Magal Security Systems Ltd.
Annual Report 2011

Plain-text annual report

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 ⌧ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR For the fiscal year ended December 31, 2011 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) Ilan Ovadia, Chief Financial Officer Magal Security Systems Ltd. P.O. Box 70, Industrial Zone Yehud 56100, Israel +972-3-5391444 (phone), +972-3-5366245 (fax) (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 Ordinary Shares, NIS 0.1 Par Value Name of each exchange on which registered 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 …….…15,819,822 (as of December 31, 2011) 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 ⌧ 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 ⌧ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No 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 ⌧ Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing: U.S. GAAP ⌧ 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: 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). Item 17 o Item 18 o Yes o No ⌧ 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 PART I ITEM 1. ITEM 2. ITEM 3. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS OFFER STATISTICS AND EXPECTED TIMETABLE KEY INFORMATION A. Selected Consolidated Financial Data. B. Capitalization and Indebtedness. C. Reasons for the Offer and Use of Proceeds. D. Risk Factors. ITEM 4. Information on the Company A. History and Development of the Company. B. Business Overview. C. Organizational Structure. D. Property, Plants and Equipment. ITEM 4A. Unresolved Staff Comments ITEM 5. Operating and Financial Review and Prospects A. Operating Results. B. Liquidity and Capital Resources C. Research and Development, Patents and Licenses. D. Trend Information. E. Off-Balance Sheet Arrangements. F. Tabular Disclosure of Contractual Obligations. Directors, Senior Management and Employees ITEM 6. A. Directors and Senior Management. B. Compensation C. Board Practices D. Employees E. Share Ownership. ITEM 7. Major Shareholders and Related Party Transactions B. Related Party Transactions. C. Interests of Experts and Counsel. ITEM 8. Financial Information A. Consolidated Statements and Other Financial Information. B. Significant Changes. The Offer and Listing A. Offer and Listing Details. B. Plan of Distribution. C. Markets. D. Selling Shareholders. E. Dilution. F. Expenses of the Issue. Additional Information ITEM 9. ITEM 10. A. Share Capital. B. Memorandum and Articles of Association. C. Material Contracts. D. Exchange Controls. E. Taxation. F. Dividends and Paying Agents. G. Statements by Experts. H. Documents on Display. - i - Page No. 1 1 1 1 1 2 2 3 12 12 13 23 23 24 24 24 37 41 42 42 42 42 42 45 46 53 53 56 58 59 59 59 60 60 60 61 61 61 61 61 62 62 62 65 65 66 77 77 77 I. Subsidiary Information. Controls and Procedures Defaults, Dividend Arrearages and Delinquencies Quantitative and Qualitative Disclosures about Market Risk Description of Securities Other Than Equity Securities ITEM 11. ITEM 12. PART II ITEM 13. ITEM 14. Material Modifications to the Rights of Security Holders and Use of Proceeds ITEM 15. 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 ITEM 16H. Mine Safety Disclosure PART III ITEM 17. ITEM 18. ITEM 19. SIGNATURE Financial Statements Financial Statements Exhibits 77 78 79 79 79 79 79 80 80 80 81 81 81 81 82 82 82 82 82 85 - 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 35 years of experience and interaction with customers, we have developed a unique set of solutions and products, optimized for perimeter, outdoor and general security applications. Our turnkey solutions are typically integrated and managed by sophisticated modular command and control software, supported by expert systems for real-time decision support. Our broad 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. As 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 under the symbol “MAGS,” and until December 1, 2011 were traded under the same symbol on the Tel Aviv Stock Exchange. Our website 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, PANTHER, GUIDAR, REPELS, SENNET, PERIMITRAX, INTELLI-FLEX, INTELLI-FIELD, INTELLIFIBER, X-FIELD, OMNITRAX, STARLED, STARNET, FRONTLINE, E-FIELD, E-FLEX, ARMOURFLEX, FLASH, FLARE, SENTRAX, OMNITRAX, XFIELD, FLEX-PS, FLEX-PI, ULTRAWAVE, FORTIS, PIPEGUARD, DTR, PINPOINTER, MAESTRO DB, the 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 and effective on December 30, 2011 was NIS 3.821 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 - ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS Not applicable. ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE PART I Not applicable. ITEM 3. KEY INFORMATION A. Selected Consolidated Financial Data. The following selected consolidated financial data for and as of the five years ended December 31, 2011 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, 2010 and 2011 and for each of the years ended December 31, 2009, 2010 and 2011 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, 2007, 2008 and 2009 and for each of the years ended December 31, 2007 and 2008 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. Consolidated Statement of Operations Data: Revenues Cost of revenues Gross profit Operating expenses: Research and development, net Selling and marketing, net General and administrative Impairment of goodwill and other intangible assets Post employment and termination benefits Other income Total operating expenses Operating income (loss) Financial expenses (income), net Income (loss) before income taxes Income taxes Income (loss) from continuing operations Income (loss) from discontinued operations, net Net income (loss) Less: net income (loss) attributable to non-controlling interest Net income (loss) attributable to Magal’s shareholders Basic net earnings (loss) per share from continuing operations Basic net earnings (loss)per share from discontinued operations Basic net earnings (loss) per share Diluted net earnings (loss) per share from continuing operations Diluted net earnings (loss) per share from discontinued operations Diluted net earnings (loss) per share Weighted average number of ordinary shares used in computing basic net $ $ $ $ $ $ $ 2007(1)(2) 2008(2) Year Ended December 31, 2009(2) (in thousands except per share data) 2010 2011 62,695 38,156 24,539 5,310 11,073 6,057 - 904 - 23,344 1,195 2,059 (864) 276 (1,140) 3,022 1,882 - 1,882 (0.11) 0.29 0.18 (0.11) 0.29 0.18 $ $ $ $ $ $ $ $ 57,105 37,559 19,546 5,556 12,953 10,243 2,772 2,582 - 34,106 (14,560) 1,314 (15,874) 3,066 (18,940) (13,662) (32,602) - (32,602) $ $ $ (1.82) (1.32) (3.14) $ (1.82) $ (1.32) (3.14) $ $ 54,518 33,404 21,114 5,059 10,820 8,100 - - - 23,979 (2,865) 1,568 (4,433) 864 (5,297) 4,216 (1,081) 54 (1,135) $ (0.52) 0.41 (0.11) $ (0.52) $ 0.41 (0.11) $ $ 49,699 31,400 18,299 4,105 11,261 7,593 - 22,959 (4,660) 967 (5,627) 602 (6,229) - (6,229) (24) (6,205) $ (0.60) - (0.60) $ (0.6) $ - (0.6) $ 88,591 49,089 39,502 3,898 19,415 8,682 - - (2,304) 29,691 9,811 (756) 10,567 723 9,844 - 9,844 - 9,844 0.78 - 0.78 0.78 - 0.78 earnings per share 10,394,989 10,396,548 10,396,548 10,396,548 12,645,283 Weighted average number of ordinary shares used in computing diluted net earnings per share 10,431,103 10,396,548 10,398,624 10,396,548 12,645,283 - 1 - Consolidated Balance Sheets Data: Cash and cash equivalents Short and long-term bank deposits, restricted deposits, marketable securities $ and escrow deposit Working capital Total assets Short-term bank credit (including current maturities of long-term loans) Long-term bank loans Loan from related party Total shareholders’ equity Ordinary shares issued and outstanding _____________ (1) 2007(1) 2008 As of December 31, 2009 (in thousands) 2010 2011 9,205 $ 16,835 $ 11,869 $ 16,596 $ 32,622 26,972 41,526 126,157 20,737 3,095 - 65,578 10,396,548 8,137 16,240 90,537 23,995 2,282 - 30,718 10,396,548 2,019 20,646 60,650 10,058 548 - 32,309 10,396,548 4,888 26,612 65,710 9,830 50 9,907 28,016 10,396,548 7,506 40,493 85,987 5,390 38 - 51,011 15,819,822 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. - 2 - D. Risk Factors. Investing in our ordinary shares involves a high degree of risk and uncertainty. You should carefully consider the risks and uncertainties described below before investing in our ordinary shares. If any of the following risks actually occurs, our business, prospects, financial condition and results of operations could be harmed. In that case, the value of our ordinary shares could decline, and you could lose all or part of your investment. Risks Related to Our Business We have a history of operating losses and may not be able to achieve and sustain profitable operations. We may not have sufficient resources to fund our operations in the future. Although we returned to profitability in 2011 after three years of losses, there can be no assurance that we will continue to operate profitably in the future. If we do not generate sufficient cash from operations, we will be required to obtain additional financing or reduce our level of expenditure. Such financing may not be available in the future, or, if available, may not be on terms favorable to us. If adequate funds are not available to us, our business, and results of operations and financial condition will be materially and adversely affected. 