Company Quick10K Filing
Magal Security Systems
20-F 2020-12-31 Filed 2021-04-26
20-F 2019-12-31 Filed 2020-04-23
20-F 2018-12-31 Filed 2019-04-15
20-F 2017-12-31 Filed 2018-03-28
20-F 2016-12-31 Filed 2017-03-29
20-F 2015-12-31 Filed 2016-03-29
20-F 2013-12-31 Filed 2014-03-27
20-F 2012-12-31 Filed 2013-03-21
20-F 2011-12-31 Filed 2012-04-04
20-F 2010-12-31 Filed 2011-04-11
20-F 2009-12-31 Filed 2010-05-03

MAGS 20F Annual Report

Item 17 O Item 18 O
Part I
Item 1. Identity of Directors, Senior Management and Advisers
Item 2. Offer Statistics and Expected Timetable Not Applicable.
Item 3. Key Information
Item 4. Information on The Company
Item 4A. Unresolved Staff Comments
Item 5. Operating and Financial Review and Prospects
Item 6. Directors, Senior Management and Employees
Item 7. Major Shareholders and Related Party Transactions
Item 8. Financial Information
Item 9. The Offer and Listing
Item 10. Additional Information
Item 11. Quantitative and Qualitative Disclosures About Market Risk
Item 12. Description of Securities Other Than Equity Securities
Part II
Item 13. Defaults, Dividend Arrearages and Delinquencies
Item 14. Material Modifications To The Rights of Security Holders and Use of Proceeds
Item 15. Controls and Procedures
Item 16A. Audit Committee Financial Expert
Item 16B. Code of Ethics
Item 16C. Principal Accountant Fees and Services
Item 16D. Exemptions From The Listing Standards for Audit Committees
Item 16E. Purchase of Equity Securities By The Issuer and Affiliated Purchasers
Item 16F. Changes in Registrant's Certifying Accountant
Item 16G. Corporate Governance
Part III
Item 17. Financial Statements
Item 18. Financial Statements
Item 19. Exhibits
Note 1:- General
Note 2:- Significant Accounting Policies
Note 4:- Other Accounts Receivable and Prepaid Expenses
Note 5:- Inventories
Note 6:- Property and Equipment
Note 7:- Other Intangible Assets, Net
Note 8:- Goodwill
Note 9:- Short-Term Bank Credit
Note 10:- Other Accounts Payable and Accrued Expenses
Note 11:- Long-Term Bank Debt
Note 12:- Commitments and Contingent Liabilities
Note 13:- Shareholders' Equity
Note 14:- Basic and Diluted Net Earnings per Share
Note 15:- Taxes on Income
Note 16:- Balances and Transactions with Related Parties
Note 17:- Segment Information
Note 18:- Selected Statements of Income Data
EX-8 exhibit_8.htm
EX-12.1 exhibit_12-1.htm
EX-12.2 exhibit_12-2.htm
EX-13.1 exhibit_13-1.htm
EX-13.2 exhibit_13-2.htm
EX-15.1 exhibit_15-1.htm
EX-15.2 exhibit_15-2.htm

Magal Security Systems Earnings 2009-12-31

Balance SheetIncome StatementCash Flow

20-F 1 zk1008217.htm 20-F zk1008217.htm


SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549

FORM 20-F
 
  o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
  x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2009
 
OR
 
  o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________
 
  o
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Date of event requiring this shell company report .................
 
Commission file number: 0-21388
 
MAGAL SECURITY SYSTEMS LTD.
(Exact Name of Registrant as specified in its charter
and translation of Registrant’s name into English)
 
Israel
(Jurisdiction of incorporation or organization)

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

+972-3-5391444 (phone), +972-3-5366245 (fax)
P.O. Box 70, Industrial Zone, Yehud 56100, Israel
(Name, Telephone, E-mail and/or Facsimile number of Company Contact Person)
 
Securities registered or to be registered pursuant to Section 12(b) of the Act:

Title of each class
Name of each exchange on which registered
Ordinary Shares, NIS 0.1 Par Value
NASDAQ Global Market
 
Securities registered or to be registered pursuant to Section 12(g) of the Act: None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None
 
Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report:
 
Ordinary Shares, par value NIS 1.0 per share …….…10,396,548
(as of December 31, 2009)

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

 

 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
Yes o   No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes x   No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   
 
Yes o   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
     
Large accelerated filer o
Accelerated filer o
Non-accelerated filer x
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
     
U.S. GAAP x
International Financial Reporting Standards as issued by the International Accounting Standards Board o
Other o

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow:
 
Item 17 o   Item 18 o

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

This Annual Report on Form 20-F is incorporated by reference into the Registrant’s Registration Statements on Form S-8, File Nos. 333-127340 and 333-164696.
 
 
 

 
 
TABLE OF CONTENTS
 
    Page No.
     
 
1
   ITEM 1.
1
   ITEM 2.
1
   ITEM 3.
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.
11
          A.
History and Development of the Company
11
          B.
Business Overview
12
          C.
Organizational Structure
23
          D.
Property, Plants and Equipment
23
   ITEM 4A.
24
   ITEM 5.
24
          A.
Operating Results
24
          B.
Liquidity and Capital Resources
39
          C.
Research and Development, Patents and Licenses
42
          D.
Trend Information
43
          E.
Off-Balance Sheet Arrangements
43
          F.
Tabular Disclosure of Contractual Obligations
43
   ITEM 6.
44
          A.
Directors and Senior Management
44
          B.
Compensation
47
          C.
Board Practices
47
          D.
Employees
54
          E.
Share Ownership
54
   ITEM 7.
56
          A.
Major Shareholders
56
          B.
Related Party Transactions
58
          C.
Interests of Experts and Counsel
59
   ITEM 8.
59
          A.
Consolidated Statements and Other Financial Information
59
          B.
Significant Changes
60
   ITEM 9.
61
          A.
Offer and Listing Details
61
          B.
Plan of Distribution
62
          C.
Markets
62
          D.
Selling Shareholders
62
          E.
Dilution
62
          F.
Expenses of the Issue
62
   ITEM 10.
62
          A.
Share Capital
62
          B.
Memorandum and Articles of Association
62
          C.
Material Contracts
66
          D.
Exchange Controls
66
          E.
Taxation
66
          F.
Dividends and Paying Agents
77
          G.
Statements by Experts
77
          H.
Documents on Display
77
          I.
Subsidiary Information
78
   ITEM 11.
78
   ITEM 12.
79
 
-i-
 

 
 
 
 
-ii-

 

INTRODUCTION

Magal Security Systems Ltd. is a leading international solutions provider of safety, security, site management and intelligence gathering and compilation solutions and products.  Based on more than 25 years of experience and interaction with customers, we have developed a unique set of solutions and products, optimized for perimeter, outdoor and general security applications.  Our turnkey solutions are typically integrated and managed by sophisticated modular command and control software, supported by expert systems for real-time decision support.  Our portfolio of critical infrastructure protection and site protection technologies includes a variety of smart barriers and fences, fence mounted detectors, virtual gates, buried and concealed detection systems and a sophisticated protection package for sub-surface intrusion.  A world class innovator in the development of closed circuit television, intelligence video analysis and motion detection technology for outdoor operation, we have successfully installed customized solutions and products in more than 75 countries worldwide.  Our ordinary shares are traded on the NASDAQ Global Market and on the Tel Aviv Stock Exchange under the symbol “MAGS.”  Our address on the Internet is www.magal-s3.com.  The information on our website is not incorporated by reference into this annual report.  As used in this annual report, the terms “we,” “us” and “our” mean Magal Security Systems Ltd. and its subsidiaries, unless otherwise indicated.
 
We have trademark rights in the United States and other national jurisdictions arising out of our trademark registrations, applications and/or use of the following trademarks and service marks: SENSTAR-STELLAR logo, the S logos, SENSTAR-STELLAR, SENSTAR-STELLAR (and design) SENSTAR, STELLAR, STELLAR SYSTEMS, STELLAR SYSTEMS (and design), PANTHER, GUIDAR, REPELS, SENNET, PERIMITRAX,  INTELLI-FLEX, INTELLI-FIELD, X-FIELD, OMNITRAX, STARLED, STARNET, FRONTLINE, E-FIELD, E-FLEX, ARMOURFLEX,  SIMPL, CROSSFIRE, FLASH, FLARE, SENTRAX, OMNITRAX, XFIELD, DTR, DreamBox, Magal logo and all other marks used to identify particular products and services associated with our businesses. Any other trademarks and trade names appearing in this annual report are owned by their respective holders.
 
Our consolidated financial statements appearing in this annual report are prepared in U.S. dollars and in accordance with generally accepted accounting principles in the United States, or U.S. GAAP.  All references in this annual report to “dollars” or “$”are to U.S. dollars and all references in this annual report to “NIS” are to New Israeli Shekels.  The representative exchange rate between the NIS and the dollar as published by the Bank of Israel on December 31, 2009 was NIS 3.775 per $1.00.
 
Statements made in this annual report concerning the contents of any contract, agreement or other document are summaries of such contracts, agreements or documents and are not complete descriptions of all of their terms.  If we filed any of these documents as an exhibit to this annual report or to any registration statement or annual report that we previously filed, you may read the document itself for a complete description of its terms.
 
This Annual Report on Form 20-F contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and within the Private Securities Litigation Reform Act of 1995, as amended.  Such forward-looking statements reflect our current view with respect to future events and financial results.  Forward-looking statements usually include the verbs, “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “projects,” “understands" and other verbs suggesting uncertainty.  We remind readers that forward-looking statements are merely predictions and therefore inherently subject to uncertainties and other factors and involve known and unknown risks that could cause the actual results, performance, levels of activity, or our achievements, or industry results, to be materially different from any future results, performance, levels of activity, or our achievements expressed or implied by such forward-looking statements.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.  We undertake no obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.  We have attempted to identify additional significant uncertainties and other factors affecting forward-looking statements in the Risk Factors section which appears in Item 3.D “Key Information -Risk Factors.”
 
 
-iii-

 
 
 
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
 
Not applicable.
 
OFFER STATISTICS AND EXPECTED TIMETABLE
 
Not applicable.
 
KEY INFORMATION
 
A.    Selected Consolidated Financial Data.
 
The following selected consolidated financial data for and as of the five years ended December 31, 2009 are derived from our audited consolidated financial statements which have been prepared in accordance with U.S. GAAP.  We have derived the following selected consolidated financial data as of December 31, 2008 and 2009 and for each of the years ended December 31, 2007, 2008 and 2009 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, 2005, 2006 and 2007 and for each of the years ended December 31, 2005 and 2006 from our audited consolidated financial statements not included in this annual report.  The selected consolidated financial data set forth below should be read in conjunction with and are qualified entirely by reference to Item 5 “Operating and Financial Review and Prospects” and our audited consolidated financial statements and notes thereto included elsewhere in this annual report.
 
   
Year Ended December 31,
 
   
2005(1)
   
2006(1)
   
2007(1)(2)
   
2008(2)
   
2009(2)
 
   
(in thousands except per share data)
 
Consolidated Statement of Operations Data:
                   
Revenues
  $ 58,385     $ 63,600     $ 62,695     $ 57,105     $ 54,518  
Cost of revenues
    36,658       37,236       38,156       37,559       33,331  
Gross profit
    21,727       26,364       24,539       19,546       21,187  
Operating expenses:
                                       
   Research and development, net
    5,265       5,378       5,310       5,556       4,816  
   Selling and marketing, net
    12,385       11,603       11,073       12,953       10,864  
   General and administrative
    4,965       5,547       6,057       10,243       8,372  
   Impairment of goodwill and other
      intangible assets
    -       -       -       2,772       -  
   Post employment and termination benefits
    -       -       904       2,582       -  
Total operating expenses
    22,615       22,528       23,344       34,106       24,052  
Operating income (loss)
    (888 )     3,836       1,195       (14,560 )     (2,865 )
Financial expenses, net
    813       864       2,059       1,314       1,568  
Income (loss) before income taxes
    (1,701 )     2,972       (864 )     (15,874 )     (4,433 )
Income taxes (tax benefit)
    (28 )     943       276       3,066       864  
Income (loss) from continuing operations
    (1,673 )     2,029       (1,140 )     (18,940 )     (5,297 )
Income (loss) from discontinued operations, net
    (1,538 )     (1,219 )     3,022       (13,662 )     4,216  
Net income (loss)
  $ (3,211 )   $ 810     $ 1,882     $ (32,602 )     (1,081 )
Less: net income attributable to non-controlling interest
    -       -       -       -       54  
Net income (loss) attributable to Magal’s shareholders
  $ (3,211 )   $ 810     $ 1,882     $ (32,602 )   $ (1,135 )
Basic net earnings (loss) per share from continuing operations
  $ (0.17 )   $ 0.20     $ (0.11 )   $ (1.82 )   $ (0.52 )
Basic net earnings (loss)per share from discontinued operations
    (0.15 )     (0.12 )     0.29       (1.32 )     0.41  
Basic net earnings (loss) per share
  $ (0.32 )   $ 0.08     $ 0.18     $ (3.14 )   $ (0.11 )
Diluted net earnings (loss) per share from continuing operations
  $ (0.17 )   $ 0.20     $ (0.11 )   $ (1.82 )   $ (0.52 )
Diluted net earnings (loss) per share from discontinued operations
  $ (0.15 )   $ (0.12 )     0.29       (1.32 )     0.41  
Diluted net earnings (loss) per share
  $ (0.32 )   $ 0.08     $ 0.18     $ (3.14 )   $ (0.11 )
Weighted average number of ordinary shares used in computing basic net earnings per share
    9,883       10,384       10,395       10,397       10,397  
Weighted average number of ordinary shares used in computing diluted net earnings per share
    9,900       10,442       10,431       10,397       10,399  
 
 
- 1 -

 
 
   
As of December 31,
 
   
2005(1)
   
2006(1)
   
2007 (1)
   
2008
   
2009
 
   
(in thousands)
 
Consolidated Balance Sheets Data:
                             
Cash and cash equivalents                                                         
  $ 10,099     $ 4,908     $ 9,205     $ 16,835     $ 11,869  
Short and long-term bank deposits,  restricted deposits, marketable securities and escrow deposit
    18,853       22,053       26,972       8,137       1,847  
Working capital
    35,071       39,884       41,526       16,240       20,467  
Total assets
    101,842       103,681       126,157       90,537       60,650  
Short-term bank credit (including current maturities of long-term loans)
    21,715       17,821       20,737       23,995       10,058  
Long-term bank loans                                                         
    1,653       7,399       3,095       2,282       548  
Total shareholders’ equity                                                         
    56,950       58,150       65,578       30,718       32,309  
 

(1)
In December 2007, we disposed of our U.S. based video monitoring business.  Accordingly, the operating results, balance sheet and cash flows relating to the video monitoring operations were presented in our statements of income, balance sheets and cash flows as discontinued operations, and the comparative operating results for prior years were reclassified.
 
(2)
In September 2009, our Board of Directors resolved to discontinue the operations of the European integration subsidiary that we acquired in September 2007.  The subsidiary was sold in December 2009.  Accordingly, operating results and cash flows for the years ended December 31, 2007, 2008 and 2009, as well as the capital gain resulting from the sale, were reclassified to disclose the results of that subsidiary as discontinued operations.
 
B.    Capitalization and Indebtedness.
 
Not applicable.

C.    Reasons for the Offer and Use of Proceeds.
 
Not applicable.

D.    Risk Factors.
 
Investing in our ordinary shares involves a high degree of risk and uncertainty.  You should carefully consider the risks and uncertainties described below before investing in our ordinary shares.  If any of the following risks actually occurs, our business, prospects, financial condition and results of operations could be harmed.  In that case, the value of our ordinary shares could decline, and you could lose all or part of your investment.
 
 
- 2 -

 
 
Risks Related to Our Business
 
Unfavorable global economic conditions may adversely affect our customers, which directly impacts our business and results of operations.
 
Our operations and performance depend on our customers, including those from the governmental sector, having adequate resources to purchase our products.  The recent turmoil in the credit markets and the global economic downturn generally adversely impacted our customers and potential customers.  Although global economic conditions have begun to stabilize or improve, the markets in which we operate remain weak.  Customers have reduced and may continue to reduce their purchasing activities in response to lack of credit, economic uncertainty and concern about the stability of markets in general, and have reduced or delayed purchases of our products.  As a result of slow moving inventory due to the recent global economic slowdown, we may be required in the future to record additional impairment charges relating to the carrying value of our intangible assets, increase our reserves for doubtful accounts and further write-down our tax assets.  In addition, the fair value of some of our assets may decrease further as a result of the weak economy and as a result, we may be required to record further impairment charges in the future. If global economic and market conditions or economic conditions in key markets remain weak or weaken further, our financial condition and operating results may be materially adversely affected.
 
Our revenues depend on government procurement procedures and practices.  A substantial decrease in our customers’ budgets would adversely affect our results of operations.
 
Our products are primarily sold to governmental agencies, governmental authorities and government-owned companies, many of which have complex and time consuming procurement procedures.  A substantial period of time often elapses from the time we begin marketing a product until we actually sell that product to a particular customer.  In addition, our sales to governmental agencies, authorities and companies are directly affected by these customers’ budgetary constraints and the priority given in their budgets to the procurement of our products.  A decrease in governmental funding for our customers’ budgets would adversely affect our results of operations.  This risk is heightened during periods of global economic slowdown.
 
Accordingly, governmental purchases of our systems, products and services may decline in the future as the governmental purchasing agencies may terminate, reduce or modify contracts or subcontracts if:
 
 
their requirements or budgetary constraints change;
 
 
they cancel multi-year contracts and related orders if funds become unavailable;
 
 
they shift spending priorities into other areas or for other products; or
 
 
they adjust contract costs and fees on the basis of audits.
 
Any such event may have a material adverse affect on us.
 
The loss of one or more of our key customers would result in a loss of a significant amount of our revenues.
 
A relatively few customers account for a large percentage of our revenues.  For the years ended December 31, 2007, 2008, and 2009, revenues generated from sales to the Israeli Ministry of Defense, or MOD, and Israeli Defense Forces, or IDF, accounted for 15.0%, 10.8% and 19.6%, respectively, of our revenues.  The MOD, IDF or any of our other major customers may not maintain their volume of business with us or, if such volume is reduced, other customers generating similar revenues may not replace the lost business.  The loss of one our more of our key customers without replacement by a customer or customers of similar volume would have a material adverse effect on our financial results.
 
 
- 3 -

 
 
We depend on large orders from a relatively small number of customers for a substantial portion of our revenues.  As a result, our revenues and operating results may vary from quarter to quarter.
 
We receive large orders from a relatively small number of customers and our revenues and operating results are subject to substantial periodic variations.  Individual orders from customers can represent a substantial portion of our revenues in any one period and significant orders by a customer during one period may not be followed by further orders from the same customer in subsequent periods.  As a result, our revenues and operating results for a specific quarter may not be indicative of our future performance and quarter-to-quarter comparisons of our operating results may not be meaningful, making it difficult for investors to evaluate our future prospects based on the results of any quarter.  In addition, we have a limited order backlog, which makes revenues in any quarter substantially dependent upon orders we deliver in that quarter.
 
We may be adversely affected by our long sales cycles.
 
We have in the past and expect in the future to experience long time periods between initial sales contacts and the execution of formal contracts for our products and completion of product installations.  The cycle from first contact to revenue generation in our business involves, among other things, selling the concept of our technology and products, developing and implementing a pilot program to demonstrate the capabilities and accuracy of our products, negotiating prices and other contract terms, and, finally, installing and implementing our products on a full-scale basis.  This cycle entails a substantial period of time, sometimes as much as one or more years, and the lack of revenues during this cycle and the expenses involved in bringing new sales to the point of revenue generation may put a substantial strain on our resources.
 
Our failure to retain and attract personnel could harm our business, operations and product development efforts.
 
Our products require sophisticated research and development, marketing and sales and technical customer support.  Our success depends on our ability to attract, train and retain qualified research and development, marketing and sales and technical customer support personnel.  Competition for personnel in all of these areas is intense and we may not be able to hire sufficient personnel to achieve our goals or support the anticipated growth in our business.  If we fail to attract and retain qualified personnel, our business, operations and product development efforts would suffer.
 
Our financial results may be adversely affected by currency fluctuations.  
 
