 2,392 2,998 3,649
Others 47 104 154
------------- ------------- ------------
$ 13,326 $ 16,363 $ 19,601
============= ============= ============

F-37

NOTE 15:- SELECTED STATEMENTS OF INCOME DATA

a. Research and development expenses, net:

Year ended December 31,
------------------------------------------
2002 2003 2004
------------ ------------ -------------

Expenses $ 3,750 $ 5,128 $ 5,088
Less - royalty-bearing grants and
investment tax credit 622 355 405
------------ ------------ -------------
$ 3,128 $ 4,773 $ 4,683
============ ============ =============

b. Financial income (expenses):

Financial expenses:
Interest on long-term debt $ (371) $ (298) $ (289)
Interest on short-term bank credit (640) (808) (849)
Foreign exchange losses (6) (692) (161)
------------- ------------- ------------
(1,017) (1,798) (1,299)
------------- ------------- ------------
Financial income:
Interest on short-term and long-term
bank deposits and structured notes 732 672 496
Foreign exchange gains 484 123 41
------------- ------------- ------------
1,216 795 537
------------- ------------- ------------
$ 199 $ (1,003) $ (762)
============= ============= ============

NOTE 16:- SUBSEQUENT EVENTS (UNAUDITED)

In 2005, the Company intends to raise additional equity to fund future
growth.

- - - - - - - - -

F-38

SIGNATURE

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

MAGAL SECURITY SYSTEMS LTD.

By: /s/Jacob Even-Ezra
------------------
Name: Jacob Even-Ezra
Title: Chairman of the Board and
Chief Executive Officer
Date: June 30, 2005