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. For example, the provision of the perimeter security and command and control solutions for the 2012 Africa Cup of Nations in the Gabonese Republic accounted for 34.8% of our revenues in 2011. Individual orders from customers can represent a substantial portion of our revenues in any one period and significant revenues from a customer during one period may not be followed by additional revenues from the same customer in subsequent periods. As a result, our revenues and operating results for a specific period 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 that is generally composed of orders that are fulfilled within a period of three to twelve months after receipt, which makes revenues in any quarter substantially dependent upon orders received in prior quarters. We may not be able to implement our new strategic plan and may not be able to successfully expand our business activity and increase our sales. In June 2010, we adopted a new strategic plan in an effort to reduce expenses and increase our business activity and sales. We determined to focus our business on our sensor activity, broaden our sales channels and close certain technology gaps in response to new demands in the market place. We intend to implement such strategic plan either though organic growth or the acquisition of, or investment in, businesses, products and technology that complement our business. We also intend to improve our presence in selected territories in order to increase our exposure to small and medium size business opportunities as a solution provider. We may not be able to implement our new strategic plan and may not be able to successfully expand our business activity and increase our sales. If we are successful in the implementation of our strategic plan, we may be required to hire additional employees in order to meet customer demands, and if we are unable to attract or retain qualified employees, our business could be adversely affected. Unfavorable global economic conditions may adversely affect our customers, which directly impact our business and results of operations. Our operations and performance depend on our target customers, including those from the governmental sector, having adequate resources to purchase our products. The turmoil in the credit markets and the global economic downturn during 2008 and 2009 generally adversely impacted our target customers. Companies and governmental authorities reduced and may continue to reduce their purchasing activities in response to a lack of credit, economic uncertainty, budget deficits and concern about the stability of markets in general, and have reduced or delayed purchases of our products. During 2011, several European countries encountered severe economic difficulties which affected the entire Euro-zone economy. The financial crisis, among other things, resulted in the down grade of the credit worthiness of several European countries. The financial and economic instability in Europe has impacted our sales in Europe, and if such economic and market conditions remain uncertain or weaken further, our financial condition and operating results may be materially adversely affected. - 3 - As a result of slow moving inventory due to a global economic slowdown, we may be required in the future to record impairment charges relating to the carrying value of our intangible assets and goodwill, 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 as a result of an uncertain economy and as a result, we may be required to record impairment charges in the future. If global economic and market conditions or economic conditions in key markets remain uncertain 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 effect 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 small number of customers account for a large percentage of our revenues. For the years ended December 31, 2009, 2010 and 2011, revenues generated from sales to the Israeli Ministry of Defense, or MOD, and Israeli Defense Forces, or IDF, accounted for 19.6%, 13.4% and 7.8%, 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 or more of our key customers without replacement by a customer or customers generating similar revenues would adversely affect our financial results. In addition, in the year ended December 31, 2011, revenues attributable to the 2012 Africa Cup of Nations in the Gabonese Republic accounted for 34.8% ($30.8 million) of our revenues and revenue from the project is expected to decline to $5.2 million in 2012 when the project is completed. 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. - 4 - 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 significantly affected by currency fluctuations. We sell most of our products in North America, Europe and Israel. Our revenues are primarily denominated in 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 dollar and non-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 dollar. In addition, the value of our non-dollar revenues could be adversely affected by the depreciation of the dollar against such currencies. In 2009 and 2010, the NIS appreciated by approximately 0.7% and 6.0%, respectively, against the dollar, while in 2011 the NIS depreciated by approximately 7.7% against the dollar. In 2010 and 2011, the Euro depreciated against the dollar by 7.4%, and 3.3%, respectively, while in 2009 the Euro appreciated against the dollar by 3.5%. In addition, the dollar cost of our operations in Canada is influenced by the exchange rate between the dollar and the Canadian dollar. In 2009 and 2010, the Canadian dollar appreciated against the dollar by 16.6% and 4.9%, respectively, while in 2011 the Canadian dollar depreciated by approximately 2.3% against the dollar. During the years ended December 31, 2009 and 2010, foreign currency fluctuations had an adverse impact on our results of operations and we recorded foreign exchange losses, net of $1,138,000 and $199,000, respectively. In 2011, foreign currency fluctuations had a positive impact on our results of operations and we recorded foreign exchange income, net of $1,394,000. Our results of operations may continue to be materially affected by currency fluctuations in the future. If we do not receive Israeli MOD approvals necessary for us to export the products we produce in Israel, our revenues may decrease. Israel’s defense export policy regulates the sale of a number of our systems and products. Current Israeli policy encourages export to approved customers of defense systems and products, such as ours, as long as the export is consistent with Israeli government policy. A license is required to initiate marketing activities. We are also required to obtain a specific export license for any hardware 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, 2009, 2010 and 2011 approximately 76.2%, 80.2% and 88.6%, 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: - 5 - • • • • • • • • different and changing regulatory requirements in the jurisdictions in which we currently operate or may operate in the future; fluctuations in foreign currency exchange rates; export restrictions, tariffs and other trade barriers; difficulties in staffing, managing and supporting foreign operations; longer payment cycles; difficulties in collecting accounts receivable; political and economic changes, hostilities and other disruptions in