We sell most of our products in North America, Europe and Israel.  Our revenues are primarily denominated in U.S. dollars, Euros and NIS, while a portion of our expenses, primarily labor expenses, is incurred in NIS and Canadian Dollars.  Additionally, certain assets, especially trade receivables, as well as part of our liabilities are denominated in NIS.  As a result, fluctuations in rates of exchange between the U.S. dollar and non- U.S. dollar currencies may affect our operating results and financial condition.  The dollar cost of our operations in Israel may be adversely affected by the appreciation of the NIS against the U.S. dollar.  In addition, the value of our non-U.S. dollar revenues could be adversely affected by the depreciation of the U.S. dollar against such currencies.  In 2007, 2008 and 2009, the NIS appreciated by approximately 9.0%, 1.1% and 0.7%, respectively, against the U.S. dollar, which had an adverse affect on our results of operations.  In 2008, the Euro depreciated against the U.S. dollar by 5.3%, while in 2007 and 2009 the Euro appreciated against the U.S. dollar by 11.7% and 3.5%, respectively.
 
In addition, the U.S. dollar cost of our operations in Canada is influenced by the exchange rate between the U.S. dollar and the Canadian dollar.  In 2008, the Canadian dollar depreciated against the U.S. dollar by approximately 19.7%, while in 2007 and 2009 the Canadian dollar appreciated against the U.S. dollar by 18.4%  and 16.6%, respectively.
 
During the years ended December 31, 2007, 2008 and 2009, foreign currency fluctuations had an adverse impact on our results of operations and we recorded foreign exchange losses, net of $792,000, $246,000 and $1,138.000, respectively.  Our results of operations may continue to be materially adversely affected by currency fluctuations in the future.
 
 
- 4 -

 
 
If we do not receive Israeli MOD approvals necessary for us to export the products we produce in Israel, our revenues may decrease.
 
Israel’s defense export policy regulates the sale of a number of our systems and products.  Current Israeli policy encourages export to approved customers of defense systems and products, such as ours, as long as the export is consistent with Israeli government policy.  A license is required to initiate marketing activities.  We are also required to obtain a specific export license for any hardware exported from Israel.  We may not be able to receive all the required permits and licenses for which we may apply in the future.  If we do not receive the required permits for which we apply, our revenues may decrease.
 
We are subject to laws regulating export of “dual use” items (items that are typically sold in the commercial market, but that also may be used in the defense market) and defense export control legislation.  Additionally, our participation in governmental procurement processes in Israel and other countries is subject to specific regulations governing the conduct of the process of procuring defense contracts.  Furthermore, solicitations for procurements by governmental purchasing agencies in Israel and other countries are governed by laws, regulations and procedures relating to procurement integrity, including avoiding conflicts of interest and corruption in the procurement process.  We may not be able to respond quickly and effectively to changing laws and regulations and any failure to comply with such laws and regulations may subject us to significant liability and penalties.
 
We face risks associated with doing business in international markets.
 
A large portion of our sales is to markets outside of Israel.  For the years ended December 31, 2007, 2008 and 2009, approximately 75.0%, 78.8% and 76.2%, respectively, of our revenues were derived from sales to markets outside of Israel.  A key component of our strategy is to continue to expand in such international markets.  Our international sales efforts are affected by costs associated with the shipping of our products and risks inherent in doing business in international markets, including:
 
 
different and changing regulatory requirements in the jurisdictions in which we currently operate or may operate in the future;
 
 
fluctuations in foreign currency exchange rates;
 
 
export restrictions, tariffs and other trade barriers;
 
 
difficulties in staffing, managing and supporting foreign operations;
 
 
longer payment cycles;
 
 
difficulties in collecting accounts receivable;
 
 
political and economic changes, hostilities and other disruptions in regions where we currently sell or products or may sell our products in the future; and
 
 
seasonal reductions in business activities.
 
Negative developments in any of these areas in one or more countries could result in a reduction in demand for our products, the cancellation or delay of orders already placed, difficulty in collecting receivables, and a higher cost of doing business, any of which could adversely affect our business, results of operations or financial condition.
 
 
- 5 -

 
 
Reduction in Israeli government spending or changes in priorities for homeland security products may adversely affect our financial condition, operating results and prospects.
 
Historically a significant portion of our revenues were from sales to the Israeli government and our financial condition, operating results and prospects would be adversely affected by Israeli government budget cutbacks or spending reductions.  We believe that the success and growth of our business will continue to depend to a certain extent upon our successful procurement of Israeli government contracts.  The award of additional contracts from the Israeli government could be adversely affected by spending reductions or budget cutbacks at government agencies that currently use or are likely to use our products.  The Israeli government may reduce its expenditures for homeland security or change its defense priorities in the coming years.  Our programs may be affected in the future if there is a reduction in Israeli government defense spending for our programs or a change in priorities to products other than ours.  Accordingly, changes in government contracting policies, budgetary constraints and delays or changes in the appropriations process could have an adverse affect on our business, financial condition and results of operations.
 
We may not be able to implement our growth strategy and may not be able to successfully integrate the operations of acquired businesses into our business.
 
As part of our growth strategy, we intend to acquire or invest in complementary (including competitive) businesses, products and technologies.  We may not be able to consummate any acquisition or investment in the future.  In addition, the process of integrating acquired assets into our operations may result in unforeseen operating difficulties and expenditures and may absorb significant management attention that would otherwise be available for the ongoing development of our business.
 
We may not be able to realize the anticipated benefits of any acquisition.  Moreover, future acquisitions by us could result in potentially dilutive issuances of our equity securities, the incurrence of debt and contingent liabilities and amortization expenses related to identifiable intangible assets, any of which could materially adversely affect our operating results and financial position.  Acquisitions also involve other risks, including risks inherent in entering markets in which we have no or limited prior experience. Our failure to successfully integrate the operations of an acquired business or to retain key employees of acquired businesses and integrate and manage our growth may have a material adverse effect on our business, financial condition, results of operation or prospects.
 
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 15 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.
 
Claims that our products infringe upon the intellectual property of third parties may require us to incur significant costs, enter into licensing agreements or license substitute technology.
 
Third parties may in the future assert infringement claims against us or claims asserting that we have violated a patent or infringed upon a copyright, trademark or other proprietary right belonging to them.  Any infringement claim, even one without merit, could result in the expenditure of significant financial and managerial resources to defend against the claim.  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.  Moreover, a successful claim of product infringement against us or a settlement could require us to pay substantial amounts or obtain a license to continue to use such technology or intellectual property.  Infringement claims asserted against us could have a material adverse effect on our business, operating results and financial condition.
 
 
- 6 -

 
 
Undetected defects in our products may increase our costs and impair the market acceptance of our products.
 
The development, enhancement and implementation of our complex systems entail substantial risks of product defects or failures.  Despite testing by us and our customers, errors may be found in existing or new products, resulting in delay or loss of revenues, warranty expense, loss of market share or failure to achieve market acceptance.  Moreover, the complexities involved in implementing our systems entail additional risks of performance failures.  We may encounter substantial delays or other difficulties due to such complexities.  Any such occurrence could have a material adverse effect upon our business, financial condition and results of operations.  In addition, the potential harm to our reputation that may result from product defects or implementation errors could be damaging to us.
 
The market for our products is characterized by changing technology, requirements, standards and products, and we may be adversely affected if we do not respond promptly and effectively to these changes.
 
The market for our products is characterized by evolving technologies, changing industry standards, changing regulatory environments, frequent new product introductions and rapid changes in customer requirements.  The introduction of products embodying new technologies and the emergence of new industry standards and practices can render existing products obsolete and unmarketable.  Our future success will depend on our ability to enhance our existing products and to develop and introduce, on a timely and cost-effective basis, new products and product features that keep pace with technological developments and emerging industry standards and address the increasingly sophisticated needs of our customers.  In the future:
 
 
we may not be successful in developing and marketing new products or product features that respond to technological change or evolving industry standards;
 
 
we may experience difficulties that could delay or prevent the successful development, introduction and marketing of these new products and features; or
 
 
our new products and product features may not adequately meet the requirements of the marketplace and achieve market acceptance.
 
If we are unable to respond promptly and effectively to changing technology, we will be unable to compete effectively in the future.
 
If subcontractors and suppliers terminate our arrangement with them, or amend them in a manner detrimental to us, we may experience delays in production and implementation of our products and our business may be adversely affected.
 
We acquire most of the components utilized in our products, including our turnkey solutions, from a limited number of suppliers.  We may not be able to obtain such items from these suppliers in the future or we may not be able to obtain them on satisfactory terms.  Temporary disruptions of our manufacturing operations would result if we were required to obtain materials from alternative sources, which may have an adverse effect on our financial results.  In addition, the installation of our fence mounted vibration detection systems in Israel is outsourced primarily to two subcontractors.  If either or both of such subcontractors were to be unable or unwilling to continue to perform such services, we would have to identify and qualify one or more substitute subcontractors to perform such services.  This could cause delays in the implementation of our fence mounted vibration detection systems in Israel, the costs associated with installing such systems may increase and our business may be adversely affected.
 
 
- 7 -

 
 
We currently benefit from government programs and tax benefits that may be discontinued or reduced in the future, which would increase our future tax expenses.  
 
We currently benefit from grants and tax benefits under Israeli government programs, which require us to meet specified conditions, including, but not limited to, making specified investments from our equity in fixed assets and paying royalties with respect to grants received.  In addition, some of these programs restrict our ability to manufacture particular products or transfer particular technology outside of Israel.  If we fail to comply with these conditions in the future, the benefits we receive could be cancelled and we could be required to refund any payments previously received under these programs, including any accrued interest, or pay increased taxes or royalties.  Such a result would adversely affect our results of operations and financial condition.  The Israeli government has reduced the benefits available under these programs in recent years and these programs and benefits may be discontinued or curtailed in the future.  If the Israeli government ends these programs and benefits, our business, financial condition, results of operations and net income could be materially adversely affected.
 
We may fail to maintain effective internal control over financial reporting , which could result in material misstatements in our financial statements.  
 
The Sarbanes-Oxley Act of 2002 imposes certain duties on us and our executives and directors.  Our efforts to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 governing internal controls and procedures for financial reporting, which started in connection with our Annual Report on Form 20-F for the year ended December 31, 2006, have resulted in increased general and administrative expense and a diversion of management time and attention, and we expect these efforts to require the continued commitment of significant resources.  Section 404 of the Sarbanes-Oxley Act requires (i) management’s annual review and evaluation of our internal control over financial reporting and (ii) an attestation report by our independent registered public accounting firm on the effectiveness of our internal control over financial reporting, in connection with the filing of the Annual Report on Form 20-F for each fiscal year.
 
In 2008, we identified a material weakness in our internal control over financial reporting with respect to a former subsidiary that was subsequently sold during 2009.  We may identify material weaknesses or significant deficiencies in our internal control over financial reporting in the future.  Failure to maintain effective internal control over financial reporting could result in material misstatements in our financial statements.  Any such failure could also adversely affect the results of our management’s evaluations and annual auditor reports regarding the effectiveness of our internal control over financial reporting.  Failure to maintain effective internal control over financial reporting could result in investigation or sanctions by regulatory authorities and could have a material adverse effect on our operating results, investor confidence in our reported financial information and the market price of our ordinary shares.
 
Risks Relating to Our Ordinary Shares
 
Volatility of the market price of our ordinary shares could adversely affect our shareholders and us.
 
The market price of our ordinary shares has been, and is likely to be, highly volatile and could be subject to wide fluctuations in response to numerous factors, including the following:
 
 
actual or anticipated variations in our quarterly operating results or those of our competitors;
 
 
announcements by us or our competitors of technological innovations or new and enhanced products;
 
 
developments or disputes concerning proprietary rights;
 
 
introduction and adoption of new industry standards;
 
 
changes in financial estimates by securities analysts;
 
 
- 8 -

 
 
 
market conditions or trends in our industry;
 
 
changes in the market valuations of our competitors;
 
 
announcements by us or our competitors of significant acquisitions;
 
 
entry into strategic partnerships or joint ventures by us or our competitors;
 
 
additions or departures of key personnel;
 
 
political and economic conditions, such as a recession or interest rate or currency rate fluctuations or political events; and
 
 
other events or factors in any of the countries in which we do business, including those resulting from war, incidents of terrorism, natural disasters or responses to such events.
 
In addition, the stock market in general, and the market for Israeli companies and home defense companies in particular, has been highly volatile.  Many of these factors are beyond our control and may materially adversely affect the market price of our ordinary shares, regardless of our performance.  In the past, following periods of market volatility, shareholders have often instituted securities class action litigation relating to the stock trading and price volatility of the company in question.  If we were involved in any securities litigation, it could result in substantial cost to us to defend and divert resources and the attention of management from our business.
 
We do not expect to distribute dividends in the foreseeable future.
 
We currently intend to retain our current and any future earnings to finance operations and expand our business and, therefore, do not expect to pay any dividends in the foreseeable future.  According to the Israeli Companies Law, a company may distribute dividends out of its profits (as defined by the Israeli Companies Law), provided that there is no reasonable concern that such dividend distribution will prevent the company from paying all its current and foreseeable obligations, as they become due, or otherwise upon the permission of the court.  In the event cash dividends are declared, such dividends will be paid in NIS.  The declaration of dividends is subject to the discretion of our board of directors and would depend on various factors, including our operating results, financial condition, future prospects and any other factors deemed relevant by our board of directors.  You should not rely on an investment in our company if you require dividend income from your investment.
 
Risks Relating to Our Location in Israel  
 
Political, economic and military instability in Israel may disrupt our operations and negatively affect our business condition, harm our results of operations and adversely affect our share price.
 
We are incorporated under the laws of the State of Israel, and our principal executive offices and some of our manufacturing and research and development facilities are located in Israel.  As a result, political, economic and military conditions affecting Israel directly influence us.  Any major hostilities involving Israel, a full or partial mobilization of the reserve forces of the Israeli army, the interruption or curtailment of trade between Israel and its present trading partners, or a significant downturn in the economic or financial condition of Israel could have a material adverse effect on our business, financial condition and results of operations.
 
Since the establishment of the State of Israel in 1948, Israel and its Arab neighbors have engaged in a number of armed conflicts.  A state of hostility, varying from time to time in intensity and degree, has led to security and economic problems for Israel.  Major hostilities between Israel and its neighbors may hinder Israel’s international trade and lead to economic downturn.  This, in turn, could have a material adverse effect on our operations and business.  Since September 2000, there has been an increase in unrest and terrorist activity in Israel of varying levels of severity.  In recent years, there has been an escalation in violence among Israel, Hamas, Hezbollah, the Palestinian Authority and other groups.  Since June 2007, when Hamas effectively took control of the Gaza Strip, there have been extensive hostilities along Israel’s border with the Gaza Strip.  Hamas has launched hundreds of missiles from the Gaza Strip against Israeli population centers, which led to an armed conflict between Israel and Hamas during December 2008 and January 2009.  Ongoing violence between Israel and the Palestinians as well as tension between Israel and neighboring Syria and Lebanon or Iran may have a material adverse effect on our business, financial conditions and results of operations.
 
 
- 9 -

 
 
Furthermore, we could be adversely affected by the interruption or reduction of trade between Israel and its trading partners.  Some countries, companies and organizations continue to participate in a boycott of Israeli companies and others doing business with Israel or with Israeli companies.  As a result, we are precluded from marketing our products to these countries, companies and organizations.  Foreign government defense export policies towards Israel could also make it more difficult for us to obtain the export authorizations necessary for our activities.  Also, over the past several years there have been calls in Europe and elsewhere to reduce trade with Israel.  Restrictive laws, policies or practices directed towards Israel or Israeli businesses may have an adverse impact on our operations, our financial results or the expansion of our business.
 
Our results of operations may be negatively affected by the obligation of our personnel to perform reserve military service.
 
Many of our employees and some of our directors and officers in Israel are obligated to perform annual reserve duty in the Israeli Defense Forces and may be called for active duty under emergency circumstances at any time.  If a military conflict or war arises, these individuals could be required to serve in the military for extended periods of time.  Our operations could be disrupted by the absence for a significant period of one or more of our executive officers or key employees or a significant number of other employees due to military service.  Any disruption in our operations could adversely affect our business.
 
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 and 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, a shareholder of an Israeli company has a duty to act in good faith in exercising his or her rights and fulfilling his or her obligations toward the company and other shareholders and to refrain from abusing his power in the company, including, among other things, in voting at the general meeting of shareholders on certain matters.  Israeli law provides that these duties are applicable in shareholder votes on, among other things, amendments to a company's articles of association, increases in a company’s authorized share capital, mergers and interested party transactions requiring shareholder approval.  In addition, a controlling shareholder of an Israeli company or a shareholder who knows that it possesses the power to determine the outcome of a shareholder vote or who has the power to appoint or prevent the appointment of a director or executive officer in the company has a duty of fairness toward the company.  However, Israeli law does not define the substance of this duty of fairness.  Because Israeli corporate law has undergone extensive revision in recent years, there is little case law available to assist in understanding the implications of these provisions that govern shareholder behavior.
 
Service and enforcement of legal process on us and our directors and officers may be difficult to obtain.
 
Service of process upon our directors and officers and the Israeli experts named herein, all of whom reside outside the United States, may be difficult to obtain within the United States.  Furthermore, since substantially all of our assets, all of our directors and officers and the Israeli experts named in this annual report are located outside the United States, any judgment obtained in the United States against us or these individuals or entities may not be collectible within the United States.
 
There is doubt as to the enforceability of civil liabilities under the Securities Act and the Securities Exchange Act in original actions instituted in Israel.  However, subject to certain time limitations and other conditions, Israeli courts may enforce final judgments of United States courts for liquidated amounts in civil matters, including judgments based upon the civil liability provisions of those and similar acts.
 
 
- 10 -

 
 
As a foreign private issuer whose shares are listed on the NASDAQ Global Market, we may follow certain home country corporate governance practices instead of certain NASDAQ requirements.  We follow Israeli law and practice instead of NASDAQ rules regarding the director nomination process, compensation of executive officers and the requirement that our independent directors have regularly scheduled meetings at which only independent directors are present.  
 
As a foreign private issuer whose shares are listed on the NASDAQ Global Market, we are permitted to follow certain home country corporate governance practices instead of certain requirements of The NASDAQ Listing Rules.  We follow Israeli law and practice instead of NASDAQ rules regarding the director nomination process, compensation of executive officers and the requirement that our independent directors have regularly scheduled meetings at which only independent directors are present.  As a foreign private issuer listed on the NASDAQ Global Market, we may also follow home country practice with regard to, among other things, the composition of the board of directors and quorum at shareholders’ meetings.  In addition, we may follow home country practice instead of the NASDAQ requirement to obtain shareholder approval for certain dilutive events (such as for the establishment or amendment of certain equity-based compensation plans, an issuance that will result in a change of control of the company, certain transactions other than a public offering involving issuances of a 20% or more interest in the company and certain acquisitions of the stock or assets of another company).  A foreign private issuer that elects to follow a home country practice instead of NASDAQ requirements must submit to NASDAQ in advance a written statement from an independent counsel in such issuer’s home country certifying that the issuer’s practices are not prohibited by the home country’s laws.  In addition, a foreign private issuer must disclose in its annual reports filed with the Securities and Exchange Commission each such requirement that it does not follow and describe the home country practice followed by the issuer instead of any such requirement.  Accordingly, our shareholders may not be afforded the same protection as provided under NASDAQ’s corporate governance rules.
 
Information on the Company
 
A.    History and Development of the Company.  
 
We were incorporated under the laws of the State of Israel on March 27, 1984 under the name Magal Security Systems Ltd.  We are a public limited liability company under the Israeli Companies Law, 5739-1999, and operate under this law and associated legislation.  Our principal executive offices and primary manufacturing and research and development facilities are located near Tel Aviv, Israel, in the Yehud Industrial Zone.  Our mailing address is P.O. Box 70, Industrial Zone, Yehud 56100, Israel and our telephone number is +972-3-539-1444.  Our agent for service of process in the United States is Senstar Inc., 13783 Park Center Road, Suite 316, Herndon, Virginia 20171.  Our address on the Internet is www.magal-S3.com.  The information on our website is not incorporated by reference into this annual report.
 
We are a leading international solutions provider of safety, security, site management and intelligence gathering and compilation solutions and products.  Based on 25 years of experience and interaction with customers, we have developed a unique set of solutions and products, optimized for perimeter, outdoor and general security applications.  Our turnkey solutions are typically integrated and managed by sophisticated modular command and control software, supported by expert systems for real-time decision support.  Our portfolio of critical infrastructure protection and site protection technologies includes a variety of smart barriers and fences, fence mounted detectors, virtual gates, buried and concealed detection systems and a sophisticated protection package for sub-surface intrusion.  A world class innovator in the development of CCTV, IVA and motion detection technology for outdoor operation, we have successfully installed customized solutions and products in more than 75 countries worldwide.
 