regions where we currently sell or products or may sell our products in the future; and seasonal reductions in business activities. Negative developments in any of these areas in one or more countries could result in a reduction in demand for our products, the cancellation or delay of orders already placed, difficulty in collecting receivables, and a higher cost of doing business, any of which could adversely affect our business, results of operations or financial condition. We have significant operations in countries that may be adversely affected by political or economic instability, corruption, major hostilities or acts of terrorism. We are a global security company with worldwide operations. Although approximately 40% of our sales are generated in Israel, North America and Western Europe, we expect to derive an increasing portion of our sales and future growth from other regions such as Africa, India, Latin America and Central and Eastern Europe, which may be more susceptible to political or economic instability. In addition, in many less-developed markets, we rely heavily on third-party distributors and other agents for the marketing and distribution of our products and solutions. Many of these third parties do not have internal compliance resources comparable to ours. Business activities in many of these markets have historically been more susceptible to corruption. If our efforts to screen third-party agents and detect cases of potential misconduct fail, we could be held responsible for the noncompliance of these third parties under applicable laws and regulations, which may have a material adverse effect on our reputation and our business, financial condition and results of operations. Significant portions of our operations are conducted outside the markets in which our products and solutions are manufactured or generally sold, and accordingly, we often export a substantial number of products into such markets. We may, therefore, be denied access to potential customers or suppliers or denied the ability to ship products from any of our subsidiaries into the countries in which we currently operate or wish to operate, as a result of economic, legislative, political and military conditions, including hostilities and acts of terrorism, in such countries. 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 effect on our business, financial condition and results of operations. - 6 - 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. Natural disasters, terrorist attacks or breaches of network or information technology security could have an adverse effect on our business. Natural disasters, terrorist acts, acts of war, cyber attacks or other breaches of network or information technology (IT) security may cause equipment failures or disrupt our systems and operations. While we maintain insurance coverage for some of these events, the potential liabilities associated with these events could exceed the insurance coverage we maintain. Our inability to operate our facilities as a result of such events, even for a limited period of time, may result in significant expenses and/or loss of market share to other competitors in the market for security systems. In addition, a failure to protect the privacy of customer and employee confidential data against breaches of network or IT security could result in damage to our reputation. Any of these occurrences could result in a material adverse effect on our results of operations and financial condition. 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 13 patents and have four (4) 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. - 7 - 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 arrangements 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. 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. We also benefit from tax credits pursuant to the Scientific Research and Experimental Development Tax incentive Program in Canada. If we fail to comply with the conditions imposed by the Israeli law or the Canadian tax program 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 or the Canadian government ends these programs and benefits, our business, financial condition, results of operations and net income could be materially adversely affected. - 8 - 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 management’s annual review and evaluation of our internal control over financial reporting in connection with the filing of the annual report on Form 20-F for each fiscal year. We may identify material weaknesses or significant deficiencies in our internal control over financial reporting. 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; • 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. - 9 - 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. 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, and our principal executive offices and manufacturing and research and development facilities are located in, the State of Israel. As a result, political, economic and military conditions affecting Israel directly influence us. Any major hostilities involving Israel, a full or partial mobilization of the reserve forces of the Israeli army, the interruption or curtailment of trade between Israel and its present trading partners, or a significant downturn in the economic or financial condition of Israel could adversely affect 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. In recent years, there was an escalation in violence among Israel, Hamas, the Palestinian Authority and other groups. Also, during 2011, riots and uprisings in several countries in the Middle East and neighboring regions have led to severe political instability in several neighboring states and to a decline in the regional security situation. Such instability may affect the local and global economy, could negatively affect business conditions and, therefore, could adversely affect our operations. To date, these matters have not had any material effect on our business and results of operations; however, the regional security situation and worldwide perceptions of it are outside our control and there can be no assurance that these matters will not negatively affect us in the future. Ongoing violence between Israel and the Palestinians as well as tension between Israel and other countries in the Middle East may have a material adverse effect on our business, financial condition and results of operations. 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. - 10 - The rights and responsibilities of the shareholders are 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, all of whom reside outside the United States, may be difficult to obtain within the United States. Furthermore, since substantially all of our assets and all of our directors and officers are located outside the United States, any judgment obtained in the United States against us or these individuals may not be collectible within the United States. There is doubt as to the enforceability of civil liabilities under the Securities Act and the Securities Exchange Act in original actions instituted in Israel. However, subject to certain time limitations and other conditions, Israeli courts may enforce final judgments of United States courts for liquidated amounts in civil matters, including judgments based upon the civil liability provisions of those and similar acts. As a foreign private issuer whose shares are listed on the NASDAQ Global Market, we may follow certain home country corporate governance practices instead of certain NASDAQ requirements. We follow Israeli law and practice instead of NASDAQ rules regarding the director nomination process, compensation of executive officers and the requirement that our independent directors have regularly scheduled meetings at which only independent directors are present. As a foreign private issuer whose shares are listed on the NASDAQ Global Market, we are permitted to follow certain home country corporate governance practices instead of certain requirements of The NASDAQ Stock Market Rules. We follow Israeli law and practice instead of NASDAQ rules regarding the director nomination process, compensation of executive officers and the requirement that our independent directors have regularly scheduled meetings at which only independent directors are present. As a foreign private issuer listed on the NASDAQ Global Market, we may also follow home country practice with regard to, among other things, the composition of the board of directors and quorum at shareholders’ meetings. In addition, we may follow home country practice instead of the NASDAQ requirement to obtain shareholder approval for certain dilutive events (such as for the establishment or amendment of certain equity-based compensation plans, an issuance that will result in a change of control of the company, certain transactions other than a public offering involving issuances of a 20% or more interest in the company and certain acquisitions of the stock or assets of another company). A foreign private issuer that elects to follow a home country practice instead of NASDAQ requirements must submit to NASDAQ in advance a written statement from an independent counsel in such issuer’s home country certifying that the issuer’s practices are not prohibited by the home country’s laws. In addition, a foreign private issuer must disclose in its annual reports filed with the Securities and Exchange Commission each such requirement that it does not follow and describe the home country practice followed by the issuer instead of any such requirement. Accordingly, our shareholders may not be afforded the same protection as provided under NASDAQ’s corporate governance rules. - 11 - ITEM 4. Information on the Company A. History and Development of the Company. We were incorporated under the laws of the State of Israel on March 27, 1984 under the name Magal Security Systems Ltd. We are a public limited liability company under the Israeli Companies Law, 5739-1999, and operate under this law and associated legislation. Our principal executive offices and primary manufacturing and research and development facilities are located near Tel Aviv, Israel, in the Yehud Industrial Zone. Our mailing address is P.O. Box 70, Industrial Zone, Yehud 56100, Israel and our telephone number is +972-3-539-1444. Our agent for service of process in the United States is Senstar Inc., 13800 Coppermine Road, Second Floor, Herndon, Virginia 20171. Our website address 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 security, safety and site management solutions and products. Based on more than 35 years of experience and interaction with customers, we have developed a unique set of solutions and products, optimized for perimeter, outdoor and general security applications. Our turnkey solutions are typically integrated and managed by sophisticated modular command and control software, supported by expert systems for real-time decision support. Our broad portfolio of critical infrastructure and site protection technologies includes a variety of smart barriers and fences, fence mounted detectors, virtual (volumetric) fences and 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, or CCTV, intelligent video analytics, or IVA, and motion detection technology for outdoor operation, we have successfully installed customized solutions and products in more than 75 countries worldwide. In June 2010, we adopted a strategic plan to focus our growth efforts on our historical primary markets: perimeter products and solutions and turnkey projects. We intend to increase revenues in the perimeter products segment by locating new channels to promote and market our products, maintaining technology leadership, investing in research and development, entering into original equipment manufacturer, or OEM, agreements and by acquiring technologies or by mergers and acquisitions. We intend to focus on and improve our presence in emerging markets such as Brazil, Russia, India and China, or the BRIC countries, in order to increase our exposure to small and medium size business opportunities for both our perimeter products and solutions and turnkey projects segments. As part of our such strategic plan we established a new joint venture in India in 2012, We are also continuing to invest in the training of our employees in order to enhance their professional skills and efficiency. To allow us to begin to implement our strategic plan, on September 8, 2010, Ki Corporation Limited, or Ki Corporation, a company affiliated with Mr. Nathan Kirsh, our principal shareholder and a director, provided us with a bridge loan in the principal amount of $10.0 million. To raise long-term funds for general working capital purposes, including to facilitate the implementation of our business strategy and the repayment of the $10 million bridge loan, we distributed to holders of our ordinary shares, at no charge, as of the close of business on June 29, 2011, subscription rights to purchase up to an aggregate of 5,273,274 of our ordinary shares. All of the subscription rights were exercised and we received net proceeds from the rights offering of approximately $15.8 million, after deducting expenses related to the rights offering in the amount of approximately $207,000. In connection with the rights offering, on June 17, 2011, we completed a private placement of 150,000 of our ordinary shares to Ki Corporation at $3.05 per share slightly above the $3.03 per share offering price in the rights offering. The private placement consideration from Ki Corporation was paid to us by means of a partial offset against the outstanding balance we owed it under the bridge loan that was provided on September 8, 2010. Our capital expenditures for the years ended December 31, 2009, 2010 and 2011 were approximately $2.0 million, $0.4 million and $1.2 million, respectively. These expenditures were principally for the renovation of our offices and production facilities in Canada, the purchase of commercial vehicles as well as computer, software and demo and promotional equipment related to our new FORTIS4G command and control system. The high level of capital expenditures in 2009 was primarily attributable to the renovation and expansion work at our executive offices and factory in Israel that we commenced in 2008 as well as the implementation of a new ERP system and an upgrade of our computer systems in Israel. - 12 - 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 plants, airports, seaports, prisons, industrial sites, oil and gas facilities, refineries, Olympic villages and stadiums and municipalities from intrusion, crime, sabotage or vandalism to infrastructure, assets and personnel. Based on more than 35 years of experience and interaction with customers, we have developed a comprehensive set of solutions and products, optimized for perimeter, outdoor and general security applications. Our portfolio of mission critical infrastructure and site protection technologies includes a variety of smart fences and barriers, fence mounted sensors, virtual (volumetric) fences and 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 our Fortis - a sophisticated, geographical information system, or GIS, based command and control system. 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 and / or turnkey projects 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. - 13 - • 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 and joint ventures. Emerging Opportunity The rapid introduction of digital communication and information technology into the security market provides us with the opportunity to consolidate safety and site management with security applications. Cities and municipalities, air and sea ports, chemical factories, Olympic villages and stadiums and critical infrastructure sites are currently implementing and enjoying the benefits of this approach to security management. This 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 departments 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 are in the forefront of this emerging market opportunity. Products and Services General Our products are focused around outdoor and perimeter intrusion detection systems, or PIDS, and applications contributing to security, outdoors safety and also site management. 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 for correctional facilities, borders, nuclear and conventional power plants, air and sea ports, military installations and other high security installations. In early 2010, two independent research organizations, Frost & Sullivan and IMS Research, recognized our company as the number one provider of PIDS technology. 