Due to the need to reduce cost and operate more efficiently and effectively, in June 2009 we determined to consolidate certain activities that were operated out of different locations in North America.  As a result, we consolidated the manufacturing, product development and technical support function of our California subsidiary with our operations in Ottawa, Canada.  All products that historically have been manufactured in the United States through subcontractors continue to be produced by subcontractors, however the process is managed out of our facilities in Ottawa, Canada.  The sales and marketing activities of our California subsidiary were moved to, and are managed from, our office in Herndon, Virginia, which is in the Washington, D.C. metropolitan area.  The transitions described above were completed in June 2009.  A small team of three people are still operating temporarily out of our facility in Fremont, California, which has been put up for sale or for lease.
 
 
- 11 -

 
 
The nature of the business and management of the European subsidiary that we purchased in 2007 required us to invest an inordinate amount of management time and effort, which we believed was not justified in light of the financial results of this subsidiary.  As a result, we determined to dispose of such subsidiary and in December 2009, we sold all of our interests in the European subsidiary.  We received total proceeds of Euro 2.9 million (approximately $4.2 million) for the sale, including repayment in full of Euro 1.8 million (approximately $2.6 million) of loans granted by us to the European subsidiary.  In addition, Euro 620,000 (approximately $920,000) that we had deposited in escrow as a contingent purchase price in connection with our acquisition of the European subsidiary was released back to us in connection with our sale of the subsidiary.
 
Recent key personnel changes.  Mr. Yoav Stern, who was appointed as our acting President as of November 10, 2008 and as our acting President and chief executive officer as of March 1, 2009, served in such positions until May 2009.  On June 3, 2009, our Board of Directors appointed Mr. Eitan Livneh as our President and chief executive officer, commencing August 2, 2009.  On April 16, 2009, Ms. Lian Goldstein, our former Vice President – Finance and chief financial officer, resigned from such offices and was replaced by Mr. Zev Morgenstern.  On December 1 2009, Mr. Morgenstern resigned from such offices.  Mr. Morgenstern remained with our company until January 31, 2010.  Mr. Ilan Ovadia replaced Mr. Morgenstern and since February 1, 2010, has served as our Senior Vice President – Finance and chief financial officer.  Mr. Israel (Relik) Shafir, was appointed as our Vice President Business Development on October 2009 and resigned from such office on March 15, 2010.
 
Capital expenditures. Our capital expenditures for the years ended December 31, 2007, 2008 and 2009 were approximately $890,000, $1.4 million and $2 million, respectively.  These expenditures were principally for the renovation and expansion of our offices and production facilities in Israel, as well as for computers, other machinery, commercial vehicles and equipment.  The increase in our capital expenditures in 2008 compared with 2007 is primarily attributable to major renovations at our executive offices and factory in Israel that commenced in 2008..  The high level of capital expenditures in 2009 was primarily attributable to the conclusion of the renovation and expansion work that we commenced in 2008 as well as the implementation of a new ERP system and an upgrade of our computer systems in Israel.
 
B.    Business Overview.
 
Overview and Strategy
 
We develop, manufacture, market and sell comprehensive computerized security systems to high profile customers.  Our systems are used in more than 75 countries to protect sensitive facilities, including national borders, military bases, power plant installations, airports, seaports, prisons, industrial sites and municipalities from intrusion, crime, sabotage or vandalism to infrastructure, assets and personnel.
 
Based on 25 years of experience and interaction with customers, we have developed a comprehensive set of solutions and products, optimized for perimeter, outdoor and general security applications.  Our portfolio of mission critical infrastructure and site protection technologies includes a variety of smart barriers and fences, fence mounted detectors, virtual gates, buried and concealed detection systems and a sophisticated protection package for sub-surface intrusion.  As a world class innovator in outdoor video motion detection, or VMD, and IVA applications, we deliver comprehensive IP technology and traditional CCTV solutions.
 
Our integrated solutions are based on a broad in-house product portfolio, complemented by OEM and third party products.  A typical turnkey solution is integrated and managed by Fortis - a sophisticated, geographical information system, or GIS, based command and control system.
 
 
- 12 -

 
 
A typical turnkey project consists of the following phases:
 
 
Studying and understanding customers’ requirements and conducting an environmental and site analysis;
 
 
Conducting a terrain survey;
 
 
Detailed planning that is focused and tailored around the users – first responders and operators in the command and control center(s);
 
 
Implementation - manufacturing, purchasing, integration, testing and installing the project;
 
 
Commissioning and training; and
 
 
Post-sales support.
 
Our revenues are principally derived from:
 
 
Sales of security products;
 
 
Installation of comprehensive security solutions derived from process bids leading to fixed-price contracts; and
 
 
Services and maintenance, based on post sale maintenance contracts.
 
Our primary objective is to become a leading international solution provider of safety, security and site management solutions and products.  To achieve this objective, we are implementing a business strategy incorporating the following key elements:
 
 
Leverage existing customer relationships.  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.
 
 
Refine and broaden our product portfolio.  We have identified the security needs of our customers and intend to enhance our current products’ capabilities, develop new products, acquire complementary technologies and products and enter into OEM agreements with third parties in order to meet those needs.
 
 
Refine and broaden our integration and turnkey delivery capabilities.  As a solution provider we depend on our capability to tailor specific solutions for each customer.  Our integration building blocks and our execution skills are key factors in achieving our growth and profitability.
 
 
Enter new markets and strengthen presence in existing markets.  We intend to continue to penetrate new geographic markets by various means, including the establishment of alliances with local distributors and international integrators of security systems.  We also intend to increase our marketing efforts in our existing markets and to acquire or invest in complementary businesses.
 
Emerging Opportunity
 
The rapid introduction of digital communication and information technology into the security market provides the opportunity to consolidate safety and site management with security applications.  Cities and municipalities, air and sea ports, chemical factories and critical infrastructure sites are already implementing and enjoying the benefits of this approach to security management.  The integration allows users to share dispersed sensors (such as cameras and emergency buttons), IT systems, traffic management tools and other resources and feed them into a single command and control platform.  Users from different functions within organizations can now share the same information, allowing for improved communication and coordination, whether it is a routine operation or crisis situation.  We believe that we are well positioned and on the forefront of this emerging market opportunity.
 
 
- 13 -

 
 
Products and Services
 
General
 
Our products are focused around outdoor and perimeter intrusion detection system, or PIDS, applications utilizing our outdoor safety and site management products and systems.  Our products are categorized into four families of systems:
 
 
Perimeter security systems, consisting of a mix of PIDS technologies with physical barrier solutions;
 
 
CCTV systems;
 
 
Command and control systems; and
 
 
Miscellaneous systems tailored for specific vertical market needs.
 
Perimeter Security Systems
 
Perimeter security systems enable customers to monitor, limit and control access by unauthorized personnel to specific regions or areas.  High-end perimeter systems are sophisticated in nature and are used by correctional facilities, military installations, power companies and other high security installations.  We believe that we are a leading provider of security systems and maintenance in this industry.
 
Our line of perimeter security systems utilizes sophisticated sensor devices to detect and locate intruders and identify the nature of intrusions.  Our perimeter security systems have been installed along thousands of kilometers of borders and facility boundaries throughout the world, including more than 600 correctional institutions in the United States and prisons in several other countries.  In addition, we have installed several hundred kilometers of high security smart perimeter systems along Israel’s borders.
 
Our line of outdoor perimeter security systems consists of the following:
 
 
Taut wire – hybrid perimeter intrusion detection systems with physical barrier;
 
 
Fence mounted vibration detection systems – mechanical, copper wire sensors or fiber optic sensors;
 
 
Smart barriers – a variety of: robust detection grids, gates and innocent looking fences, designed to protect water passages, VIP residences and other outdoor applications;
 
 
Buried cable sensors;
 
 
Electrical field disturbance sensors (volumetric); and
 
 
Microwave sensors.
 
Taut Wire Perimeter Intrusion Detection Systems
 
Our taut wire perimeter systems consist of wire strung at high tension between anchor posts.  Sensor posts are located at the middle between anchor posts.  These sensor posts contain one or more devices that detect changes in the tension being exerted on and by the taut wires.  Any force applied against these wires or released from them (such as by cutting) that is not within the parameters designed into the sensors themselves or programmed into the central control units, automatically triggers an alarm.  We use taut wire perimeter systems as both an integral component of intruder detection systems and as a physical barrier to infiltration.
 
 
- 14 -

 
 
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 variation, 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 typically sold for between $60 to $150 per meter.
 
Fence Mounted Vibration Detection Systems
 
We offer various types of vibration detection systems.  While less sensitive than taut wire installations, the adaptability of these systems to a wide range of pre-existing barrier structures makes these products viable alternatives for cost-conscious customers.  Our vibration detection devices are most effective when installed on common metal fabric perimeter systems, such as chain link or welded mesh.  In our BARRICADE system, electro-mechanical sensors are attached to fence panels approximately three meters apart on any of several common types of fence structures.  Once attached to the fence, each sensor detects vibrations in the underlying structures.  The sensor system’s built-in electro-mechanical filtering combines with system input from a weather sensor to minimize the rate of false alarms from wind, hail or other sources of nuisance vibrations.
 
Intelli-FLEX, Intelli-FIBER and fence protection systems, or FPS, microprocessor-based triboelectric and electric cable fence sensors are vibration sensitive transducers.  These systems detect any attempt to cut, climb or penetrate the fence and have microphonic properties.  The microphonic feature permits audio to be used for low-cost alarm assessment, providing users with an additional tool for determining the nature of an attempted intrusion.  Our vibration detection system is typically sold for between $10 to $60 per meter.
 
Buried Cable Sensor
 
Omnitrax is a fifth generation, covert outdoor perimeter security intrusion detection sensor that generates an invisible radar detection field around buried sensor cables.  An alarm is emitted and the exact location identified within one meter if an intruder disturbs the field.  Targets are detected by their conductivity, size and movement and the digital processor is able to filter out common alarms caused by environmental conditions and small animals.  The Omnitrax system is sold for between $40 to $80 per meter.
 
Electrical Field Disturbance Sensors
 
Terrain following volumetric sensors can detect intrusions before the intruder touches the sensor.  They can be installed on buildings, free-standing posts, existing fences, walls or rooftops, and will sense changes in the electrostatic field when events, such as intruders penetrating through the wires, take place.  The system’s tall, narrow, well contained detection zone allows the sensor to be installed in almost any application and minimizes nuisance alarms caused by nearby moving objects.  Our flagship product is X-Field; it consists of a set of four or eight parallel field sensing wires and is sold for between $100 and $190 per meter.  We also offer a deployable volumetric sensor, used to protect military forces deployed on short notice who need fast reaction with minimal effort.
 
 
- 15 -

 
 
Microwave Products
 
We also offer a range of bi-static microwave products that are designed for stable, reliable operation in extreme outdoor environments.  Coverage distances range from 180 meters to 450 meters.
 
CCTV Systems
 
We have a proven track record in delivering CCTV and IVA solutions that are designed for use in outdoor applications.
 
DreamBox
 
At the heart of our CCTV solution, we typically supply an integrated control system which seamlessly integrates real time video with other sensors (such as PIDS) and information layers.  For example, a megapixel VMD camera covering a wide area can automatically start tracking a suspect detected by the PIDS.  In parallel, the IP camera can increase the streamed video frame rate and alarm the control center guard to examine the intruder.  Our investments in IVA tools help eliminate dependency on constant human monitoring.  Automatic tools and algorithms extract abnormalities and only irregular events are transferred and analyzed for verification.  This approach saves bandwidth and storage and more importantly requires human intervention only when needed.  Our unique to the industry IVA / VMD has been developed to meet the challenge of the outdoor environment (such as weather effects, moving objects like trees, glare and flashing lights).
 
DreamBox is a real-time all-in-one multimedia analysis and management platform that is designed for use in outdoor security applications.  It supports both analog and IP cameras and integrates many CCTV related applications into one box.  DreamBox has a built in autonomous network switch that supports a unique meshed distributed architecture to enable data sharing, processing and storage between all units on the network.  These features ensure high data redundancy, no single points of failure and no need for a central server.
 
DreamBox fits any sensitive critical site that requires real-time multi-media surveillance, providing strong motion detection and analysis.  It is ideal for outdoor applications where cameras are covering wide areas and data may be dispersed in multiple locations, yet the entire site needs to function as a single, coherent and centrally managed data center.
 
DreamBox has a proven track record in high-end vertical markets that require outdoor security such as military bases, government organizations, airports, seaports, mass transportation, correctional facilities, utilities and industrial sites.
 
DreamBox does not try to compete with other commercial off-the-shelf CCTV products and solutions.  We are focused on high-end customers who cannot rely on standard indoor products and requires tailored, modular and flexible solutions at an affordable price.
 
MTC-1500E
 
MTC-1500E is a high-end yet affordable, dual technology (thermal and charge-coupled device) outdoor surveillance system.  A high-quality image rendered by the thermal sensor provides long distance detection and recognition of humans in day, night and under poor visibility conditions.  The two cameras are mounted on a single pedestal and controlled through an agile and accurate pan-tilt-zoom-focus engine.
 
The MTC-1500E is suitable for the protection of any critical object or site.  Markets for the system include airports, seaports, critical border crossings, utilities (such as oil, gas, refineries and water dams), prisons, municipalities and city protection applications.
 
 
- 16 -

 
 
MSS-1500
 
MSS-1500 is a dual camera (day and night) system designed for outdoor rapid deployment operations.  The system is tailored for law enforcement, security and special operations forces.  It enables camera installation close to the required observation area and communicates data to a remote center.  The deployable element has a low footprint for concealed operation and can be put into operation within less than five minutes.
 
The system has been designed and packaged to support defense, law enforcement and security special operations in various vertical markets and scenarios.  These applications include intelligence-based operations for border protection, homeland security and fighting organized crime.  Other applications include securing VIPs while they commute or providing surveillance protection of exposed perimeter zones in construction sites.
 
MagCam
 
The MagCam is a combination of day/night camera and illuminator installed within a DTR taut wire perimeter intrusion detection system to provide complete and uniform fence surveillance under both very bright daylight and total darkness.  Combined with the DTR taut wire system’s alarm, the system displays a clear view of the alerted section and its neighboring sections, enabling the operator to verify and asses the relevant region.  Connecting the MagCam to our DreamBox provides an exceptional second intrusion detecting layer based on sophisticated outdoor video analytics, such as virtual fence algorithms.
 
Command and Control Systems
 
The development of communication and IT technology has significantly affected the security market.  Multiple security systems and technologies, sometimes supplied by different vendors, can now be integrated into a unified command and control system.  We offer two types of command and control systems:
 
        Sentient - a basic security management system, or SMS; and
 
        Fortis – a high-end comprehensive command and control system
 
Sentient
 
Sentient is pre-integrated with a range of our PIDS sensors and can begin operating immediately without any software installation.  The system also provides tools for adaptation to a specific site by adding maps, assigning zones and sensor icons to maps.  Sentient is our new generation basic SMS application, replacing multiple legacy systems.
 
Fortis
 
FORTIS is a comprehensive, wide area and real time command and control solution, designed for entities requiring management of security, safety and dispatching.  It is designed to manage all daily routines and site activities, security, regular and irregular events as well as crisis situations.
 
FORTIS architecture integrates with legacy systems and sensors from the physical level through a configuration and business logic layer and up to the situational awareness and management levels.  It is based on a strong GIS engine, which creates a common layer for inputs, outputs and presentation.  The GIS engine enables the display of synchronized information in time and space across all screens such as location of mobile forces, located alarms from stationary sensors, video of related cameras, pop-ups of associated radar screens and managed voice communication related to the managed area.  Real-time information enables security personnel to respond immediately, while maintaining a full two-way communication and situational awareness between the command and control center(s) and the first responders.
 
 
- 17 -

 
 
During 2009, we consolidated other command and control systems (such as our legacy MagNet command and control system) into the Fortis.  The target markets for Fortis are municipalities, city protection applications and as part of other integrated solutions supplied by us, for use in airport, border and homeland security applications.
 
Miscellaneous Systems
 
Sub-Terrain Protection
 
We offer an innovative, covert security system known as PipeGuard that is designed to protect underground pipelines, safes and other buried assets from theft, vandalism and third-party damage, based on leading edge advanced technologies.
 
A PipeGuard solution will include an array of standalone sensors, all communicating within a meshed network that senses any attempt to dig close to the protected assets.  It can be easily integrated into a full turnkey solution, including perimeter intrusion protection, ground or air patrols and alarm monitoring and control.  PipeGuard combines geophones with advanced technology recognition algorithm capabilities based on the analysis of seismic signals to effectively filter out false alarms.  This intelligent signal processing provides a high probability of detection and low false and nuisance alarm rates.
 
We believe that the target markets for PipeGuard are in the western and developed countries where environmental issues are, or will become, regulated.  PipeGuard is an ideal solution for identifying leakages from existing oil and gas pipes in order to avoid third party damages.
 
Life Safety / Duress Alarm Products
 
Our products include high reliability, personal, portable duress alarm systems to protect personnel in prisons.  These products identify individuals in distress and can pinpoint the location of the distress signal with an indoor-to-outdoor and floor-to-floor accuracy unmatched by any other product.
 
Flash personal emergency alarm systems, or Flash, and flare personal emergency locating systems, or Flare, use radio frequency technology to provide a one touch emergency system that is so small it can be worn on a belt.  The systems, sold mainly to prisons, consist of transmitters that send distress signals to receivers mounted throughout the building.  Receivers relay the signal to a central location, indicating that someone requires assistance and their location in the building.  The systems employ automated testing procedures that help to reduce maintenance costs.  The hardware and software was developed and researched in the United States and competes against infrared and other similar technologies.
 
Our personal alarm system uses an ultrasonic based emergency notification and communication system.  The system, sold mainly to prisons in the United States, allows individuals moving throughout a facility to quickly indicate their exact location in a crisis situation.
 
Marketing, Sales and Distribution
 
We believe that our reputation as a vendor of high-security products in one of the world’s most security conscious countries often provides us and our sales representatives with direct access to senior government and corporate officials in charge of security matters elsewhere.
 
Our sales efforts focus on:
 
 
Products (mainly PIDS).  Products are sold indirectly through system integrators and distribution channels.  Due to the sophistication of our products, we often need to approach end-users directly and be in contact with system integrators, however the sale is directed through a third party; and
 
 
Solutions.  This part of the business deals with end-customers or high-end system integrators.  We offer a full comprehensive solution, which includes our in-house portfolio of products and products manufactured by third parties.  Solutions are focused around our core strategy (outdoor security, safety and site management).  We take responsibility for the full turnkey solution and we provide our home-made products, OEM products and third party sourced products, as needed by the customer.
 
 
- 18 -

 
 
We have sales offices in the United States, the United Kingdom, Germany, Mexico, China, Romania, Columbia and Spain, as well as in our two main offices in Israel and Canada.  These offices serve the growing needs of local, state and federal homeland security requirements and focus on marketing and selling products as well as comprehensive solutions.
 
Perimeter Security Systems
 
We generally sell our PIDS to distributors and systems integrators for various geographic territories or for specific projects.  In addition to marketing activities, some of our distributors and system integrators also provide installation and maintenance services for our products.  We currently have over 50 distributors and system integrators who resell these systems.  We occasionally use agents to find suitable distributors and pay finders’ fees to these agents for their services.
 
CCTV Systems and Command and Control Systems
 
Our marketing efforts for our security management and control systems, DreamBox and turnkey projects consists of direct contacts with potential customers.  We offer the MagNet, Fortis and DreamBox products primarily as part of comprehensive turnkey project solutions or, at the customer’s preference, as stand-alone products.
 
Pipeline Security Systems
 
The target markets for our pipeline security systems include oil and gas companies, owners and operators of pipelines or communication cables and governmental agencies engaged with security and environmental issues.
 
Life Safety
 
We market our personal emergency location systems directly to potential customers, mainly correctional facilities in North America.
 