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 and prisons in the United States and in several other countries. In addition, we have installed several hundred kilometers of high security smart perimeter systems along Israel’s borders. - 14 - 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 “microphonic” 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. Taut wire technology provides three critical elements of protection against unauthorized intruders: deterrence, detection and delaying (until first responders may react and intercept the intruder). 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 to the end user for between $75 to $190 per meter (depending, among other things, on the model, height, density, and corrosion protection level of the system). 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. Our BARRICADE II system leverages the same configuration of the first generation and adds a ranging feature, which provides the capability to locate the exact vibrated sensor (rather than causing an alarm of a full physical segment of approximately100 meters). - 15 - Intelli-FLEX, FLEX PS, 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 to the end user for between $15 to $60 per meter. We recently developed and began to sell the Pinpointer, a fence-mounted vibration sensor that is capable of defining the exact location of an intrusion to within 2 to 3 meters (6.5 to 10 ft.). While maintaining the legacy features of the original sensor, Pinpointer has the ability to identify the exact disturbed sensor along a long chain of sensors, which are typically 2 to 3 meters (6.5 to 10 ft.) apart. 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 and/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. 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. During the second quarter of 2011, we expect to launch a new version of our microwave product, which has a K band improved sensor, is fully digital and has extended processing and communication features. CCTV Systems We have a proven track record in delivering CCTV and IVA solutions that are designed for use in outdoor applications. Maestro DB 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). Maestro DB is our new fully digital generation management platform that is designed for use in outdoor security applications, including sensitive critical sites that require real-time multi- media surveillance, providing strong motion detection and video analytics. The system is ideal for outdoor applications where cameras cover wide areas and data may be dispersed in multiple locations, yet the entire site needs to function as a single, coherent site with a centrally managed data base. Maestro DB supports IP streamed video from IP cameras (if the camera source is analog, an encoder is used, it uses an enhanced software version of our original DreamBox platform and runs on COTS servers. Maestro DB supports high resolution video inputs (megapixel and high definition). - 16 - Our video solutions have 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. Maestro DB does not try to compete with standard 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). 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 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 Maestro DB 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 three types of command and control systems: • • Fortis – a high-end comprehensive command and control system; StarNet 1000 - a basic security management system, or SMS; and • Network Manager – a middleware (software) package. - 17 - Fortis FORTIS4G, is our latest Physical Security Management Information, or PSIM, system. It 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. FORTIS4G 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. The target markets for Fortis4G are municipalities, city protection applications and, as part of other integrated solutions supplied by us, for use in airport, border and homeland security applications. StarNet 1000 StarNet 1000, an SMS, is suitable as a high-end system for basic sites, consisting of a PIDS with a few other devices. MX is another SMS that is being sold and supported only in the United States, and we intend to retire this system during 2012. Network Manager Network Manager is a middleware (software) package that is as an interface between our family of PIDS sensors and any command and control solution, be it our own system or an external third party application. It is provided to integrators with a full software development kit to enable fast integration of our PIDS into any other SMS and physical security information system. 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. 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 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 alerting utility operators early enough before digging causes catastrophic damage to existing oil and gas pipes. 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. - 18 - Flash and flare personal emergency locating systems 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 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. PAS is another personal alarm system that uses an ultrasonic based emergency notification 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). In many cases we take responsibility for the full turnkey solution and we integrate and deliver a full solution, including civil works, installation, training, warranty and after sale support. We have sales offices in the United States, the United Kingdom, Germany, Mexico, China, Romania, Colombia and Spain, as well as in our two main offices in Israel and Canada. The following table shows the breakdown of our consolidated revenues for the calendar years 2009, 2010 and 2011 by operating segment: Perimeter products Turnkey projects Eliminations Total $ $ - 19 - 2009 Year Ended December 31, 2010 (In thousands) 33,248 $ 17,249 $ 39,102 15,416 - 54,518 $ (798) 49,699 $ 2011 30,012 59,707 (1,128) 88,591 Customers The following table shows the geographical breakdown of our consolidated revenues for the calendar years 2009, 2010 and 2011: Israel North America Europe South and Latin America Africa Others Total $ $ 2009 Year Ended December 31, 2010 (In thousands) 9,838 $ 15,393 9,787 9,958 1,108 3,615 49,699 $ 12,968 13,763 10,808 3,986 3,747 9,246 54,518 $ $ 2011 10,091 13,373 10,913 12,145 35,499 6,570 88,591 For the years ended December 31, 2009, 2010 and 2011, revenues generated from sales to the MOD and IDF accounted for 19.6%, 13.4% and 7.8%, respectively, of our revenues. The Mexican Federal Prisons Authority, or SSP, a client in Mexico, accounted for 11.4% and 10.7% of our revenues in the years ended December 31, 2010 and 2011. In addition, our project in the Gabonese Republic accounted for 34.8% of our revenues in the year ended December 31, 2011. We cannot assure you that any of our major customers will maintain their level of business with us or that, if such business 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 generating similar revenues 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 2011, we derived approximately 3.9% of our total revenues from maintenance and services. 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 2009, 2010 and 2011 were approximately $5.1 million, $4.1 million and $3.9 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 3.5% 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 of $172,000, $0 and $68 in the years ended December 31, 2009, 2010 and 2011, respectively. As of December 31, 2011, our aggregate contingent obligation to the OCS was $1.3 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 in the event we seek to transfer any of our technology. Each application to the OCS is reviewed separately, and 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 Tax Incentive Program, or SR&ED 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 Program contracts from experimental development, applied research, basic research and support work. Under the SR&ED 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, 2009, 2010 and 2011, our Canadian subsidiary recognized $167,000, $239,000 and $268,000, respectively, of investment tax credits. As of December 31, 2011, 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 PIDS Sensors. 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. The PIDS market is very fragmented. According to Frost & Sullivan and IMS Research, we rank first based on market share with approximately 15% of the market in February 2012. Our competition includes Elfar Ltd. and RB-Tec Ltd. in Israel, and South West Microwave Inc., Future Fiber Technologies, Detection Security Systems Inc., Fiber Sensys Inc., Optellios Inc., Geoquip Ltd., GPS Standard SpA and Cias Elettronica Srl outside of Israel. Turn Key Projects and Solutions. Hundreds of solution providers offer security products and services. Most of the integrators focus on indoor applications, but some also offer outdoor solutions. Most of the market players are local to their countries; however some are global, such as Honeywell and Siemens. In some cases we may cooperate with global integrators or may supply equipment to them. We believe that our principal competitors in Israel for security solutions are Elbit Systems Ltd., C. Mer Industries Ltd., Afcon Industries Ltd. and Orad Ltd. We believe that our principal competitor for the PipeGuard system is Future Fibre Technologies Pty. Ltd. and 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 13 patents issued and have four (4) patent applications pending in the U.S. and in several other countries and have obtained licenses to use proprietary technologies developed by third parties. We cannot assure you: • • • that patents will be issued from any pending applications, or that the claims allowed under any patents will be sufficiently broad to protect our technology; that any patents issued or licensed to us will not be challenged, invalidated or circumvented; or as to the degree or adequacy of protection any patents or patent applications may or will afford. In addition, we claim proprietary rights in various technologies, know-how, trade secrets and trademarks relating to our principal products and operations. We cannot assure you as to the degree of protection these claims may or will afford. It is our policy to protect our proprietary rights in our products and operations through contractual obligations, including confidentiality and non-disclosure agreements with certain employees and distributors. We cannot assure you as to the degree of protection these contractual measures may or will afford. Although we are not aware that we are infringing upon the intellectual property rights of others, we cannot assure you that an infringement claim will not be asserted against us in the future. We believe that our success is less dependent on the legal protection that our patents and other proprietary rights may or will afford than on the knowledge, ability, experience and technological expertise of our employees. We cannot provide any assurance that we will be able to protect our proprietary technology. The unauthorized use of our proprietary technology by third parties may impair our ability to compete effectively. We could become subject to litigation regarding intellectual property rights, which could seriously harm our business. - 22 - 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, Intelli-Fiber, Flex- PS, Flex PI Ultrawave, Senstar, Senstar-Stellar and the Senstar-Stellar logo, Sentrax, Omnitrax, Xfield, DTR, Pinpointer, DreamBox, Maestro DB, Fortis, Pipeguard 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 which may also 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 Structre. We, or one of our subsidiaries, own 100% of the outstanding capital stock of subsidiaries operating in Canada, Colombia, Germany, Mexico, the United Kingdom, the United States, Romania and Spain. Set forth below are our significant subsidiaries. Subsidiary Name Senstar Corp Senstar LA D. Property, Plants and Equipment. Country/State of Incorporation/Organization Canada Mexico Ownership Percentage 100% 100% 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 $84,000 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, Fortis4G, Maestro DB, PipeGuard, MTC-1500, MSS-1500 and other perimeter systems 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 Omnitrex buried cable intrusion detection system, the X- Field volumetric system, the Intelli-FLEX and FlexPS 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 $20,000 per year plus taxes for use as additional storage and system integration space under a month to month tenancy. - 23 - We also lease small offices in China, Colombia, Germany, Mexico, Romania, Spain, the United Kingdom, and Virginia and California in the United States, for our sales and marketing entities. The aggregate annual rent for such offices was approximately $ 277,000 in 2011. We believe that our facilities are suitable and adequate for our current operations and the foreseeable future. ITEM 4A. Unresolved Staff Comments None. ITEM 5. Operating and Financial Review and Prospects The following discussion of our results of operations and financial condition should be read in conjunction with our consolidated financial statements and the related notes thereto included elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth in Item 3.D. “Key Information–Risk Factors.” 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, Olympic villages and stadiums and industrial locations from terrorism, theft and other security threats. Our revenues are derived from our two operating segments: • • Perimeter Products segment - sales of perimeter products, including services and maintenance that are performed either on a fixed-price basis or pursuant to time-and-materials based contracts, and Turnkey Projects segment - installation of comprehensive turnkey solutions for which revenues are generated from long-term fixed price contracts. Perimeter Products Segment Prior to 2010, our Perimeter Products segment included the operations of four subsidiaries, Senstar Stellar Corp, or Senstar Canada, Senstar Gmbh, or Senstar Germany, Senstar Limited, or Senstar UK, and Magal Senstar Inc., or the U.S. Subsidiary. The Perimeter Products segment also included our operations in Israel. We acquired Senstar Canada and Senstar Germany in January 1997 and at the same time, established Senstar UK and considered Senstar Canada, Senstar Germany and Senstar UK as one operating unit due to the commonality of their operations and products, with Senstar Germany and Senstar UK acting as distributors for Senstar Canada. Our U.S. Subsidiary, which we acquired in September 1997, was considered a separate operating unit within the Perimeter Products segment. In connection with the strategic plan we formulated in 2010, we consolidated the operations of certain of our subsidiaries. Accordingly, during 2010 we began to consider Senstar Canada, Senstar Germany, Senstar UK and the U.S Subsidiary as one reporting unit within the Perimeter Products segment. The Israeli operations of the Perimeter Products segment as well as the Spanish operations are considered as two separate reporting units within that segment. - 24 - Turnkey Projects Segment The Turnkey Projects segment has operations worldwide and the segment includes a number of reporting units operating in Israel, Mexico, Colombia and a division of Senstar Canada. 2010 Strategic Plan In June 2010 we adopted a strategic plan, which we believe provides a foundation for the future growth in our revenues. This plan is based on the growing worldwide demand for perimeter security, especially in the BRIC countries. As part of our strategic plan, we intend to stimulate revenue growth by introducing new sales channels for our products as well as creating long-term alliances with large international integrators in order to increase the sales of our products to such integrators. We are also investing in research and development in order to maintain our leadership position in the PIDS market. In addition, we intend to enter into new OEM agreements, purchase third party technologies or enter into merger and acquisition transactions in order to maintain and enhance our technological prominence. We also intend to increase our sales efforts for our perimeter solutions and turn-key projects in those territories where we see growing demand, such as the BRIC countries, and plan to improve our presence in these territories either through the establishment of local offices or through joint-ventures and partnering with local entities. 