The following table shows the breakdown of our consolidated revenues for the calendar years 2007, 2008 and 2009 by operating segment:
 
   
Year Ended December 31,
 
   
2007
   
2008
   
2009
 
   
(In thousands)
 
Perimeter products
  $ 43,781     $ 41,126     $ 39,066  
Turnkey projects
    18,487       15,727       15,416  
Other
    427       252       36  
   Total
  $ 62,695     $ 57,105       54,518  
 
 
- 19 -

 
 
Customers  
 
The following table shows the geographical breakdown of our consolidated revenues for the calendar years 2007, 2008 and 2009:
 
   
Year Ended December 31,
 
   
2007
   
2008
   
2009
 
   
(In thousands)
 
Israel
  $ 15,663     $ 12,097     $ 12,968  
North America
    14,869       15,648       13,763  
Europe
    18,342       15,603       10,808  
South and Latin America
    6,818       4,542       3,986  
Africa
    1,199       1,319       1,567  
Others
    5,804       7,896       11,426  
   Total
  $ 62,695     $ 57,105     $ 54,518  
 
For the years ended December 31, 2007, 2008 and 2009, revenues generated from sales to the MOD and IDF accounted for 15%, 10.8% and 19.6%, respectively, of our revenues.  We cannot assure you that the MOD, IDF or any of our other major customers will maintain their volume of business with us or that, if such volume is reduced, other customers generating similar revenues will replace the lost business.  The loss of one or more of our key customers without replacement by a customer or customers of similar volume would have a material adverse effect on our financial results.
 
Support and Maintenance
 
Our systems are installed by us or by the customer after appropriate training, depending on the size of the specific project and the location of the customer’s facilities, as well as on the customer’s prior experience with our systems.  We generally provide our customers with training on the use and maintenance of our systems.  This training is conducted either on-site or at our facilities.  In addition, some of our local perimeter security systems customers have signed maintenance contracts with us.  For systems installed outside of Israel, maintenance is provided by an independent third party, by distributors or by the end-user.  We also provide services, maintenance and support on an “as needed” basis.
 
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 2009, we derived approximately 6.3 % of our total revenues from maintenance and services.  We generally provide a 12 to 24 month warranty on most of our products.
 
Research and Development; Royalties
 
We place considerable emphasis on research and development to improve our existing products and technology and to develop new products and technology.  We believe that our future success will depend upon our ability to enhance our existing products and technology and to introduce on a timely basis new commercially viable products and technology addressing the needs of our customers.  We intend to continue to devote a significant portion of our personnel and financial resources to research and development.  As part of our product development process, we seek to maintain close relationships with our customers to identify market needs and to define appropriate product specifications.  Our development activities are a direct result of the input and guidance we receive from our marketing personnel during our annual meetings with such personnel.  In addition, the heads of research and development for each of our development centers discussed below meet annually to identify market needs for new products.
 
Our research and development expenses during 2007, 2008 and 2009 were approximately $5.3 million, $5.6 million and $4.8 million, respectively.  In addition to our own research and development activities, we also acquire know-how from external sources.  We cannot assure you that any of our research and development projects will yield profitable results.
 
 
- 20 -

 
 
We have the following two development centers, each of which develops products and technologies based on its area of expertise:
 
 
In Israel - we develop a wide range of products including our taut wire, mechanical vibration, video and high-end SMS, command and control systems and PipeGuard; and
 
 
In Canada - we develop our buried cable sensors, fence mounted vibration detection systems, mechanical, copper and fiber-optic fence sensors, electrostatic volumetric detection, medium to high-end control systems, microwave detection, personal alarm systems and small to medium control systems.
 
Office of the Chief Scientist of the Israeli Ministry of Industry, Trade and Labor
 
We have historically sought co-financing of our development projects from the Office of the Chief Scientist of the Israeli Ministry of Industry, Trade and Labor, or the OCS.  We are obligated to pay royalties to the OCS, amounting to 3% to 4.5% of revenues derived from sales of the products funded with these grants and ancillary services, up to an amount equal to 100% of the grants received, linked to the U.S. dollar.  All grants received after January 1, 1999 also bear interest equal to the 12 month LIBOR rate.  The obligation to pay these royalties is contingent on actual sales of the products, and in the absence of such sales, no payment is required.  We paid royalties amounting to $143,000, $125,000 and $172,000 in the years ended December 31, 2007, 2008 and 2009, respectively.  As of December 31, 2009, our aggregate contingent obligation to the OCS amounted to $1.2 million.
 
The terms of these grants require that the manufacture of products developed with these grants be performed in Israel and prohibit transferring technology developed with grants without the prior consent of the Research Committee of the OCS.  We cannot assure you that, if requested, the OCS will grant such consent.  Each application to the OCS is reviewed separately, so we cannot assure you that the Israeli Government will continue to support our research and development.
 
Scientific Research and Experimental Development Tax Incentive Program
 
Introduced by the Canadian Government in the 1980s, the Scientific Research and Experimental Development, or SR&ED, tax incentive program is intended to encourage Canadian businesses of all sizes to conduct applied research and development in Canada that will lead to new, improved, or technologically advanced products, processes, principles, methodologies or materials.  The SR&ED program gives claimants cash refunds and/or tax credits for their expenditures on eligible research and development work done in Canada.  Qualifying expenditures may include wages, materials, machinery, equipment, travel and training expenses, property taxes, utility expenses, some overhead and SR&ED contracts from experimental development, applied research, basic research and support work.
 
Under the SR&D tax incentive program, Canadian-controlled private corporations are entitled to an investment tax credit of 35% for the first $2 million in qualified expenditures and 20% on any excess amount.  Other Canadian corporations, proprietorships, partnerships, and trusts are entitled to an investment tax credit of 20% of all qualified expenditures.  For the years ended December 31, 2007, 2008 and 2009, our Canadian subsidiary recognized $160,000, $234,000 and $259,000, respectively, of investment tax credits. As of December 31, 2009, our Canadian subsidiary made a full valuation allowance in respect of such investment tax credits.
 
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 facilities in Yehud, Israel and Ottawa, Canada.  See Item 4D., “Information on the Company - Property, Plants and Equipment.”
 
We acquire most of the components utilized in our products, including our turnkey products, and certain services from a limited number of suppliers and subcontractors.  We cannot assure you that we will continue to be able to obtain such items from these suppliers on satisfactory terms.  Alternative sources of supply are available, and therefore we are not dependent upon these suppliers and subcontractors.  We also maintain an inventory of systems and spare parts in order to enable us to overcome potential temporary supply shortages until an alternate source of supply is available.  Nevertheless, temporary disruptions of our manufacturing operations would result if we were required to obtain materials from alternative sources, which may have an adverse effect on our financial results.
 
 
- 21 -

 
 
Competition
 
The principal factors affecting competition in the market for security systems are a system’s high probability for detection and low probability of false and nuisance alarms.  We believe that a manufacturer’s reputation for reliable equipment is a major competitive advantage, and that such a reputation will usually be based on the performance of the manufacturer’s installed systems.  Additional competitive factors include quality of customer support, maintenance and price.  We believe that we are competitive with respect to these factors and that we have a good reputation in the markets in which we compete.
 
Several companies, including Elbit Systems Ltd., Elfar Ltd. and RB-Tec Ltd. in Israel, and Detektion Security Systems Inc., Fiber Sensys, Future Fiber Technologies Pty, Geoquip Ltd., Herras, Remsdaq, Siemens AG and Southwest Microwave Inc., outside of Israel, produce high-security detection systems.
 
There are a number of companies that have developed video motion detection systems, including Bosch, Geutebruck GmbH, Ioimage Ltd., Nice Systems Ltd., ObjectVideo Inc. and Siemens AG.
 
We believe that our principal competitors for DreamBox systems are DVTel Inc, Indigo, Nice Systems Ltd. and Verint Systems Inc.
 
We believe that our principal competitors for our security management systems include, among others, C. MER Industries Ltd., Dornier, EADS N.V., Elbit Systems Ltd., Honeywell Inc., Lockheed Martin Corporation, Nice Systems Ltd, Rafael Advanced Defense Systems Ltd, Raytheon Company, Siemens AG and 4D.
 
We believe that our principal competitor for the PipeGuard system is an Australian company, Future Fibre Technologies Pty. Ltd.
 
We believe that our principal competitors for personal emergency location systems are Actall Corp. and Visonic Networks.
 
Some of our competitors and potential competitors have greater research, development, financial and personnel resources, including governmental support, or more extensive business experience than we do.  We cannot assure you that we will be able to maintain the quality of our products relative to those of our competitors or continue to develop and market new products effectively.
 
Intellectual Property Rights  
 
We have approximately 15 patents issued and have patent applications pending in the United States and in several other countries and have obtained licenses to use proprietary technologies developed by third parties.  We cannot assure you:
 
 
that patents will be issued from any pending applications, or that the claims allowed under any patents will be sufficiently broad to protect our technology;
 
 
that any patents issued or licensed to us will not be challenged, invalidated or circumvented; or
 
 
as to the degree or adequacy of protection any patents or patent applications may or will afford.
 
 
- 22 -

 
 
In addition, we claim proprietary rights in various technologies, know-how, trade secrets and trademarks relating to our principal products and operations.  We cannot assure you as to the degree of protection these claims may or will afford.  It is our policy to protect our proprietary rights in our products and operations through contractual obligations, including confidentiality and non-disclosure agreements with certain employees and distributors.  We cannot assure you as to the degree of protection these contractual measures may or will afford.  Although we are not aware that we are infringing upon the intellectual property rights of others, we cannot assure you that an infringement claim will not be asserted against us in the future.  We believe that our success is less dependent on the legal protection that our patents and other proprietary rights may or will afford than on the knowledge, ability, experience and technological expertise of our employees.  We cannot provide any assurance that we will be able to protect our proprietary technology.  The unauthorized use of our proprietary technology by third parties may impair our ability to compete effectively.  We could become subject to litigation regarding intellectual property rights, which could seriously harm our business.
 
We have trademark rights associated with our use of Flash and Intelli-FLEX, and rights obtained by trademark registration for Flare, Perimitrax, Panther, Intelli-FIELD, Senstar, Senstar-Stellar and the Senstar-Stellar logo, Sentrax, Omnitrax, Xfield, DTR, DreamBox and the Magal logo.
 
Government Regulations
 
Israel’s defense export policy regulates the sale of a number of our systems and products.  Current Israeli policy encourages export to approved customers of defense systems and products, such as ours, as long as the export is consistent with Israeli government policy.  A license is required to initiate marketing activities.  We are also required to obtain a specific export license for any hardware eventually exported from Israel.  We cannot assure you that we will receive all the required permits and licenses for which we may apply in the future.
 
In 2007, an Israeli law regulating export of “dual use” items (items that are typically sold in the commercial market, but that also may be used in the defense market) came into effect.  In addition, a new Defense Export Control Law was adopted in 2007 and the law’s supplemental regulations became effective in February 2008.  Such laws enhance enforcement of export control legislation, provide certain exemptions from license requirements and broaden certain areas of licensing, particularly with respect to transfer of technology.  In addition, our participation in governmental procurement processes in Israel and other countries is subject to specific regulations governing the conduct of the process of procuring defense contracts.  Furthermore, solicitations for procurements by governmental purchasing agencies in Israel and other countries are governed by laws, regulations and procedures relating to procurement integrity, including avoiding conflicts of interest and corruption in the procurement process.
 
In addition, antitrust laws and regulations in Israel and other countries often require governmental approvals for transactions that are considered to limit competition.  Such transactions may include cooperative agreements for specific programs or areas, as well as mergers and acquisitions.
 
C.    Organizational Structure.
 
We, or one of our subsidiaries, own 100% of the outstanding capital stock of subsidiaries operating in Canada, the United States, Germany, Mexico, the United Kingdom, Columbia and Romania, and 76% of the outstanding share capital of our Spanish subsidiary.
 
D.    Property, Plants and Equipment.
 
Our principal facility in Israel is a two-story 2,533 square meter facility located on a 4,352 square meter parcel in the Yehud Industrial Zone, which is owned by us and registered in our name.  Approximately 600 square meters are devoted to administrative, marketing and management functions and approximately 700 square meters are used for engineering, system integration and customer service.  We use the remaining 1,233 square meters for production management and production operations, including manufacturing, assembly, testing, warehousing, shipping and receiving.  In 2007, we entered into a lease for a one-story 810 square meter facility located on a 1,820 square meter parcel in the Yehud Industrial Zone for $80,000 per year for use in production and operations.  The lease is for a period of 23 years.  The products that we manufacture at our facilities in the Yehud Industrial Zone include our taut-wire intrusion detection systems, our vibration detection systems, our video-motion detection systems, MagNet, Fortis, DreamBox, PipeGuard, MTC-1500, MSS-1500 and other perimeter systems.
 
 
- 23 -

 
 
We own a 33,000 square foot facility in Carp, Ontario, Canada.  Approximately 9,000 square feet are devoted to administrative, marketing and management functions, and approximately 8,000 square feet are used for engineering, system integration and customer service.  We use the remaining 16,000 square feet for production operations, including cable manufacturing, assembly, testing, warehousing, shipping and receiving.  We own an additional 182,516 square feet of vacant land adjacent to this property, which is being held for future expansion.  We also rent 358,560 square feet of land near this facility for use as an outdoor sensor test and demonstration site for our products including the Perimitrax/Panther 2000 and Omnitrex buried cable intrusion detection systems, the Intelli-Field electro static detection system, the X-Field volumetric system, the Intelli-FLEX microphonic fence detection system, Flash and Flare, and various perimeter monitoring and control systems.  The rent for this site is Canadian $3,500 per year plus taxes under a lease that expires in November 2014.  In addition, we lease a 1,900 square foot facility adjacent to our Carp, Ontario property for Canadian $22,800 per year plus taxes for use as additional storage and system integration space under a month to month tenancy.
 
We own a 20,000 square foot facility in Fremont, California that formerly served as a manufacturing and sales facility.  We are currently seeking to sell or lease this facility.
 
We also lease small offices in Germany, Mexico, Romania, Spain, the United Kingdom and in Virginia in the United States, for our sales and marketing entities.  The aggregate annual rent for such offices was approximately $0.2 million in 2009.
 
We believe that our facilities are suitable and adequate for our current operations and the foreseeable future.
 
ITEM 4A.               Unresolved Staff Comments
 
None.
 
Operating and Financial Review and Prospects
 
The following discussion of our results of operations and financial condition should be read in conjunction with our consolidated financial statements and the related notes thereto included elsewhere in this annual report.  This discussion contains forward-looking statements that involve risks and uncertainties.  Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth in Item 3.D. “Key Information–Risk Factors.”
 
A.    Operating Results.
 
Overview
 
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:
 
 
installation of comprehensive security solutions for which revenues are generated from long-term fixed price contracts;
 
 
sales of security products; and
 
 
services and maintenance, which are performed either on a fixed-price basis or pursuant to time-and-materials based contracts.
 
 
- 24 -

 
 
Business Challenges/Areas of Focus
 
Our primary business challenges and areas of focus include:
 
 
continuing the growth of revenues and profitability of our perimeter security system line of products;
 
 
enhancing the introduction and recognition of our new products into the markets;
 
 
penetrating into new markets and strengthening our presence in existing markets; and
 
 
succeeding in selling our comprehensive turnkey solutions.
 
Our business is subject to the effects of general global economic conditions.  If general economic conditions or economic conditions in key markets remain weak or weaken further, demand for our products could be adversely affected.
 
Key Performance Indicators and Sources of Revenues
 
Our management believes that our revenues, sources of revenues and operating income are among the key performance indicators for our business.  Our revenues from our principal lines of business for the three years ended December 31, 2007, 2008 and 2009 were as follows:
 
   
Year Ended December 31,
 
   
2007
   
2008
   
2009
 
   
(In thousands)
 
Perimeter products
  $ 43,781     $ 41,126     $ 39,066  
Turnkey projects
    18,487       15,727       15,416  
Other
    427       252       36  
   Total
  $ 62,695     $ 57,105       54,518  
 
Our operating income (loss) from our principal lines of business for the three years ended December 31, 2007, 2008 and 2009 were as follows:
 
   
Year Ended December 31,
 
   
2007
   
2008
   
2009
 
   
(In thousands)
 
Perimeter products
  $ 2,260     $ (9,337 )   $ (1,070 )
Turnkey projects
    (844     (5,230 )     (1,812 )
Other
    (193 )     7       17  
Eliminations
    (28 )     -       -  
   Total
  $ 1,195     $ (14,560 )   $ (2,865 )
 
Cost and Expenses
 
Cost of revenues.  Our cost of revenues for perimeter products consists of component and material costs, direct labor costs, subcontractors costs, shipping expenses, overhead related to manufacturing and depreciation.  Our cost of revenues for turnkey projects consists primarily of component and material costs, subcontractor costs, direct labor costs and overhead related to the turnkey projects.  Our cost of revenues for “other” consists primarily of direct labor costs and material costs relating to our maintenance services.
 
Our gross margin is affected by the proportion of our revenues generated from perimeter products, turnkey projects and other.  Our revenues from perimeter products generally have higher gross margins than our other segments.
 
 
- 25 -

 
 
Research and development expenses, net.  Research and development expenses, net consists primarily of expenses for on-going research and development activities and other related costs.
 
Selling and marketing expenses.  Selling and marketing expenses consist primarily of commission payments, compensation and related expenses of our sales teams, attendance at trade shows and advertising expenses and related costs for facilities and equipment.
 
General and administrative expenses.  Our general and administrative expenses consist primarily of salary and related costs associated with our executive and administrative functions, legal and accounting expenses, allowances for doubtful accounts and bad debts and other miscellaneous expenses.  Staff costs include direct salary costs and related costs, such as severance pay, social security and retirement fund contributions, vacation and other pay.
 
Depreciation and Amortization. The amount of depreciation and amortization attributable to our business segments for the years ended December 31, 2007, 2008 and 2009 are as follows:
 
   
Year Ended December 31,
 
   
2007
   
2008
   
2009
 
   
(In thousands)
 
Perimeter products
  $ 1,087     $ 782     $ 1,166  
Turnkey projects
    117       409       38  
Other
    3       -       -  
   Total
  $ 1,207     $ 1,191     $ 1,204  
 
Financial Expenses, Net. Financial expenses, net include exchange rate differences arising from changes in the value of monetary assets and monetary liabilities stated in currencies other than the functional currency of each entity, currency and hedge transactions, interest charged on loans from banks as well as interest income on our cash and cash equivalents and short term investments.
 
Tax expense.  Tax expense consists of federal, state and local taxes on the income of our business.  Our taxable income in Israel was subject to corporate tax at the statutory rate of 29% in 2007, 27% in 2008 and 26% in 2009.  The rate was reduced to 25% in 2010, and will be further reduced to 24% in 2011, 23% in 2012, 22% in 2013, 21% in 2014, 20% in 2015 and 18% in 2016 and thereafter.
 
Discussion of Critical Accounting Policies
 
The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates and the use of different assumptions would likely result in materially different results of operations.  Critical accounting policies are those that are both most important to the portrayal of our financial position and results of operations and require management’s most difficult, subjective or complex judgments.  Although not all of our significant accounting policies require management to make difficult, subjective or complex judgments or estimates, the following policies and estimates are those that we deem most critical:
 
Revenue Recognition
 
We generate our revenues mainly from (i) installation of comprehensive security systems for which revenues are generated from long-term fixed price contracts; (ii) sales of security products; and (iii) services and maintenance, which are performed either on a fixed-price basis or as time-and-materials based contracts.
 
 
- 26 -

 
 
Revenues from installation of comprehensive security systems are generated from fixed-price contracts according to which the time between the signing of the contract and the final customer acceptance is usually over one year. Such contracts require significant customization for each customer’s specific needs and, as such, revenues from this type of contract are recognized in accordance with ASC 605-35 Revenue Recognition -Construction-Type and Production-Type Projects" (formerly Statement of Position ("SOP") No. 81-1, "Accounting for Performance of Construction-Type and Certain Production-Type Contracts"), using contract accounting on a percentage of completion method. Accounting for long-term contracts using the percentage-of-completion method stipulates that revenue and expense are recognized throughout the life of the contract, even though the project is not completed and the purchaser does not have possession of the project Percentage of completion is calculated based on the “Input Method.”
 
Project costs include materials purchased to produce the solutions, related labor and overhead expenses and subcontractor’s costs.  The percentage to completion is measured by monitoring costs and efforts devoted using records of actual costs incurred to date in the project compared to the total estimated project requirement, which corresponds to the costs related to earned revenues.  The amounts of revenues recognized are based on the total fees under the agreements and the percentage of completion achieved.  Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are first determined, in the amount of the estimated loss on the entire contract.
 
Estimated gross profit or loss from long-term contracts may change due to changes in estimates resulting from differences between actual performance and original forecasts.  Such changes in estimated gross profit are recorded in results of operations when they are reasonably determinable by management, on a cumulative catch-up basis.
 
We believe that the use of the percentage of completion method is generally appropriate as we have the ability to make reasonably dependable estimates of the extent of progress towards completion, contract revenues and contract costs.  In addition, executed contracts include provisions that clearly specify the enforceable rights regarding services to be provided and received by the parties to the contracts, the consideration to be exchanged and the manner and the terms of settlement, including in cases of termination for convenience.  In most cases we expect to perform our contractual obligations and our customers are expected to satisfy their obligations under the contract.
 