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 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 uncertain 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 (loss) are among the key performance indicators for our business. Our revenues from our perimeter products and turnkey projects segments for the three years ended December 31, 2009, 2010 and 2011 were as follows: Perimeter products Turnkey projects Eliminations Total $ $ 2009 Year Ended December 31, 2010 (In thousands) 33,248 $ 17,249 $ 39,102 15,416 - 54,518 $ (798) 49,699 $ 2011 30,012 59,707 (1,128) 88,591 The increase in revenues from turnkey projects was primarily due to our increased activity in Africa, mainly with respect to the 2012 Africa Cup of Nations project in the Gabonese Republic which we received in 2011. In addition, our Mexican subsidiary, which received a large scale project in mid-2010, recorded increased revenues from that project as well as from other smaller projects that resumed in 2011. - 25 - Our operating income (loss) from our perimeter products and turnkey projects segments for the three years ended December 31, 2009, 2010 and 2011 were as follows: Perimeter products Turnkey projects Other income Eliminations Total $ $ (1,053) (1,812) - - (2,865) $ $ (1,641) (2,716) - (303) (4,660) $ 2009 Year Ended December 31, 2010 (In thousands) $ 2011 2,665 5,224 2,304 (382) 9,811 Our profit in 2011 was primarily due to increased government spending in certain territories which led to new projects while our losses in 2009 and 2010 were primarily due to the global economic slowdown and the reduction in governments spending that began in the latter part of 2008. As orders and new projects were delayed, competition increased and margins were squeezed. We believe that this trend is continuing to reverse and that government spending in certain territories is returning to previous levels. 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 gross margin is affected by the proportion of our revenues generated from perimeter products, turnkey projects. Our revenues from perimeter products generally have higher gross margins than our other segment. 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, 2009, 2010 and 2011 are as follows: Perimeter products Turnkey projects Total 2009 Year Ended December 31, 2010 (In thousands) 665 886 $ $ 397 318 1,062 $ 1,204 $ 2011 722 497 1,219 $ $ 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. - 26 - Tax expense. Tax expense consists of federal, state and local taxes on the income of our business. We paid income taxes in Germany, Spain and Mexico in 2009, in Germany, Colombia and Mexico in 2010 as well as in 2011, but did not pay taxes elsewhere because of our operating losses. 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 turnkey systems for which revenues are generated from long-term fixed price contracts; and (ii) sales of perimeter products, including services and maintenance that are performed either on a fixed-price basis or as time-and-materials based contracts. and (iii) services and maintenance, which are performed either on a fixed-price basis or as time-and-materials based contracts. Revenues from installation of comprehensive turnkey 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,” 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.” Turnkey projects 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, 2011, we had recorded $4.9 million of such unbilled receivables. - 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 2009, 2010 and 2011, we recorded inventory write-offs from continuing operations in the amounts of $1.4 million, $0.3 million and $1.0 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.” 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. As of December 31, 2011, we had a net deferred tax asset of $303,000 attributable to our subsidiaries. We had total estimated available carryforward tax losses of $12.9 million with respect to our operations in Israel and our subsidiaries had estimated total available carryforward tax losses of $9.0 million, of which $7.9 million was attributable to our U.S. Subsidiary, which may be used as an offset against future taxable income for periods ranging between 12 and 18 years. As of December 31, 2011, we recorded a full valuation allowance on these 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 We have recorded goodwill as a result of past acquisitions, which represents the excess of the cost over the net fair value of the assets of the businesses acquired. We follow ASC 350, “Intangibles – Goodwill and Other,” which 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 2011 were five years of projected net cash flows, a discount rate of 14.9% and a long-term growth rate of 1.0%. 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. As required by ASC 820, “Fair Value Measurements and disclosures,” we apply assumptions that market place participants would consider in determining the fair value of a reporting unit. The only goodwill on our balance sheet as of December 31, 2011 relates to Senstar Germany and Senstar Canada within the Perimeter Products segment. During 2010 and 2011 no impairment losses were identified. 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” 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. As required by ASC 820, “Fair Value Measurements and Disclosures,” we apply assumptions that market place participants would consider in determining the fair value of our long-lived assets. During 2010 and 2011, no impairment losses were identified. Functional Currency and Financial Statements in U.S. Dollars While our functional currency is the NIS, our reporting currency is the U.S. dollar. 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, 2009, 2010 and 2011, our foreign currency translations totaled $3.9 million, $3.4 million and $0.6 million, respectively. During the years ended December 31, 2009, 2010 and 2011, we recorded accumulated foreign currency translation/expense of approximately $1.4 million, $1.2 million and $0.6 million, respectively, included in our balance sheets as part of “accumulated other comprehensive income.” As of December 31, 2009, 2010 and 2011, foreign currency translation adjustments, net of $3.8 million, $5.1 million and $4.5 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. - 29 - After the re-measurement process is complete the financial statements are translated into our 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 and restricted short-term and long-term bank deposits at December 31, 2011, $32.7 million was deposited with major Israeli banks, whose deposits are insured by the Israeli government. An additional $7.4 million was deposited mainly with the Royal Bank of Canada, Deutsche Bank, Comerica Bank and BBVA Bancomer Bank. Cash and cash equivalents deposited with U.S. banks or other banks 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, 2009, 2010 and 2011, we recorded ($153,000), $601,000 and $411,000 of expenses (income) related to doubtful accounts, respectively. As of December 31, 2011, our allowance for doubtful accounts amounted to $1.1 million. A loan granted to a third party entity in connection with a possible future cooperation between us and the entity is secured by a personal guarantee of the beneficial owner of the entity. However, in 2008 we evaluated the likelihood of the 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 likelihood of repayment of this loan and due to the global economic climate at the time 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. In 2010, due to anticipated difficulties in the implementation of the projects for which the loan was provided we estimated that the repayment of the loan was not probable, and therefore made a provision for the entire loan balance amounting to $206,000. In October 2011 we extended the repayment by additional one year. 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. Results of Operations In 2011, our operating results showed a material improvement over our prior three years results, which had been negatively impacted by the global economic slowdown and the reduction in governments spending that began in the latter part of 2008. During those year orders and new projects were delayed, competition increased and margins were squeezed. In 2011, government spending in certain territories began to increase which led to the initiation of new projects. We believe that this trend is continuing and that government spending in certain territories is returning to previous levels. 