Fees are payable upon completion of agreed upon milestones and subject to customer acceptance. Amounts of revenues recognized in advance of contractual billing are recorded as unbilled accounts receivable.  The period between most instances of advanced recognition of revenues and the customers' billing generally ranges between one to six months.  As of December 31, 2009, we had recorded $5.9 million of such unbilled receivables.
 
Although our basic accounting policy is percentage-of-completion, the completed-contract method is used for certain contracts when we cannot make reasonably dependable estimates for such contracts or if inherent hazards make estimates doubtful.  Inherent hazards are conditions and events that do not occur in the normal course of business.  Under the completed-contract method, billings and costs are accumulated on the balance sheet under the caption “cost incurred on long term contracts” while the contract is in progress, but no revenue is recognized until the contract is completed or substantially completed.  When revenues and costs are recognized based upon substantial completion of the contract, an accrual is recorded for the estimated remaining costs to be incurred and for the estimated amounts of any unresolved claims or disputes related to the contract that are probable of payment.  During 2008, we concluded that certain projects in Africa carried out by our European subsidiary that we purchased in 2007 are not typical compared to our other projects and identified inherent hazards related to these projects and a delay in payments from the customer.  As a result, we concluded that we could not make reasonably dependable estimates in order to calculate the percentage of completion of these projects and therefore, in 2008 we began to apply the completed contract method to these projects.  In December 2009 we disposed of our European subsidiary. Consequently, as of December 31, 2009 we have not used the completed-contract method when computing our revenues.  We sell security products to customers according to customers’ orders without installation work. The customers do not have a right to return the products. Revenues from security product sales are recognized in accordance with Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition in Financial Statements" when delivery has occurred, persuasive evidence of an agreement exists, the vendor's fee is fixed or determinable, no further obligation exists and collectability is probable.
 
 
- 27 -

 
 
Services and maintenance are performed under either fixed-price based or time-and-materials based contracts. Under fixed-price contracts, we agree to perform certain work for a fixed price. Under time-and-materials contracts, we are reimbursed for labor hours at negotiated hourly billing rates and for materials. Such service contracts are not in the scope of  ASC 605-35, 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 collectability is reasonably assured.
 
Deferred revenue includes unearned amounts under installation service contracts, service contracts and maintenance agreements.
 
Inventories
 
Inventories are stated at the lower of cost or market value.  We periodically evaluate the quantities on hand relative to historical and projected sales volumes, current and historical selling prices and contractual obligations to maintain certain levels of parts.  Based on these evaluations, inventory write-offs are provided to cover risks arising from slow-moving items, discontinued products, excess inventories, market prices lower than cost and adjusted revenue forecasts.  Cost is determined as follows:
 
 
Raw materials, parts and supplies - using the “first-in, first-out” method.
 
 
Work-in-progress and finished products - on the basis of direct manufacturing costs with the addition of allocable indirect manufacturing costs.
 
During 2007, 2008 and 2009, we recorded inventory write-offs from continuing operations in the amounts of $646,000, $2.0 million and $1.4 million, respectively.  Such write-offs were included in cost of revenues.
 
Income taxes
 
We account for income taxes in accordance with ASC 740 "Income Taxes" (formerly SFAS No. 109, "Accounting for Income Taxes")  This statement prescribes the use of the liability method whereby deferred tax asset and liability account balances are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.  We provide a valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value.
 
As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate.  This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes.  These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet.  We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and we must establish a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized.  Increases in the valuation allowance result in additional expense to be reflected within the tax provision in the consolidated statement of income.
 
At December 31, 2009, we had a deferred tax asset of $272,000 attributable to our subsidiaries.  We had total estimated available carryforward tax losses of $18.8 million with respect to our operations in Israel.  As of December 31, 2009, we recorded a full valuation allowance on these carryforward tax losses due to the uncertainty of their future realization.  As of December 31, 2009, our subsidiaries had estimated total available carryforward tax losses of $9.5 million, which may be used as an offset against future taxable income for periods ranging between 12 and 20 years.  As of December 31, 2009, we recorded a full valuation allowance for our subsidiaries’ carryforward tax losses due to the uncertainty of their future realization.  Utilization of U.S. net operating losses may be subject to a substantial annual limitation due to the “change in ownership” provisions of the Internal Revenue Code of 1986 and similar state provisions.  The annual limitation may result in the expiration of net operating losses before utilization.
 
 
- 28 -

 
 
Goodwill
 
Goodwill has been recorded as a result of past acquisitions and represents the excess of the cost over the net fair value of the assets of the businesses acquired.  We operate in two operating segments, which also constitute our two reporting units (“Projects” and “Perimeter”).  Goodwill was allocated to the two reporting units.  All remaining goodwill as of December 31, 2009 is allocated to the Perimeter reporting unit.  We follow ASC 350, "Intangibles – Goodwill and Other" (originally issued as SFAS 142, "Goodwill and Other Intangible Assets").
 
ASC 350 requires goodwill to be tested for impairment, at the reporting unit level, at least annually or between annual tests in certain circumstances, and written down when impaired, rather than being amortized.  We perform our annual goodwill impairment test at December 31 of each year, or more often if indicators of impairment are present.
 
ASC 350 prescribes a two phase process for impairment testing of goodwill. The first phase screens for impairment, while the second phase (if necessary) measures impairment. In the first phase of impairment testing, goodwill attributable to each of the reporting units is tested for impairment by comparing the fair value of each reporting unit with its carrying value. If the carrying value of the reporting unit exceeds its fair value, the second phase is then performed. The second phase of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. Fair value is determined using discounted cash flows, based on the income approach, as we believe that this approach best approximates the reporting unit’s fair value at this time. 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.
 
The material assumptions used for the income approach for 2009 were five years of projected net cash flows, a discount rate of 15.1% and a long-term growth rate of 1%. We considered historical rates and current market conditions when determining the discount and growth rates to use in our analysis.  If these estimates or their related assumptions change in the future, we may be required to record impairment charges for our goodwill.
 
Effective 2009, as required by ASC 820, "Fair Value Measurements and disclosures" (formerly SFAS 157, "Fair Value Measurements," we apply assumptions that market place participants would consider in determining the fair value of a reporting unit.
 
During 2007 and 2009, no impairment losses were identified.  In 2008, following our annual impairment test of goodwill, we determined that the fair value of our European subsidiary had decreased and that as a result, goodwill in the amount of $8.4 million established in connection with its acquisition in September 2007 had been impaired.  Following the 2008 annual impairment test, we also determined that the fair value of our U.S. subsidiary had significantly declined and that as a result, goodwill in the amount of $2.4 million attributable to the subsidiary had been impaired.
 
Impairment of long lived assets
 
Our long-lived assets and certain identifiable intangibles are reviewed for impairment in accordance with ASC 360 “Property, Plant, and Equipment” (formerly 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 2007 and 2009, no impairment losses were identified.  In 2008, we determined that $1.7 million of intangible assets attributable to customers of our European subsidiary had been impaired and as a result, we recorded an impairment charge of $1.7 million attributable to such intangible assets.  As of December 31, 2008, following such impairment, we had $2.5 million of intangible assets attributable to customers of our European subsidiary.  In addition, impairment of other intangible assets amounted to approximately $351,000 in 2008 attributable to the write-off of certain know-how.
 
 
- 29 -

 
 
Functional Currency and Financial Statements in U.S. Dollars
 
We have determined that our reporting currency is the U.S. dollar.  As of October 1, 2006, our functional currency changed from the U.S. dollar to NIS.  Translation adjustments resulting from translating our financial statements from NIS to the U.S. dollar are reported as a separate component in shareholders’ equity.  As of December 31, 2007, 2008 and 2009, our foreign currency translations totaled $2.6 million, $3.3 million and $3.9 million, respectively.
 
Accordingly, as of December 31, 2007, 2008 and 2009, we recorded accumulated foreign currency translation income (expense) of approximately $3.5 million, ($3.3 million) and $1.4 million, respectively, included in our balance sheets as part of “accumulated other comprehensive income.”  As of 2007, 2008 and 2009, foreign currency translation adjustments, net of $5.8 million, $2.5 million and $3.8 million, respectively, were included under “accumulated other comprehensive income.”
 
The first step in the translation process is to identify the functional currency for each entity included in the financial statements.  The accounts of each entity are then “re-measured” in its functional currency.  All transaction gains and losses from the re-measurement of monetary balance sheet items are reflected in the statement of operations as financial income or expenses, as appropriate.
 
After the re-measurement process is complete the financial statements are translated into the reporting currency, which is the U.S. dollar, using the current rate method.  Equity accounts are translated using historical exchange rates.  All other balance sheet accounts are translated using the exchange rates in effect at the balance sheet date.  Statement of operations amounts have been translated using the average exchange rate for the year. The resulting translation adjustments are reported as a component of shareholders’ equity in accumulated other comprehensive income (loss).
 
Concentrations of credit risk
 
Financial instruments that are potentially subject to concentrations of credit risk consist principally of cash and cash equivalents, short and long-term bank deposits, marketable securities, unbilled accounts receivable, trade receivables, long-term trade receivables and long-term loans.
 
Of our cash and cash equivalents, marketable securities and short-term and long-term bank deposits at December 31, 2009, $ 7.1million was invested in major Israeli and U.S. banks and approximately $6.6 million was invested in other banks, mainly with BBVA Bancomer, Deutsche Bank and RBC Royal Bank.  Cash and cash equivalents invested in the United States may be in excess of insured limits and are not insured in other jurisdictions.  Generally these deposits maybe redeemed upon demand and therefore bear low risk.
 
The short-term and long-term trade receivables and the unbilled accounts receivable of our company and our subsidiaries are derived from sales to large and solid organizations located mainly in Israel, the United States, Canada, Mexico and Europe.  We perform ongoing credit evaluations of our customers and to date have not experienced any material losses.  An allowance for doubtful accounts is determined with respect to those amounts that we have determined to be doubtful of collection and in accordance with an aging policy.  In certain circumstances, we may require letters of credit, other collateral or additional guarantees.  During the years ended December 31, 2007, 2008 and 2009, we recorded ($68,000), $755,000 (not including $468,000 recorded under discontinued operations) and ($153,000) of expenses (income) related to doubtful accounts, respectively.  The increase in expenses related to doubtful accounts in 2008 was primarily a result of the global economic downturn, which had an adverse influence on the liquidity of some of our clients.  As of December 31, 2009, our allowance for doubtful accounts amounted to $0.9 million.
 
 
- 30 -

 
 
A loan granted to a third party entity in connection with a possible future cooperation between us and the entity is secured by a personal guarantee of the beneficial owner of the entity.  However, in 2008 we evaluated the anticipated repayment of the loan and due to anticipated difficulties in implementation of the projects for which the loan was provided, we estimated that 50% of the loan will not be repaid and therefore, recorded a provision of $550,000 attributable to the loan.  In 2009, we further evaluated the anticipated repayment of this loan and due to the current global economic climate and the prospects of the projects for which the loan was provided, we determined that the loan will not be repaid in full and therefore recorded an additional provision of $319,000 attributable to this loan.  See Note 12h to the consolidated financial statements.
 
We have no significant off-balance sheet concentration of credit risks, such as foreign exchange contracts or foreign hedging arrangements, except derivative instruments, which are detailed below.
 
Derivative instruments
 
ASC 815, "Derivatives and Hedging" (formerly SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"), requires us to recognize all of our derivative instruments as either assets or liabilities in the statement of financial position at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged.
 
To protect against the change in the forecasted foreign currency cash flows of certain sale arrangements resulting from changes in the exchange rate, from time to time we have entered into forward contracts to hedge portions of our forecasted revenue and unbilled accounts receivable denominated in foreign currencies.  We have designated the forward instruments as cash flow hedges for accounting purposes.
 
For derivative instruments designated as cash flow hedges (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same line item associated with the forecasted transaction in the same period or periods during which the hedged transaction affects earnings.
 
We recorded $666,000, $291,000 and $0 as financial expenses related to forward contracts transactions in 2007, 2008 and 2009, respectively.
 
Fair value of financial instruments
 
Effective January 1, 2008, we adopted ASC 820, "Fair Value Measurements and Disclosures" (formerly SFAS 157), except as it applies to the nonfinancial assets and nonfinancial liabilities subject to ASC 820-10-50-8A (formerly FSP 157-2). We chose to adopt the delay of the effective date of ASC 820 for one year for goodwill and customers related intangible assets. Effective January 1, 2009, we adopted ASC 820 for nonfinancial assets and liabilities measured at fair value on a nonrecurring basis.
 
ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, ASC 820 establishes a three tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
 
Level 1
-
Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2
-
Includes other inputs that are directly or indirectly observable in the marketplace.

Level 3
-
Unobservable inputs which are supported by little or no market activity.
 
 
- 31 -

 

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
 
Due to the nature of our customers and products, our revenues are often generated from a relatively small number of large orders.  Consequently, individual orders from individual customers can represent a substantial portion of our revenues in any one period and significant orders by any customer during one period may not be followed by further orders from the same customer in subsequent periods.  Our revenues and operating results may, therefore, vary substantially from period to period.  Consequently, we do not believe that our revenues and operating results should necessarily be judged on a quarter-to-quarter comparative basis.
 
Results of Operations
 
The following table presents certain financial data expressed as a percentage of revenues for the periods indicated:
 
   
Year Ended December 31,
 
   
2007
   
2008
   
2009
 
Revenues
    100.0 %     100.0 %     100.0 %
Cost of revenues
    60.9       65.8       61.1  
Gross profit
    39.1       34.2       38.9  
Operating expenses:
                       
   Research and development, net
    8.5       9.7       8.8  
   Selling and marketing, net
    17.7       22.7       19.9  
   General and administrative
    9.7       17.9       15.4  
   Impairment of goodwill and other intangible assets
    --       4.9       -  
   Post employment and termination benefits
    1.4       4.5       -  
Operating income (loss)
    1.9       (25.5 )     (5.2 )
Financial expenses, net
    (3.3 )     (2.3 )     (2.9 )
(Loss) before income taxes
    (1.4 )     (27.8 )     (8.1 )
Income taxes
    0.4       5.4       1.6  
Income (loss) from continuing operations
    (1.8 )     (33.2 )     (9.7 )
Income (loss) from discontinued operations, net
    4.8       (23.9 )     7.7  
Net income (loss)
    3.0 %     (57.1 )%     (2.0 )%

Year Ended December 31, 2009 Compared with Year Ended December 31, 2008
 
Revenues.  Revenues decreased by 4.5% from $57.1 million for the year ended December 31, 2008 to $54.5 million for the year ended December 31, 2009.  Revenues from sales of perimeter systems decreased by 5.0% from $41.1 million in 2008 to $39.1 million in 2009, primarily due to a reduction in sales in Western Europe as a result of the global economic slowdown and reduced spending in such market.  Revenues from security turnkey projects decreased by 2.0% from $15.7 million in 2008 to $15.4 million in 2009, primarily due to a reduction in system installations by our Canadian subsidiary.  Other revenues (mostly service revenues and revenues derived from newly developed products) decreased by 85.7% from $252,000 in 2008 to $36,000 in 2009.  We anticipate that our revenues will increase in 2010 as a result of anticipated improvements in the global economy.
 
 
- 32 -

 
 
Cost of revenues. Cost of revenues decreased by 11.3% from $37.6 million for the year ended December 31, 2008 to $33.3 million for the year ended December 31, 2009.  The decrease was primarily due to a decrease in the U.S. dollar value of our non-U.S. dollar denominated expenses as a result of changes in foreign currency exchange rates in 2009, as well as a more favorable mix of products and projects.  Cost of revenues also benefited from the rationalization of costs and consolidation of the North American business into one unit during the second quarter of 2009.  In 2008 and 2009, our cost of revenues also includes a loss provision attributable to two strategic projects that had a negative gross margin, which loss was lower in 2009 compared to 2008.  Cost of revenues as a percentage of revenues decreased from 65.8% in 2008 to 61.1% in 2009, primarily due to a more favorable mix of products and projects in 2009 compared to 2008 and a decrease in inventory write-off from $2.0 million in 2008 to $1.4 million in 2009, despite the lower volume of sales in 2009 compared to 2008.  Our cost of revenues as a percentage of revenues was also positively impacted by the decline in the average NIS/U.S. dollar exchange rate in 2009, as the percentage of our cost of revenues denominated in NIS is higher than the percentage of revenues denominated in NIS.
 
Research and development expenses, net.  Research and development expenses, net decreased by 13.3% from $5.6 million for the year ended December 31, 2008, to $4.8 million for the year ended December 31, 2009.  The decrease in research and development expenses is primarily attributable to the decrease in the number of our U.S. subsidiary’s research and development staff due to the consolidation of the North American business into one unit and the decline in the average exchange rate of the NIS against the U.S. dollar in 2009, which reduced the U.S. dollar value of our NIS denominated expenses.  Research and development expenses, net amounted to 9.7% of revenues in 2008, compared to 8.8% in 2009.  We anticipate that our research and development expenses will not materially change in 2010.
 
Selling and marketing expenses, net.  Selling and marketing expenses, net decreased by 16.1% from $13.0 million for the year ended December 31, 2008 to $10.9 million for the year ended December 31, 2009.  The decrease in selling and marketing expenses in 2009 was primarily due to the decrease in the number of our U.S. subsidiary’s selling and marketing staff due to the consolidation of the North American business into one unit.  Sales commissions also decreased in 2009 due to a different mix of revenues in 2009 compared to 2008.  The decrease in selling and marketing expenses is also attributable to the decline in the average exchange rate of the NIS against the U.S. dollar in 2009, which reduced the U.S. dollar value of our NIS denominated expenses.  Selling and marketing expenses, net amounted to 22.7% and 19.9% of revenues in 2008 and 2009, respectively.
 
General and administrative expenses.  General and administrative expenses decreased from $10.2 million for the year ended December 31, 2008 to $8.4 million for the year ended December 31, 2009, a decrease of 18.3%.  The decrease in general and administrative expenses in 2009 was primarily due to an approximately $0.9 million decrease in the allowance for doubtful accounts in such period.  In 2008, we significantly increased the allowance for doubtful accounts as a result of the global economic downturn, which had an adverse affect on the liquidity of some of our customers.  In 2009, costs associated with our compliance with the requirements of the Sarbanes-Oxley Act of 2002 (including the implementation of internal controls) as well as other audit and legal expenses also decreased by approximately $1.0 million.  The decrease in general and administrative expenses is also attributable to the decline in the average exchange rate of the NIS against the U.S. dollar in 2009, which reduced the U.S. dollar value of our NIS denominated expenses. General and administrative expenses amounted to 17.9% of revenues in 2008 compared to 15.4% in 2009.
 
Impairment of goodwill and other intangible assets.  In  2008, following our annual impairment test of goodwill and long lived assets, we determined that the fair value of our European subsidiary acquired in September 2007 had decreased and that as a result, goodwill in the amount of $8.4 million had been impaired.  As a result, for the year ended December 31, 2008, we recorded a non-cash goodwill impairment charge of $8.4 million.  In addition, we determined that $1.7 million of intangible assets attributable to customers of our European subsidiary had been impaired and as a result, we recorded a $1.7 million impairment charge.  The goodwill and intangible assets impairment is classified as a discontinued operation.  Following the 2008 annual impairment test, we also determined that the fair value of our U.S. subsidiary had significantly declined and that as a result, goodwill in the amount of $2.4 million attributable to the U.S. subsidiary had been impaired.  Impairment of other intangible assets amounted to approximately $351,000 in 2008 attributable to the write-off of certain know-how.   We did not record any impairment of goodwill and other intangible assets for the year ended December 31, 2009.
 
 
- 33 -

 
 
Post employment and termination benefits.  For the year ended December 31, 2008, we recorded a post employment and termination benefits expense of $2.6 million, or 4.5% of our total revenues, related to benefits payable to our former president and chief executive officer as well as other senior employees in connection with their retirement from their respective offices.  We did not record any post employment and termination benefits expense in 2009.
 
Operating income (loss).  We had an operating loss of $14.6 million for the year ended December 31, 2008 compared to an operating loss of $2.9 million for the year ended December 31, 2009.  The operating losses of our three business segments for the years ended December 31, 2008 and 2009 are as follows:
 
   
Year Ended December 31,
 
   
2008
   
2009
 
   
(In thousands)
 
Perimeter products                                                                      
  $ (9,337 )   $ (1,070 )
Turnkey projects                                                                      
    (5,230 )     (1,812 )
Other                                                                      
    7       17  
Total                                                                
  $ (14,560 )   $ (2,865 )
 
The operating loss of our perimeter products segment decreased from $9.3 million for the year ended December 31, 2008 to $1.1 million for the year ended December 31, 2009, primarily as a result of a decrease in the U.S. dollar value of our non- U.S. dollar denominated expenses as a result of changes in foreign currency exchange rates in 2009, as well as a more favorable mix of products.  Cost of revenues and operating expenses had also decreased due to the rationalization of costs and consolidation of the North American business into one unit in during the second quarter of 2009.  The operating loss of our turnkey projects segment decreased from $5.2 million in the year ended December 31, 2008 to $1.8 million for the year ended December 31, 2009, primarily as a result of a more profitable mix of projects in 2009.  In 2008 and 2009, we also recorded a loss provision attributable to two strategic projects that had a negative gross margin, which loss was lower in 2009 compared to 2008.  Our operating results from other operations increased from an operating income of $7,000 for the year ended December 31, 2008 to operating income of $17,000 for the year ended December 31, 2009.
 
Financial expenses, net.  Financial expenses, net, increased from $1.3 million for the year ended December 31, 2008 to $1.6 million for the year ended December 31, 2009, an increase of 19.3%.  The increase was primarily due to an increase in foreign exchange losses, net that was offset in part by a gain from the sale of marketable securities compared to a loss from the sale of marketable securities in 2008.
 
Income taxes. We recorded an income tax expense of $0.9 million for the year ended December 31, 2009 compared to an income tax expense of $3.1 million for the year ended December 31, 2008, primarily as a result of valuation allowances recorded in 2009 with respect to our Canadian subsidiary’s investment tax credit asset, due to the uncertainty of its future realization.  In 2008, we recorded a full valuation allowance with respect to our carryforward tax losses due to the uncertainty of their future realization.
 
Year Ended December 31, 2008 Compared with Year Ended December 31, 2007
 
Revenues.  Revenues decreased by 8.9% from $62.7 million for the year ended December 31, 2007 to $57.1 million for the year ended December 31, 2008.  Revenues from sales of perimeter systems decreased by 6.1% from $43.8 million in 2007 to $41.1 million in 2008, primarily due to a reduction in sales in Israel and the United States as a result of the global economic slowdown and reduced spending in the U.S. market.  Revenues from security turnkey projects decreased by 14.9% from $18.5 million in 2007 to $15.7 million in 2008.  The decrease is primarily attributable to the cancellation and postponement of certain projects in Latin America.  Other revenues (mostly service revenues and revenues derived from newly developed products) decreased by 41% from $427,000 in 2007 to $252,000 in 2008.
 
 
- 34 -

 
 
Cost of revenues.  Cost of revenues decreased by 1.6% from $38.2 million for the year ended December 31, 2007 to $37.6 million for the year ended December 31, 2008, primarily due the decrease in revenues.  Cost of revenues as a percentage of revenues increased from 60.9% in 2007 to 65. 8% in 2008, primarily due to an inventory write-off of $2.0 million in 2008 following the cancellation of a project in Latin America and the write-off of certain products and equipment associated with our North American research and development and manufacturing activities, compared to an inventory write-off $646,000 in 2007.  Our cost of revenues as a percentage of revenues was also adversely impacted by the appreciation of the NIS against the U.S. dollar in 2008, which increased the U.S. dollar value of our NIS-denominated expenses and the higher percentage of cost of revenues denominated in NIS compared to U.S. dollars.  The gross margin of our other subsidiaries was adversely affected by a decrease in their revenues, while their cost of revenues decreased by a smaller percentage due to fixed costs.  In 2008, our cost of revenues also includes a loss provision attributable to two strategic projects that had a negative gross margin.
 
Research and development expenses, net.  Research and development expenses, net increased by 4.6% from $5.3 million for the year ended December 31, 2007, to $5.6 million for the year ended December 31, 2008.  The increase in research and development expenses is primarily attributable to the appreciation of the NIS against the U.S. dollar in 2008 that increased the U.S. dollar value of our NIS denominated expenses by 12.8%.  In addition, we invested additional funds in the development and further improvement of our products in 2008, mainly the Fortis integrated command and control system.  This increase was offset in part by a decrease in the number of our U.S. subsidiary’s research and development staff.  Research and development expenses, net amounted to 8.5% of revenues in 2007, compared to 9.7% in 2008.
 
Selling and marketing expenses, net.  Selling and marketing expenses, net increased by 17.0% from $11.1 million for the year ended December 31, 2007 to $13.0 million for the year ended December 31, 2008.  The increase in selling and marketing expenses in 2008 was primarily due to an increase in sales commissions due to a different mix of revenues recorded in 2008 compared to 2007.  The increase in selling and marketing expenses is also attributable to the appreciation of the NIS against the U.S. dollar in 2008, which increased the U.S. dollar value of our NIS denominated expenses by 12.8%.  Selling and marketing expenses, net amounted to 17.7% and 22.7% of revenues in 2007 and 2008, respectively.
 
General and administrative expenses.  General and administrative expenses increased from $6.1 million for the year ended December 31, 2007 to $10.2 million for the year ended December 31, 2008, an increase of 69.1%.  The increase in general and administrative expenses in 2008 was primarily due to an increase in our allowance for doubtful accounts of approximately $0.8 million as a result of the recent global economic downturn, which had an adverse affect on the liquidity of some of our customers.  In addition, we recorded a provision of $550,000 related to a loan granted to a third party following our determination that the full amount of the loan will not be repaid.  In 2008, costs associated with our compliance with the requirements of the Sarbanes-Oxley Act of 2002 (including the implementation of internal controls) and other audit expenses increased by approximately $600,000.  The increase in general and administrative expenses is also attributable to the appreciation of the NIS against the U.S. dollar in 2008, which increased the U.S. dollar value of our NIS denominated expenses by 12.8%.  General and administrative expenses amounted to 9.7% of revenues in 2007 compared to 17.9% in 2008.
 
Impairment of goodwill and other intangible assets.  In  2008, following our annual impairment test of goodwill and long lived assets, we determined that the fair value of our European subsidiary acquired in September 2007 had decreased and that as a result, goodwill in the amount of $8.4 million (including $3.3 million attributable to amounts prepaid on account of future earn-out payments) had been impaired.  As a result, for the year ended December 31, 2008, we recorded a non-cash goodwill impairment charge of $8.4 million.  In addition, we determined that $1.7 million of intangible assets attributable to customers of our European subsidiary had been impaired, and as a result, we recorded an impairment charge of $1.7 million.  The impairment of goodwill and intangible assets related to our European subsidiary were classified as a discontinued operation following the sale of our European subsidiary in December 2009.  Following the 2008 annual impairment test, we also determined that the fair value of our U.S. subsidiary had significantly declined and that as a result, goodwill in the amount of $2.4 million attributable to the U.S. subsidiary had been impaired.  Impairment of other intangible assets amounted to approximately $351,000 in 2008 attributable to the write-off of certain know-how.  We did not record any impairment of goodwill and other intangible assets for the year ended December 31, 2007.
 
 
- 35 -

 
 
Post employment and termination benefits.  For the year ended December 31, 2008, we recorded a post employment and termination benefits expense of $2.6 million, or 4.5% of our total revenues, related to benefits payable to our former president and chief executive officer and other senior employees in connection with their retirement from their respective offices.  For the year ended December 31, 2007, we recorded a post employment and termination benefits expense of $904,000, or 1.4% of our total revenues, related to benefits payable to the former chairman of our board of directors in connection with his retirement.
 
Operating income (loss).  We had operating income of $1.2 million for the year ended December 31, 2007 compared to an operating loss of $14.6 million for the year ended December 31, 2008.  The operating income (loss) of our three business segments for the years ended December 31, 2007 and 2008 are as follows:
 
   
Year Ended December 31,
 
   
2007
   
2008
 
   
(In thousands)
 
Perimeter products                                                                      
  $ 2,260     $ (9,337 )
Turnkey projects                                                                      
    (844     (5,230 )
Other                                                                      
    (193 )     7  
Eliminations                                                                      
    (28 )     -  
Total                                                                
  $ 1,195     $ (14,560 )
 
The operating income of our perimeter products segment decreased from $2.2 million for the year ended December 31, 2007 to an operating loss of $9.3 million for the year ended December 31, 2008, primarily as a result of the decrease in revenues of this segment, compared with a smaller decrease in cost of revenues due to the fixed-cost portion of our expenses.  The decrease in 2008 is also due to a $2.8 million impairment of goodwill and other intangible assets charge, an increase in doubtful debt expenses and the appreciation of the NIS against the U.S. dollar in 2008, which increased our NIS denominated expenses by 12.8%.  The operating loss of our turnkey projects segment increased from $844,000 in the year ended December 31, 2007 to an operating loss of $5.2 million in the year ended December 31, 2008, primarily as a result of a loss provision that we recorded in 2008 attributable to two strategic projects that had a negative gross margin as well as the appreciation of the NIS against the U.S. dollar in 2008 as described above.  Our operating results from other operations improved from an operating loss of $193,000 for the year ended December 31, 2007 to operating income of $7,000 for the year ended December 31, 2008.
 
Financial expenses, net.  Financial expenses, net, decreased from $2.1 million for the year ended December 31, 2007 to $1.3 million for the year ended December 31, 2008, a decrease of 36.2%.  The decrease was primarily due to a decrease in interest expenses, net, recorded on long and short-term debt, a decrease in forward contract losses and a decrease in foreign exchange losses compared with 2007.  The decrease was offset in part by a loss of $442,000 attributable to our investments in marketable securities.
 
Income taxes. We recorded an income tax expense of $276,000 for the year ended December 31, 2007 compared to an income tax expense of $3.1 million for the year ended December 31, 2008, primarily as a result of an increase in the valuation allowance that we recorded with respect to our carryforward tax losses in 2008.  In 2008, we recorded a full valuation allowance with respect to our carryforward tax losses compared with a partial allowance recorded in 2007, due to the uncertainty of their future realization.  The increase was offset in part by a decrease in tax expenses with respect to prior years.
 
Seasonality
 
Our operating results are characterized by a seasonal pattern, with a higher volume of revenues towards the end of the year and lower revenues in the first part of the year.  This pattern, which is expected to continue, is mainly due to two factors:
 
 
our customers are mainly budget-oriented organizations with lengthy decision processes, which tend to mature late in the year; and
 
 
- 36 -

 
 
 
due to harsh weather conditions in certain areas in which we operate during the first quarter of the calendar year, certain services are put on hold and consequently payments are delayed.
 
See also Item 3.D. “Key Information–Risk Factors.”  Our revenues are dependent on government procurement procedures and practices, and because we receive large product orders from a relatively small number of customers, our revenues and operating results are subject to substantial periodic variations.
 
Impact of Inflation and Currency Fluctuationson Results of Operations, Liabilities and Assets
 
We sell most of our products in North America, Europe and Israel.  Our financial results, which are reported in U.S. dollars, are affected by changes in foreign currency.  Our revenues are primarily denominated in U.S. dollars, Euros and NIS, while a portion of our expenses, primarily labor expenses, is incurred in NIS and Canadian Dollars.  Additionally, certain assets, especially trade receivables, as well as part of our liabilities are denominated in NIS.  As a result, fluctuations in rates of exchange between the U.S. dollar and non- U.S. dollar currencies may affect our operating results and financial condition.  The dollar cost of our operations in Israel may be adversely affected by the appreciation of the NIS against the U.S. dollar.  In addition, the value of our non-U.S. dollar revenues could be adversely affected by the depreciation of the U.S. dollar against such currencies.
 
The appreciation of the NIS in relation to the U.S. dollar has the effect of increasing the U.S. dollar value of any unlinked assets and the U.S. dollar amounts of any unlinked liabilities and increasing the U.S. dollar value of revenues and expenses denominated in other currencies.  Conversely, the depreciation of the NIS in relation to the U.S. dollar has the effect of reducing the U.S. dollar value of any of our liabilities which are payable in NIS (unless such costs or payables are linked to the U.S. dollar).  Such depreciation also has the effect of decreasing the U.S. dollar value of any asset that is denominated in NIS or receivables payable in NIS (unless such receivables are linked to the U.S. dollar).  In addition, the U.S. dollar value of revenues and expenses denominated in NIS would increase.  Because foreign currency exchange rates fluctuate continuously, exchange rate fluctuations may have an impact on our profitability and period-to-period comparisons of our results.  The effects of foreign currency re-measurements are reported in our consolidated financial statements in current operations.
 
The following table presents information about the rate of inflation in Israel, the rate of depreciation or appreciation of the NIS against the U.S. dollar, and the rate of inflation of Israel adjusted for the devaluation:
 
Year ended
 December 31,
 
Israeli inflation
 rate %
 
NIS depreciation
(appreciation)
rate %
 
Israeli inflation adjusted
for devaluation
(appreciation) %
             
2005
 
2.4
 
6.8
 
(4.4)
2006
 
(0.1)
 
(8.2)
 
8.1
2007
 
3.4
 
(9.0)
 
12.4
2008
 
3.8
 
(1.1)
 
4.9
2009
 
3.9
 
(0.7)
 
4.6

In addition, the U.S. dollar cost of our operations in Canada is influenced by the exchange rate between the U.S. dollar and the Canadian dollar.  In 2008, the Canadian dollar depreciated against the U.S. dollar by approximately 19.7%, while in 2007 and 2009 the Canadian dollar appreciated against the U.S. dollar by 18.4% and 16.6%, respectively.
 
We recorded foreign currency exchange losses, net of $792,000, $246,000 and $1,138.000 for the years ended December 31, 2007, 2008 and 2009, respectively.  We cannot assure you that in the future our results of operations may not be materially adversely affected by currency fluctuations.
 
 
- 37 -

 
 
To manage this risk, from time to time, we have entered into forward exchange contracts to hedge some of our foreign currency exposure relating to revenue and unbilled accounts receivable denominated in foreign currencies.  We have designated the forward instruments as cash flow hedges for accounting purposes.  For derivative instruments designated as cash flow hedges (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same line item associated with the forecasted transaction in the same period or periods during which the hedged transaction affects earnings.
 
We recorded $666,000, $291,000 and $0 of financial expenses attributable to forward exchange contracts transactions for the year ended December 31, 2007, 2008 and 2009, respectively.
 
Conditions in Israel
 
We are incorporated under the laws of, and our principal executive offices and manufacturing and research and development facilities are located in, the State of Israel.  See Item 3D “Key Information – Risk Factors – Risks Relating to Our Location in Israel” for a description of governmental, economic, fiscal, monetary and political policies or factors that have materially affected or could materially affect our operations.
 
Effective Corporate Tax Rate
 
Israeli companies are generally subject to income tax on their worldwide taxable income.  The applicable rate for 2009 was 26%.  The rate was reduced to 25% in 2010, and will be further reduced to 24% in 2011, 23% in 2012, 22% in 2013, 21% in 2014, 20% in 2015 and 18% in 2016 and thereafter.  However, certain of our manufacturing facilities have been granted “Approved Enterprise” status under the Law for the Encouragement of Capital Investments, 1959, as amended, commonly referred to as the Investments Law, and, consequently, are eligible, subject to compliance with specified requirements, for tax benefits beginning when such facilities first generate taxable income.  The tax benefits under the Investments Law are not available with respect to income derived from products manufactured outside of Israel.  We have derived, and expect to continue to derive, a substantial portion of our income from our Approved Enterprise facilities.  Subject to certain restrictions, we are entitled to a tax exemption in respect of income derived from our approved facilities for a period of two years, commencing in the first year in which such income is earned, and will be entitled to a reduced tax rate of 10% to 25% for an additional five to eight years depending on our compliance as a foreign investors’ company.  If we do not qualify as a foreign investors’ company, we will instead be entitled to a reduced rate of 25% for an additional five years, rather than eight years.  A foreign investors’ company is defined in the Investments Law as a company in which more than 25% of its shareholders are non-Israeli residents.  Pursuant to the Investments Law, a foreign investors’ company may enjoy benefits for a period of up to ten years (the actual length of the benefits period is graduated based on the percentage of foreign ownership).
 
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, 2009, we had a deferred tax asset of $272,000 attributable to our subsidiaries.  We had total estimated available carryforward tax losses of $18.8 million with respect to our operations in Israel to offset against future taxable income.  We have recorded a full valuation allowance over such carryforward tax losses due to the uncertainty of their future realization.  As of December 31, 2009, our subsidiaries had estimated total available carryforward tax losses of $9.5 million, which may be used as an offset against future taxable income for periods ranging between 12-20 years.  As of December 31, 2009, we recorded a full valuation allowance for our subsidiaries’ carryforward tax losses due to the uncertainty of their future realization.  Utilization of U.S. net operating losses may be subject to a substantial annual limitation due to the “change in ownership” provisions of the Internal Revenue Code of 1986 and similar state tax law provisions.  The annual limitation may result in the expiration of net operating losses before utilization.
 
 
- 38 -

 
 
Recently Issued Accounting Standards
 
In June 2009, the FASB issued an update to ASC 810, "Consolidation," which, among other things, (i) requires ongoing reassessments of whether an entity is the primary beneficiary of a variable interest entity and eliminates the quantitative approach previously required for determining the primary beneficiary of a variable interest entity; (ii) amends certain guidance for determining whether an entity is a variable interest entity; and (iii) requires enhanced disclosure that will provide users of financial statements with more transparent information about an entity’s involvement in a variable interest entity. The update is effective for interim and annual periods beginning after November 15, 2009. We do not expect the adoption of the update to have a material impact on our financial condition or results of operations.
 
In October 2009, the FASB issued an update to ASC 605-25, "Revenue Recognition – Multiple-Element Arrangements", that provides amendments to the criteria for separating consideration in multiple-deliverable arrangements to:
 
 
a)
Provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated and how the consideration should be allocated;
 
 
b)
Require an entity to allocate revenue in an arrangement using estimated selling prices ("ESP") of deliverables if a vendor does not have vendor-specific objective evidence of selling price ("VSOE") or third-party evidence of selling price ("TPE");
 
 
c)
Eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method; and
 
 
d)
Require expanded disclosures of qualitative and quantitative information regarding application of the multiple-deliverable revenue arrangement guidance.
 
The mandatory adoption is January 1, 2011, however, we may elect to early adopt the provisions prospectively to new or materially modified arrangements beginning January 1, 2010.  We are currently evaluating the resulting impact on our consolidated results of operations and financial condition.
 
B.    Liquidity and Capital Resources
 
General
 
From our inception until our initial public offering in March 1993, we financed our activities mainly through cash flow from operations and bank loans.  In March 1993, we received proceeds of $9.8 million from an initial public offering of 1,380,000 ordinary shares.  In February 1997, we raised $9.4 million from a follow-on offering of 2,085,000 ordinary shares and in April 2005, we raised an additional $14.9 million from a follow-on offering of 1,700,000 ordinary shares.  The proceeds from these offerings together with cash flow from operations and our credit facilities are our main sources of working capital.
 
The nature of the business and management of the European subsidiary that we purchased in 2007 required us to invest an inordinate amount of management time and effort, which we believed was not justified in light of the financial results of this subsidiary.  As a result, we determined to dispose of such subsidiary and in December 2009, we sold all of our interests in the European subsidiary. We received total proceeds of Euro 2.9 million (approximately $4.2 million) for the sale, including repayment in full of Euro 1.8 million (approximately $2.6 million) of loans granted by us to the European subsidiary.  In addition, Euro 620,000 (approximately $920,000) that we had deposited in escrow as a contingent purchase price in connection with our acquisition of the European subsidiary was released back to us in connection with our sale of the subsidiary.
 
 
- 39 -

 
 
Our working capital at December 31, 2008 and 2009, was $16.2 million and $ 20.5 million, respectively.  Cash and cash equivalents amounted to $16.8 million at December 31, 2008 compared to $11.9 million at December 31, 2009.  Short-term and long-term bank deposits, marketable securities, restricted bank deposits and escrow deposits amounted to $1.8 million at December 31, 2009 compared to $8.1 million at December 31, 2008.  Our cash and cash equivalents, short and long-term bank deposits and marketable securities are held mainly in U.S. dollars, Euros and NIS.
 
We expect to fund our short-term liquidity needs, including our obligations under our credit facilities, other contractual agreements and any other working capital requirements, from cash and cash equivalents, operating cash flows and our credit facilities.  We believe that our current cash and cash equivalents, including bank facilities, bank deposits, marketable securities and our expected cash flows from operations in 2010 will be sufficient to meet our cash requirements through 2010.  However, our liquidity could be negatively affected by a decrease in demand for our products, including the impact of potential reductions in customer purchases that may result from the current general economic climate.
 
Cash Flows
 
The following table summarizes our cash flows for the periods presented:
 
   
Year ended December 31,
   
   
2007
   
2008
   
2009
   
   
(in thousands)
   
Net cash provided by continuing operations
    286     $ 1,093     $ 5,651  
Net cash used in discontinued operations
    9,615       (378 )     120  
Net cash provided by operating activities
    9,901       715       5,771  
Net cash provided by (used in) investing activities
    (464 )     6,639       3,988  
Net cash provided by (used in)financing activities
    (5,477 )     2,665       (14,494 )
Effect of exchange rate changes on cash and cash equivalents
    337       (2,389 )     (231 )
Increase (decrease) in cash and cash equivalents
    4,297       7,630       (4,966 )
Cash and cash equivalents at the beginning of the year
    4,908       9,205       16,835  
Cash and cash equivalents at the end of the year
  $ 9,205       16,835       11,869  
 
Net cash provided by operating activities was approximately $5.8 million in the year ended December 31, 2009 compared to $0.7 million in the year ended December 31, 2008 and $9.9 million in the year ended December 31, 2007.  Net cash provided by operating activities in the year ended December 31, 2009 was primarily attributable to $1.2 million of depreciation and amortization expenses, a $0.3 million write-off of a long-term loan, $0.7 million of stock-based compensation expense, a decrease in trade receivables of $3.9 million, a decrease of $3.9 million in inventories, a decrease of $0.8 million in deferred income taxes, a $2.0  million decrease in other accounts receivable and prepaid expenses, an increase of $0.6 million in customer advances and a $0.4 million increase in accrued severance pay, which was offset in part by a decrease of $0.6 million in unbilled accounts receivable, a decrease of $0.9 million in trade payables, a decrease of $1.6 million in other account payable and accrued expenses and by a gain from discontinued operations of $4.2 million.  Net cash provided by operating activities in the year ended December 31, 2008 was primarily attributable to a loss from discontinued operations of $13.7 million, a $2.8 million non-cash goodwill and other intangible assets impairment charge, $1.2 million of depreciation and amortization expenses, a decrease in trade receivables of $10.6 million, a decrease in inventories of $2.0 million, an increase of $2.4 million in deferred income taxes, a decrease of $1.2 million in customer advances and a decrease of $1.7 million in accrued interest and exchange differences on marketable securities and short-term and long-term bank deposits.  This was offset in part by a decrease in trade payables of $1.7 million and an increase in unbilled accounts receivables of $1.2 million.  Net cash provided by operating activities in the year ended December 31, 2007 was primarily attributable to net cash provided by discontinued operations of $9.6 million, an increase of $3.1 million in trade receivables, an increase of $1.8 million in unbilled accounts receivable, an increase of $1.5 million in accrued interest on marketable securities and short-term and long-term bank deposits and depreciation and amortization expenses of $1.2 million.  This was offset in part by a decrease in customer advances of $0.7 million, a decrease in other accounts payable and accrued expenses of $1.7 million, an increase of $1.8 million in long-term trade receivables, an increase of $1.5 million of inventories and an increase of $0.8 million of deferred income taxes and a gain from discontinued operations of $3.0 million.
 
 
- 40 -

 
 
Net cash provided by investing activities was approximately $4.0 million for the year ended December 31, 2009 compared to approximately $6.6 million for the year ended December 31, 2008 and net cash used in investing activities of approximately $464,000 for the year ended December 2007.  In the year ended December 31, 2009, we received proceeds of $2.9 million from the sale of our European subsidiary, $1.3 million and $0.9 million from the sale of short-term bank deposits and marketable securities, respectively, and $0.9 million from the release of an escrow deposit, which amounts were offset in part by purchases of $2.0 million of property and equipment and $27,000 of know-how and patents.  In the year ended December 31, 2008, we received proceeds of $3.8 million from the sale of marketable securities and $11.1 million from the sale of short-term bank deposits, which were offset in part by purchases of $1.4 million and $2.0 million of short-term bank deposits and marketable securities, respectively.  In addition, we purchased $1.4 million of property, plant and equipment and $ 29,000 of know-how and patents.  In the year ended December 31, 2007, we acquired a European integration company for $4.1 million and purchased $5.5 million of marketable securities, $4.4 million of escrow deposits and $890,000 of property and equipment, which was offset by proceeds of $5.6 million from the sale of marketable securities and $5.7 million from the sale of short-term bank deposits.
 
In the year ended December 31, 2009, net cash used in financing activities was $14.5 million, primarily attributable to a decrease of $14.5 million in short-term bank credits and the repayment of a $0.8 million long-term bank loan, which was offset by net cash provided by discontinued operations of $0.8 million.  In the year ended December 31, 2008, net cash provided by financing activities was $2.7 million, primarily due to an increase of $7.0 million in short-term bank credits, which was offset by the repayment of $4.3 million of long-term bank loans.  In the year ended December 31, 2007, net cash used in financing activities was $5.5 million, primarily due to the repayment of $7.2 million of short-term bank credits and repayment of $796,000 of long-term bank loans, which was offset in part by net cash provided by discontinued operation of $2.5 million and from the receipt of $43,000 from the exercise of employee stock options.
 
We had capital expenditures of approximately $890,000, $1.4 million and $2.0 million in 2007, 2008 and 2009, respectively.  These capital expenditures were principally for computers, other machinery and equipment and for expanding and renovating our facilities.  We estimate that our capital expenditures for 2010 will total approximately $1.3 million, substantially all of which will relate to our perimeter security and project segments.  We expect to finance these expenditures primarily from our cash and cash equivalents, operating cash flows and our credit facilities.   However, the actual amount of our capital expenditures will depend on a variety of factors, including general economic conditions.
 
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, and Bank Hapoalim B.M totaling $23.7 million in the aggregate, of which $ 6 million are reserved exclusively for guarantees.  There are no restrictions as to our use of any of these credit lines.  In January 2010 we entered into a new credit arrangement with these banks and granted the banks a first degree fixed change over our registered but unissued share capital and goodwill and a first degree floating charge over all of our assets and rights.  Our loans under these credit lines are denominated in dollars and NIS.  As part of the restructuring of our credit arrangements we have concluded and repaid in full all of our credit facilities with Mizrahi Tefahot Bank B.M.  As of December 31, 2009, we are not under any obligation to maintain financial ratios or other terms in respect of our credit lines.
 
In addition, our subsidiaries currently have credit lines with Bank Leumi USA, Royal Bank of Canada, and Deutsche Bank, totaling $3.6 million in the aggregate.
 
Our Canadian subsidiary, which is primarily engaged in sale of perimeter products and turnkey projects, has undertaken to maintain general covenants and the following financial ratios and terms in respect of its outstanding credit lines: a quick ratio of not less than 1.25:1; a ratio of total liabilities to tangible net worth of not greater than 0.75:1; and tangible net worth of at least $9.0 million.  As of December 31, 2009, our Canadian subsidiary was in compliance with these ratios and terms.
 
 
- 41 -

 
 
 
As of December 31, 2009, we had approximately $10.7 million available under our credit lines.  In addition, our subsidiaries had approximately $1.4 million available under their credit lines.
 
As of December 31, 2009, our outstanding balances under our credit lines in Israel consisted of:
 
 
Short-term NIS-denominated loans of approximately $7.7 million, bearing interest at an average rate of 4.75%;
 
 
Long-term U.S. dollar-denominated loan of approximately $1.1 million, bearing interest at an average rate of 0.87%;
 
 
Long-term NIS-denominated loan of approximately $0.1 million, bearing interest at an average rate of 2.0%; and
 
 
Several bank performance and advance payment guarantees totaling approximately $4.6 million, at an annual cost of 0.6%-1.25%.
 
As of December 31, 2009, the outstanding balances under our subsidiaries’ credit lines consisted of:
 
 
Long-term loan of approximately $0.2 million, bearing interest at a fixed rate of 5.45%.  The loan is payable in 20 quarterly installments of $47,200, commencing February 2006.  We have guaranteed the full amount of this loan;
 
 
Long-term loan of approximately $1.0 million, bearing interest at a fixed rate of 5.45%.  The loan was due in one installment in November 2010. We prepaid the loan in January, 2010 ; and
 
 
Short-term Canadian dollar-denominated loan of approximately $0.5 million, bearing interest at an average rate of 2.75%.
 
C.    Research and Development, Patents and Licenses.
 
Government Grants
 
We participate in programs sponsored by the Israeli Government for the support of research and development activities.  In the past we have received royalty-bearing grants from the OCS for certain of our research and development projects for perimeter security products.  We did not obtain any grants from the OCS for the years ended December 31, 2007, 2008 and 2009.  We are obligated to pay royalties to the OCS amounting to 3%-4.5% of revenues derived from sales of the products funded with these grants and ancillary services, up to 100% of the grants received, linked to the U.S. dollar.  All grants received after January 1, 1999 also bear interest equal to the 12 month LIBOR rate.  The obligation to pay these royalties is contingent on actual sales of the products, and in the absence of such sales no payment is required.
 
For the years ended December 31, 2007, 2008 and 2009, we paid the OCS royalties in the amount of $143,000, $125,000 and $172,000, respectively.  These royalties related to sales of perimeter security products and management security systems.  As of December 31, 2009, we had a contingent obligation to pay royalties to the OCS in the amount of approximately $1.2 million upon the successful sale of perimeter security products developed using research and development programs sponsored by the OCS.
 
The Israeli Government, through the Fund for the Encouragement of Marketing Activities, or the Fund, awarded us grants for overseas marketing expenses during the years 2001 to 2003.  To date, we have received an aggregate of $253,000 in grants from the Fund.  Under the terms of the grants, we are obligated to pay certain royalties on the increase in export sales from the year the grant was received and the following year, up to the amount of the grants we received.  During the years ended December 31, 2007, 2008 and 2009, we did not pay any royalties.  As of December 31, 2009, we had a remaining contingent obligation to the Fund of $82,000.
 
 
- 42 -

 
 
Investment Tax Credit
 
Our Canadian subsidiary is eligible for investment tax credits for its research and development activities and for certain current and capital expenditures.  For the years ended December 31, 2007, 2008 and 2009, our Canadian subsidiary recognized $160,000, $234,000 and $259,000, respectively, of investment tax credits.
 
In addition, as of December 31, 2009, our Canadian and U.S. subsidiaries had available investment tax credits of approximately $1.1 million to reduce future federal and provincial income taxes payable.  These credits will expire in 2025 through 2029. As of December 31, 2009, our subsidiaries made a full valuation allowance in respect of such investment tax credits.
 
D.    Trend Information.
 
In recent years consolidation in the defense industry has affected competition, resulting in an increase in the relative size and resources of our competitors.  We adapt to evolving market conditions by adjusting our technology and business strategy.  We also anticipate increased competition in defense markets due to declining defense budgets in certain countries.  While the recent global financial developments have reduced defense spending, we believe in our ability to compete on the basis of our technology and systems development capabilities that offer customers tailored solutions for their technological and operational needs.
 
We believe that increased security concerns have spurred expenditure in the critical infrastructure and city protection markets as well as in the area of security as an integral part of building management systems.  We also believe that we will benefit from the need of system integrators and manufacturers to bridge the gap between security and IT requirements and to interface with different systems in a scalable, reliable and secure manner.
 
We cannot assure you that the MOD, IDF or any of our other major customers will maintain their volume of business with us or that, if such volume is reduced, other customers of similar volume will replace the lost business.  The loss of one or more of these existing customers without replacement by a customer or customers of similar volume would have a material adverse effect on our financial results.
 
As of December 31, 2009, our backlog amounted to approximately $17.8 million, of which approximately $15.1 million is expected to be delivered by the end of 2010 and $2.7 million is expected to be delivered by the end of 2011.  As of March 31, 2010, our backlog amounted to approximately $29.7 million, of which approximately $21.6 million is expected to be delivered by the end of 2010 and $8.1 million is expected to be delivered by the end of 2011.
 
See also discussion in Item 5A. “Operating and Financial Review and Prospects - Operating Results.”
 
E.     Off-Balance Sheet Arrangements.
 
We are not a party to any material off-balance sheet arrangements.  In addition, we have no unconsolidated special purpose financing or partnership entities that are likely to create material contingent obligations.
 
F.    Tabular Disclosure of Contractual Obligations.
 
The following table summarizes our minimum contractual obligations and commercial commitments as of December 31, 2009 and the effect we expect them to have on our liquidity and cash flow in future periods.
 
 
- 43 -

 
 
   
Payments due by period
 
Contractual Obligations
 
Total
   
Less than 1 year
   
1-2 years
   
3-5 years
   
More than 5 years
 
   
(in thousands)
 
Long-term bank debt obligations
  $ 2,372     $ 1,824     $ 548     $ -     $ -  
Operating lease obligations
  $ 3,182     $ 807     $ 778     $ 234     $ 1,363  
Purchase obligations
                                       
Other long-term liabilities reflected on our balance sheet under U.S. GAAP
  $ 3,562       -       -       -     $ 3,562  
Total
  $ 9,116     $ 2,631     $ 1,326     $ 234     $ 4,925  
 
In addition, we have guaranteed advance payments and the performance of our work to certain of our customers (usually government entities).  Such guarantees are required by contract for our performance during the installation and operational period of projects throughout Israel and the rest of the world.  The guarantees for installation typically expire soon after certain milestones are met and guarantees for operations typically expire proportionally over the contract period.  The maximum potential amount of future payments we could be required to make under our guarantees at December 31, 2009 and March 31, 2010 were $4.6 million and $4.1million, respectively.  We have not recorded any liability for such amounts as we expect that our performance will be acceptable and to date, no performance bank guarantees have been exercised against us except with respect to our dispute relating to a project in Eastern Europe.  See Item 8.A - “Consolidated Statements and Other Financial Information-Legal Proceedings.”
 
Directors, Senior Management and Employees
 
A.    Directors and Senior Management.
 
Set forth below are the name, age, principal position and a biographical description of each of our directors and executive officers:
 
Name
 
Age
 
Position
         
Jacob Perry
 
66
 
Chairman of the Board of Directors
Eitan Livneh
 
56
 
President and Chief Executive Officer
Hagai Katz
 
59
 
General Manager, Israel Division, Senior Vice President - Marketing
Asaf Even-Ezra
 
44
 
Senior Vice President –Worldwide Sales
Yehonatan Ben-Hamozeg
 
51
 
Senior Vice President – Product Development and Projects
Ilan Ovadia
 
43
 
Senior Vice President – Finance, Chief Financial Officer and Secretary
Jacob Even-Ezra (1)(3)
 
79
 
Director
Nathan Kirsh
 
78
 
Director
Shaul Kobrinsky(1)(2)(3)
 
58
 
External Director
Zeev Livne (3)
 
65
 
Director
Jacob Nuss(2)
 
62
 
Director
Barry Stiefel
 
60
 
Director
Anat Winner (1)(2)
 
51
 
External Director
 

(1)  Member of our Investment Committee.
(2)  Member of our Audit Committee.
(3)  Member of our Mergers and Acquisitions Committee.

Messrs. Perry, Even-Ezra, Kirsh, Livne, Nuss and Steifel will serve as directors until our 2010 Annual General Meeting of Shareholders.  Mr. Kobrinsky and Ms. Winner will serve as external directors pursuant to the provisions of the Israeli Companies Law for three-year terms until our 2010 annual general meeting of shareholders.
 
 
- 44 -

 
 
Mr. Jacob Even-Ezra is the father of Mr. Asaf Even-Ezra.  There are no other family relationships among our directors and senior executives.
 
Jacob Perry has served as the chairman of our board of directors since January 2008.  Prior thereto, Mr. Perry served as the deputy chairman of our board of directors from 2006 and has served as a director of our company since December 2002.  From 1995 to December 2002, Mr. Perry served as the President and chief executive of Cellcom Israel Ltd., one of Israel’s leading cellular phone operators.  Mr. Perry served 29 years with the Israeli General Security Service, and served as its director from 1988 until 1995.  Mr. Perry has also served as a coordinator to the Israeli Prime Minister on the subject of prisoners of war and missing persons.  He was a board member of El-Al Israel Airlines and a member of the management of many public organizations.  Mr. Perry is also a chairman of the board of directors of Mizrahi Tefahot Bank B.M. Mr. Perry serves as a director of Tamarind Technologies, and New Kopel, an Israeli vehicle and car service group.  Mr. Perry holds a B.A. degree in Oriental Studies and History of the Jewish People from Tel-Aviv University and completed the Advanced Management Program at Harvard Business School.
 
Eitan Livneh has served as our president and chief executive officer since August 2009.  Prior to joining our company and from February 2007, Mr. Livneh served as President and chief executive officer of Tadiran Telecom Ltd., a leading Israel-based telecommunications company.  Between January 2000 and February 2007, Mr. Livneh was the chief executive officer of Elgo Irrigation Ltd., and prior to that, a general manager at Packer Plada Group Ltd.  From 1989 to 1994, Mr. Livneh was vice president, marketing and assistant to the President of Elisra Electronic Systems Ltd.  Mr. Livneh holds a B.A. degree in Economics and Business Administration from Bar-Ilan University, Tel Aviv, Israel
 
Hagai Katz has served as our general manager, Israel division and corporate vice president - marketing and products since January 2009.  Prior to joining our company and from 2007, Mr. Katz served as the chief executive officer of Transtech Airport Solutions Ltd.  From 2004 to 2007 Mr. Katz  served as the chief executive officer of UAV Tactical Systems Ltd., based in the United Kingdom.  Prior to that, Mr. Katz served in a number of leading technology companies, including NICE Systems (NASDAQ: NICE), where he served in various senior positions including chief operating officer and President of its video analytics division.  Mr. Katz holds a B.A. degree in Computer Sciences from the Technion - Israel Institute of Technology and an M.Sc. degree in Business Engineering from the Ben-Gurion University of the Negev.
 
Asaf Even-Ezra has served as our senior vice president – worldwide sales since December 2008  Mr. Even-Ezra joined our company in 1995 and served as our vice president - Israel and West European sales and marketing from 1998 to July 2007 and as our executive vice president - sales and marketing from July 2007 to December 2008.  Mr. Even-Ezra holds a B.A. degree and an M.B.A. degree in Business, both from the New York Institute of Technology.
 
Yehonatan Ben-Hamozeg has served as our senior vice president – product development and projects since January 2009.  Mr. Ben Hamozeg joined our company in December 2002 and served as our vice president - integrated systems development until January 2009.  Before joining our company, Mr. Ben Hamozeg served in the IDF for 24 years and retired as a Colonel.  Mr. Ben Hamozeg holds a B.A. degree in Economics and Statistics and an M.B.A. degree in Business Management, both from Haifa University.
 
Ilan Ovadia joined our company in December 2009 as our chief financial officer and secretary and has served as our senior vice president - finance, chief financial officer and secretary since February 2010.  Prior to joining our company, Mr. Ovadia served for four years as executive vice president, chief financial officer and vice president of human resources of Haifa Chemicals Ltd.  From 2000 to 2004, Mr. Ovadia served as the chief financial officer and vice president of Operations of Elgo Irrigation Ltd.  Mr. Ovadia also served as financial manager of Shapir Marine and Civil Engineering Ltd., an infrastructure and contracting company, and as the financial manager of Hapach Metal Industries Ltd., an Israeli public company.  Mr. Ovadia is qualified as a Chartered Public Accountant (Israel) and served as a senior portfolio coordinator at PriceWaterhouseCoopers.  Mr. Ovadia holds a B.A. degree in Accounting and Economics and an M.B.A. degree (magna cum laude), both from the Hebrew University of Jerusalem.
 
 
- 45 -

 
 
Jacob Even-Ezra has served as a director since 1984 and is a member of our investment committee.  From 1984 until December 2007, Mr. Even-Ezra served as the chairman of our board of directors.  From 1984 until 2006, Mr. Even-Ezra also served as our chief executive officer, and from 1987 until 1990 he also served as our president.  Mr. Even-Ezra is currently a member of the Executive Council and the Management Committee of Tel Aviv University.  From 1985 to 1988, Mr. Even-Ezra also served as the chairman of the Israel Export Institute.  Mr. Even-Ezra holds a B.Sc. degree in Electrical Engineering from the Technion - Israel Institute of Technology.
 
Nathan Kirsh has served as a director since 1984.  Mr. Kirsh is an independent investor.  Mr. Kirsh serves as one of the trustees of the Eurona Foundation, the beneficial owner of 100% of the ordinary shares of our company that are held by Mira Mag Inc.  Mr. Kirsh holds a B.S. degree in Commerce from the University of Witwatersrand, Johannesburg, South Africa.
 
Barry Stiefel, has served as a director since November 2008.  Mr. Stiefel served as a director of one of our UK subsidiaries from 1986 to 1990.  Since 2001, Mr. Stiefel has served as a consultant for a variety of companies, including Premedia Limited and its subsidiaries.  From 1990 until 2001, Mr. Stiefel was the chief executive officer of Meridian VAT Reclaim Group, which he founded.  Between 1985 and 1990, Mr. Stiefel served as consultant in the field of trade finance.  From 1981 to 1985, Mr. Stiefel served as finance director of Fisher Brothers Lumber Company Limited, a South African company.  Mr. Stiefel holds a B.Sc degree in Mathematics and Chemistry and a B.A. degree in Accounting, both from the University of Witwatersrand in South Africa.  Mr. Stiefel is a chartered accountant in South Africa, and is registered as an auditor (not in public practice) in the United Kingdom.
 
Zeev Livne has served as a director since July 2004.  Mr. Livne has served as the chairman of Livne Strategic Consultants Ltd. since 2001.  Prior to that, Mr. Livne served in the IDF for 39 years and retired as a Major General.  During his long military career with the IDF, Mr. Livne served as the Defense Attaché to the United States and Canada from 1997 to 2001, Military Secretary to the Prime Minister of Israel from 1996 to 1997 and Ground Force Commander from 1994 to 1996.  From 1992 to 1994 Mr. Livne established the IDF Home Front Command and served as its first Commander.  Mr. Livne serves on the board of directors of PAZKAR Ltd., a private Israeli company.  Mr. Livne holds a B.A. degree in History from Tel Aviv University and an M.A. degree in Geography from the University of Haifa.
 
Shaul Kobrinsky has served as an external director since July 2004 and is the chairman of our audit committee and a member of our investment committee.  Mr. Kobrinsky has served as the President and Chief Executive Officer of Urdan Industries Ltd., an investment and holding company since 1997.  Since 2003, Mr. Kobrinsky has served as senior managing director of Alagem Capital Group a Beverly Hills based investment group.  From 1989 to 1997, Mr. Kobrinsky served as chief executive officer of Cargal Ltd., an Israeli company that manufactures corrugates.  Prior to that and from 1984, Mr. Kobrinsky served as deputy managing director of Clal Industries Ltd., a holding and investment company.  Mr. Kobrinsky serves as an external director and a member of the audit committee of Scope Metal Trading Ltd., a public company traded on the Tel Aviv Stock Exchange.  Mr. Kobrinsky holds a B.A. degree in Economics from Tel Aviv University.  Mr. Kobrinsky is a member of the Antitrust Court of the State of Israel.
 
Jacob Nuss has served as a director since 1993 and is a member of our audit committee.  Mr. Nuss has served as the vice president - internal auditing of IAI since 2004, and served as IAI’s deputy vice president - internal auditing from 1999 to 2003.  From 1993 to 1999, Mr. Nuss served as the director of finance of IAI’s electronics group.  From 1991 to 1993, Mr. Nuss served as assistant to the chairman of the board of directors of IAI.  Mr. Nuss has served in various financial management capacities at IAI since 1975.  Mr. Nuss holds a B.A. degree in Economics and Business Management from Bar Ilan University and an M.B.A. degree in Business from Tel Aviv University.  Mr. Nuss holds a certificate in internal auditing.
 
Anat Winner has served as an external director since July 2004 and is a member of our audit committee and our investment committee.  Ms. Winner has been self employed as a business advisor since July 2003.  Ms. Winner also serves as a director of Internet Gold-Golden Lines Ltd. (NASDAQ: IGLD) and B Communications Ltd. (NASDAQ: BCOM).  From October 2001 to May 2003, Ms. Winner served as chief executive officer and chief financial officer of Israel News Ltd.  From 1999 to October 2001, Ms. Winner served as chief financial officer of DBS Satellite Services (1998) Ltd. (YES), an Israeli company that is engaged in setting up and operating broadcasting satellite television television systems.  From 1995 to 1998, Ms. Winner served as chief financial officer of Eurocom Cellular Communications Ltd., an Israeli company that is engaged in importing and marketing cellular phones.  From 1989 to 1995, Ms. Winner served in various finance positions, including chief financial officer of the Seed Company (1939) Ltd.  From 1984 to 1989 Ms. Winner served as a senior audit manager with Ronel Stetner & Co., certified public accountants in Israel.  Ms. Winner holds a B.A. degree in Accounting and Economics from Haifa University and has been a certified public accountant in Israel since 1987.
 
 
- 46 -

 
 
B.    Compensation
 
During the year ended December 31, 2009, our executive officers and directors as a group (consisting of 19 persons, of whom 6 retired during 2009 and subsequent to December 31, 2009) earned aggregate compensation of approximately $2.1 million for their services as officers and directors, of which $1.9 million was paid in 2009.  As of December 31, 2009, the aggregate amount set aside or accrued for pension, retirement, recreation payments and vacation or similar benefits for our directors and executive officers was approximately $1.4 million.  In addition, we have provided automobiles to our executive officers at our expense, and Mr. Jacob Even-Ezra, a director, is reimbursed for the costs of a chauffeur.
 
Since January 1, 2008, we pay Mr. Perry, the chairman of our board of directors, a monthly payment of NIS 50,000 (approximately $13,245), which amount is linked to the Israeli consumer price index and subject to a 10% annual increase, and he is also entitled to an annual bonus based on our performance and customary social benefits.
 
We pay our external directors and our independent directors (directors who are not employees of our company or officers or employees of any entity that beneficially owns 5% or more of our ordinary shares) an annual fee of NIS 59,100 (approximately $15,656) and a fee of NIS 2,200 (approximately $583) for each board or committee meeting that they attend.  Such amounts are linked to the Israeli consumer price index and are updated on a semi-annual basis and accordingly, were adjusted to reflect changes in the Israeli consumer price index in February and August 2009 and February 2010.
 
As of December 31, 2009, our directors and executive officers as a group, then consisting of 15 persons, held options to purchase an aggregate of 966,000 ordinary shares, having exercise prices ranging from $3.48 to $8.56.  Generally, the options vest over a two to four years period.  Of such options, options to purchase 18,000 ordinary shares expire in December 2010; options to purchase 83,336 ordinary shares expire in August 2014; options to purchase 24,500, 19,250, 19,250 and 7,000 ordinary shares expire in January, 2014, 2015, 2016 and 2017 respectively; options to purchase 300,000 ordinary shares expire in three equal portions of 100,000 ordinary shares each in August 2013, 2014 and 2015; options to purchase 24,500, 24,500, 48,500, 58,500 and 22,000 ordinary shares expire in April, 2013, 2014, 2015, 2016 and 2017 respectively; options to purchase 34,000, 58,000, and 58,000 ordinary shares expire in December, 2013, 2014 and 2015 respectively; options to purchase 20,833 expire in each of February 2014, November 2014, February 2015, May 2015, August 2015, November 2015, February 2016, May 2016 and August 2016, or earlier upon termination of employment as an executive officer or service as a director of our company.  All of such options were granted under our 2003 Stock Option Plan.  See this Item 6E. “Directors, Senior Management and Employees - Share Ownership - Stock Option Plans.”
 
We follow Israeli law and practice instead of the requirements of the NASDAQ Listing Rules regarding the compensation of our chief executive office and other executive officers.  See Item 16G. “Corporate Governance.”
 
C.    Board Practices
 
Introduction
 
According to the Israeli Companies Law and our Articles of Association, the management of our business is vested in our board of directors.  The board of directors may exercise all powers and may take all actions that are not specifically granted to our shareholders.  Our executive officers are responsible for our day-to-day management.  The executive officers have individual responsibilities established by our chief executive officer and board of directors.  Executive officers are appointed by and serve at the discretion of the board of directors, subject to any applicable agreements.
 
 
- 47 -

 
 
Election of Directors
 
Our articles of association provide for a board of directors of not less than three and not more than 11 members, as may be determined from time to time at our annual general meeting.  Our board of directors is currently composed of eight directors.
 
Our directors (except the external directors, as detailed below), are elected by our shareholders at our annual general meeting and hold office until the next annual general meeting.  All the members of our board of directors (except the external directors), may be reelected upon completion of their term of office.  Our annual general meetings of shareholders are held at least once every calendar year, but not more than 15 months after the last preceding annual general meeting.  In the intervals between our annual general meetings of shareholders, the board of directors may from time to time appoint a new director to fill a casual vacancy or to add to their number, and any director so appointed will remain in office until our next annual general meeting of shareholders and may be re-elected.
 
Under the Israeli Companies Law, our board of directors is required to determine the minimum number of directors who must have “accounting and financial expertise,” as such term is defined in regulations promulgated under the Israeli Companies Law.  Our board of directors has determined that at least one director must have “accounting and financial expertise.”  Our board of directors has further determined that Ms. Anat Winner has the requisite “accounting and financial expertise.”
 
We do not follow the requirements of the NASDAQ Listing Rules regarding the nomination process of directors, and instead, we follow Israeli law and practice, in accordance with which our directors are recommended by our board of directors for election by our shareholders.  See Item 16G. “Corporate Governance.”
 
External and Independent Directors
 
External directors.  The Israeli Companies Law requires Israeli companies with shares that have been offered to the public in or outside of Israel to appoint at least two external directors.  The Israeli Companies Law provides that a person may not be appointed as an external director if the person, or the person’s relative, partner, employer or an entity under that person’s control, has or had during the two years preceding the date of appointment any affiliation with the company, or any entity controlling, controlled by or under common control with the company.  The term “relative” means a spouse, sibling, parent, grandparent, child or child of spouse or spouse of any of the above.  In general, the term “affiliation” includes an employment relationship, a business or professional relationship maintained on a regular basis, control and service as an office holder.  Regulations promulgated under the Israeli Companies Law include certain additional relationships that would not be deemed an “affiliation” with a company for the purpose of service as an external director. In addition, no person may serve as an external director if the person’s position or other activities create, or may create, a conflict of interest with the person’s responsibilities as director or may otherwise interfere with the person’s ability to serve as director.  If, at the time an external director is appointed, all current members of the board of directors are of the same gender, then that external director must be of the other gender.  A director of one company may not be appointed as an external director of another company if a director of the other company is acting as an external director of the first company at such time.
 
At least one of the elected external directors must have “accounting and financial expertise” and any other external director must have “accounting and financial expertise” or “professional qualification,” as such terms are defined by regulations promulgated under the Israeli Companies Law.  However, Israeli companies listed on certain stock exchanges outside Israel, including The NASDAQ Global Market, such as our company, are not required to appoint an external director with “accounting and financial expertise” if a director with accounting and financial expertise who qualifies as an independent director for purposes of audit committee membership under the laws of the foreign country in which the stock exchange is located serves on its board of directors.  All of the external directors of such a company must have “professional qualification.”
 
 
- 48 -

 
 
The external directors are elected by shareholders at a general meeting.  The shareholders voting in favor of their election must include at least one-third of the shares of the non-controlling shareholders of the company who voted on the matter.  This minority approval requirement need not be met if the total shareholdings of those non-controlling shareholders who vote against their election represent 1% or less of all of the voting rights in the company.
 
In general, external directors serve for a three-year term and may be reelected to one additional three-year term.  However, Israeli companies listed on certain stock exchanges outside Israel, including The NASDAQ Global Market, such as our company, may appoint an external director for additional terms of not more than three years subject to certain conditions.  Such conditions include the determination by the audit committee and board of directors, that in view of the director’s professional expertise and special contribution to the company’s board of directors and its committees, the appointment of the external director for an additional term is in the best interest of the company.  External directors can be removed from office only by the same special percentage of shareholders that can elect them, or by a court, and then only if the external directors cease to meet the statutory qualifications with respect to their appointment or if they violate their fiduciary duty to the company.
 
Each committee of the board of directors that is authorized to exercise powers vested in the board of directors must include at least one external director and the audit committee must include all the external directors.  An external director is entitled to compensation as provided in regulations adopted under the Israeli Companies Law and is otherwise prohibited from receiving any other compensation, directly or indirectly, in connection with such service.
 
Independent Directors.  In general, NASDAQ Listing Rules require that the board of directors of a NASDAQ-listed company have a majority of independent directors and that its audit committee have at least three members and be comprised only of independent directors, each of whom satisfies the respective “independence” requirements of NASDAQ and the Securities and Exchange Commission.  However, foreign private issuers, such as our company, may follow certain home country corporate governance practices instead of certain requirements of the NASDAQ Listing Rules.  On June 30, 2006, we provided NASDAQ with a notice of non-compliance with respect to the requirement to maintain a majority of independent directors, as defined under NASDAQ Listing Rules.  Instead, under Israeli law and practice we are required to appoint at least two external directors, within the meaning of the Israeli Companies Law, to our board of directors.  However, despite such notification of non-compliance, we maintain a majority of independent directors.  In addition, in accordance with the rules of the Securities and Exchange Commission and NASDAQ, we have the mandated three independent directors, as defined by the rules of the Securities and Exchange Commission and NASDAQ, on our audit committee.
 
Pursuant to a recent amendment to the Israeli Companies Law, an Israeli company whose shares are publicly traded may elect to adopt a provision in its articles of association pursuant to which a specified part of its board of directors will be comprised of individuals complying with certain independence criteria prescribed by the Israeli Companies Law.  Such independent directors shall have all the qualifications of an outside director; however, he or she is not subject to the “accounting and financial expertise” or “professional qualification” requirements and may be elected and removed from office by a simple majority vote of the general shareholders meeting.  We have not included such a provision in our articles of association.
 
Our board of directors has determined that Ms. Winner and Mr. Kobrinsky qualify both as independent directors under the requirements of the Securities and Exchange Commission and NASDAQ and as external directors under the requirements of the Israeli Companies Law.  Our board of directors has further determined that Messrs. Nuss and Livne qualify as independent directors under the requirements of the Securities and Exchange Commission and NASDAQ.
 
 
- 49 -

 
 
Audit Committee
 
Under the Israeli Companies Law, the board of directors of any public company must establish an audit committee.  The audit committee must consist of at least three directors and must include all of the external directors.  The audit committee may not include the chairman of the board of directors; any director employed by the company or providing services to the company on an ongoing basis; or a controlling shareholder or any of the controlling shareholder’s relatives.  The responsibilities of the audit committee include identifying irregularities in the management of the company’s business and approving related party transactions as required by law.  Under Israeli law, an audit committee may not approve an action or a transaction with a controlling shareholder, or with an office holder, unless at the time of approval two external directors are serving as members of the audit committee and at least one of the external directors was present at the meeting in which an approval was granted.
 
In addition, the NASDAQ Listing Rules require us to establish an audit committee comprised of at least three members, all of whom must be independent directors, each of whom is financially literate and satisfies the respective ‘‘independence’’ requirements of the Securities and Exchange Commission and NASDAQ and one of whom has accounting or related financial management expertise at senior levels within a company.
 
Our audit committee consists of three board members who satisfy the respective “independence” requirements of the Securities and Exchange Commission, NASDAQ and Israeli law for audit committee members.  Our audit committee is currently composed of Messrs. Shaul Kobrinsky and Jacob Nuss and Ms. Anat Winner.  The audit committee meets at least once each quarter.  Our audit committee charter is available on our website at www.magal-s3.com.
 
Investment Committee
 
Our board of directors has established an investment committee, which is responsible for the investment of our cash and our hedging transactions.  The investment committee is currently composed of Messrs. Jacob Even-Ezra and Shaul Kobrinsky and Ms. Winner.
 
Mergers and Acquisitions Committee
 
Our board of directors has established a mergers and acquisitions committee, which is responsible for the examination and review of merger and acquisition opportunities and making recommendations to the board of directors with respect to such opportunities.  The mergers and acquisitions committee is currently composed of Messrs. Jacob Even-Ezra, Zeev Livne and Shaul Kobrinsky.
 
Internal Auditor
 
Under the Israeli Companies Law, the board of directors of a public company must appoint an internal auditor nominated by the audit committee.  The role of the internal auditor is to examine whether the company’s actions comply with the law, integrity and orderly business practice.  Under the Israeli Companies Law, the internal auditor may not be an interested party, an office holder, or an affiliate, or a relative of an interested party, office holder or affiliate, nor may the internal auditor be the company’s independent accountant or its representative.  Mr. Daniel Shapira, Certified Public Accountant (Israel) is our internal auditor.
 
Directors’ Service Contracts
 
There are no arrangements or understandings between us and any of our subsidiaries, on the one hand, and any of our directors, on the other hand, providing for benefits upon termination of their employment or service as directors of our company or any of our subsidiaries.
 
 
- 50 -

 
 
Approval of Related Party Transactions Under Israeli Law
 
Fiduciary Duties of Office Holders
 
The Israeli Companies Law codifies the fiduciary duties that “office holders,” including directors and executive officers, owe to a company. An “office holder” is defined in the Israeli Companies Law as a director, general manager, chief business manager, deputy general manager, vice general manager, other manager directly subordinate to the general manager or any other person assuming the responsibilities of any of the foregoing positions without regard to such person’s title. An office holder’s fiduciary duties consist of a duty of care and a fiduciary duty. The duty of care requires an office holder to act at a level of care that a reasonable office holder in the same position would employ under the same circumstances. This includes the duty to utilize reasonable means to obtain (i) information regarding the appropriateness of a given action brought for his approval or performed by him by virtue of his position and (ii) all other information of importance pertaining to the foregoing actions. The fiduciary duty includes (i) avoiding any conflict of interest between the office holder’s position in the company and any other position he holds or his personal affairs, (ii) avoiding any competition with the company’s business, (iii) avoiding exploiting any business opportunity of the company in order to receive personal gain for the office holder or others, and (iv) disclosing to the company any information or documents relating to the company’s affairs that the office holder has received due to his position as an office holder.
 
Disclosure of Personal Interests of an Office Holder; Approval of Transactions with Office Holders
 
The Israeli Companies Law requires that an office holder promptly, and no later than the first board meeting at which such transaction is considered, disclose any personal interest that he or she may have and all related material information known to him or her and any documents in their position, in connection with any existing or proposed transaction by us. In addition, if the transaction is an extraordinary transaction, that is, a transaction other than in the ordinary course of business, other than on market terms, or likely to have a material impact on the company’s profitability, assets or liabilities, the office holder must also disclose any personal interest held by the office holder’s spouse, siblings, parents, grandparents, descendants, spouse’s descendants and the spouses of any of the foregoing, or by any corporation in which the office holder or a relative is a 5% or greater shareholder, director or general manager or in which he or she has the right to appoint at least one director or the general manager.
 
Under the Israeli Companies Law, all arrangements as to compensation of office holders who are not directors require approval by the board of directors, and exculpation, insurance and indemnification of, or an undertaking to, indemnify an office holder who is not a director requires both board of directors and audit committee approval.  The compensation of office holders who are directors must be approved by our audit committee, board of directors and shareholders.
 
Some transactions, actions and arrangements involving an office holder (or a third party in which an office holder has an interest) must be approved by the board of directors or as otherwise provided for in a company’s articles of association, however, a transaction that is adverse to the company’s interest may not be approved. In some cases, such a transaction must be approved by the audit committee and by the board of directors itself, and under certain circumstances shareholder approval may be required. A director who has a personal interest in a transaction that is considered at a meeting of the board of directors or the audit committee may not be present during the board of directors or audit committee discussions and may not vote on the transaction, unless the transaction is not an extraordinary transaction or the majority of the members of the board or the audit committee have a personal interest, as the case may be. In the event the majority of the members of the board of directors or the audit committee have a personal interest, then the approval of the general meeting of shareholders is also required.
 
Disclosure of Personal Interests of a Controlling Shareholder; Approval of Transactions with Controlling Shareholders
 
The disclosure requirements that apply to an office holder also apply to a transaction in which a controlling shareholder with respect to his or her personal interest in any existing or proposed transaction by us.  The Israeli Companies Law provides that an extraordinary transaction with a controlling shareholder or an extraordinary transaction with another person in whom the controlling shareholder has a personal interest or a transaction with a controlling shareholder or his relative regarding terms of service and employment, must be approved by the audit committee, the board of directors and shareholders.  The shareholder approval for such a transaction must include at least one-third of the shareholders who have no personal interest in the transaction who voted on the matter (not including abstentions).  The transaction can be approved by shareholders without this one-third approval if the total shareholdings of those shareholders who have no personal interest and voted against the transaction do not represent more than one percent of the voting rights in the company.
 
 
- 51 -