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 revenues from a customer during one period may not be followed by additional significant revenues from the same customer in subsequent periods. Accordingly, our revenues and operating results may 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. - 30 - The following table presents certain financial data expressed as a percentage of revenues for the periods indicated: Revenues Cost of revenues Gross profit Operating expenses: Research and development, net Selling and marketing, net General and administrative Other income Operating income (loss) Financial income (expenses), net Income (loss) before income taxes Income taxes Income (loss) from continuing operations Income from discontinued operations, net Net income (loss) Year Ended December 31, 2010 2009 2011 100.0% 61.3 38.7 9.3 19.8 14.8 (5.2) (2.9) (8.1) 1.6 (9.7) 7.7 (2.0)% 100% 63.2 36.8 8.3 22.7 15.3 (9.5) (1.9) (11.4) 1.2 (12.6) - (12.6)% 100% 55.4 44.6 4.4 21.9 9.8 (2.6) 11.1 0.9 12.0 0.9 11.1 - 11.1% Year Ended December 31, 2011 Compared with Year Ended December 31, 2010 Revenues. Revenues increased by 78.3% from $49.7 million for the year ended December 31, 2010 to $88.6 million for the year ended December 31, 2011. Revenues from sales of perimeter systems decreased by 9.7% from $33.3 million in 2010 to $30.0 million in 2011, primarily due to a reduction in sales in North America and Western Europe, which are the main markets for our perimeter products, due to the economic situation in such markets. Revenues from security turnkey projects increased by 246% from $17.2 million in 2010 to $59.7 million in 2011, primarily due to a large project in Africa. We anticipate that our revenues, excluding the revenues from the above mentioned large project in Africa, will increase in 2012 as a result of anticipated improvements in certain territories, governmental spending and our current level of backlog. Cost of revenues. Cost of revenues increased by 56.3% from $31.4 million for the year ended December 31, 2010 to $49.1 million for the year ended December 31, 2011. This increase was primarily due to the increase in revenues. Cost of revenues as a percentage of revenues decreased from 63.2% in 2010 to 55.4% in 2011, primarily due to the increased sales without a matching increase in fixed costs and better mix of projects. Our cost of revenues as a percentage of revenues was adversely impacted by the devaluation in the NIS and Canadian dollar against the U.S. dollar exchange rate in 2011, as the percentage of our cost of revenues denominated in NIS and Canadian dollars is higher than the percentage of revenues denominated in NIS and Canadian dollars. Research and development expenses, net. Research and development expenses, net slightly decreased by 5% from $4.1 million for the year ended December 31, 2010 to $3.9 million for the year ended December 31, 2011. The decrease in research and development expenses is primarily attributable to increased use of in-house engineering labor rather than the use of outsourced subcontractors and the change in manpower within that department. Research and development expenses, net amounted to 8.3% of revenues in 2010, compared to 4.4% in 2011, due to our higher revenues in 2011. We anticipate that our research and development expenses will increase slightly in 2012. - 31 - Selling and marketing expenses, net. Selling and marketing expenses, net increased by 72.4% from $11.3 million for the year ended December 31, 2010 to $19.4 million for the year ended December 31, 2011. The increase in selling and marketing expenses in 2011 was primarily due to increased sales commissions which derive from the different and broader mix of revenues in 2011 compared with 2010, as well as associated expenses such as royalties, sales bonuses and travel expenses. The increase is also attributable to the average exchange rate appreciation of the NIS and the Canadian dollar against the U.S. dollar in 2011, which increased the U.S. dollar value of our NIS and Canadian dollar denominated expenses. Selling and marketing expenses, net amounted to 22.7% and 21.9% of revenues in 2010 and 2011, respectively. General and administrative expenses. General and administrative expenses increased by 14.3% from $7.6 million for the year ended December 31, 2010 to $8.7 million for the year ended December 31, 2011. The increase in general and administrative expenses in 2011 was primarily due to increased compensation to our management arising from our record performance as well as the impact of the average exchange rate appreciation of the NIS and Canadian dollar against the U.S. dollar in 2011, which increased the U.S. dollar value of our NIS and Canadian dollar denominated expenses, and expenses incurred by our Colombian subsidiary, which started its operation in 2010. General and administrative expenses amounted to 15.3% of revenues in 2010 compared to 9.8% in 2011. Other income. In 2011 we collected an arbitration award of approximately $2.5 million and recorded income of $2.3 million from the arbitration, net of legal expenses. Operating profit (loss). We had an operating loss of $4.7 million for the year ended December 31, 2010 compared to an operating profit of $9.8 million for the year ended December 31, 2011. The operating profit (losses) of our business segments for the years ended December 31, 2010 and 2011 are as follows: Perimeter products Turnkey projects Other income Eliminations Total Year Ended December 31, 2011 2010 $ $ $ (In thousands) (1,641) (2,716) - (303) (4,660) $ 2,665 5,224 2,304 (382) 9,811 Our perimeter products segment recorded an operating loss of $1.6 million for the year ended December 31, 2010 compared to operating income of $2.7 million for the year ended December 31, 2011, primarily as a result of our focus on the turnkey project segment, which led to a reduction in operating expenses allocated to the perimeter products segment as well as the increased contribution of maintenance income as a percentage of income, which has a relatively higher operating margin. Our turnkey project segment recorded an annual loss of $2.7 million in the year ended December 31, 2010 compared to an operating income of $5.2 million for the year ended December 31, 2011, primarily as a result of the increased activity in the African market. Financial expenses (income), net. Our financial expenses, net, for the year ended December 31, 2010 were $1 million compared to financial income, net of $0.8 million for the year ended December 31, 2011. The change was due to foreign exchange gains, net of $1.4 million in the year ended December 31, 2011 compared to foreign exchange losses, net of $199,000 in the year ended December 31, 2010, as well as increased interest income resulting from our higher level of cash equivalents, short term and long term deposits in 2011, which was offset in part by increased interest expense on a related party loan. Income taxes. We recorded income tax expense of $0.6 million for the year ended December 31, 2010 compared to income tax expense of $0.7 million for the year ended December 31, 2011. Tax expenses primarily relate to the tax expenses of our foreign subsidiaries in Mexico and Germany and a valuation allowance recorded with respect to tax withheld by our clients in 2011. Year Ended December 31, 2010 Compared with Year Ended December 31, 2009 Revenues. Revenues decreased by 8.8% from $54.5 million for the year ended December 31, 2009 to $49.7 million for the year ended December 31, 2010. Revenues from sales of perimeter systems decreased by 15% from $39.1 million in 2009 to $33.3 million in 2010, primarily due to a reduction in sales to the Israeli MOD as well as reduced sales to the Far East markets. Revenues from security turnkey projects increased by 11.9% from $15.4 million in 2009 to $17.2 million in 2010, primarily due to a large project received by our Mexican subsidiary. - 32 - Cost of revenues. Cost of revenues decreased by 6% from $33.4 million for the year ended December 31, 2009 to $31.4 million for the year ended December 31, 2010. This decrease was primarily due to the reduction in revenues. Cost of revenues as a percentage of revenues increased from 61.3% in 2009 to 63.2% in 2010, primarily due to the reduced sales without a matching reduction in fixed costs. Our cost of revenues as a percentage of revenues was adversely impacted by the devaluation in the NIS and Canadian dollar against the U.S. dollar exchange rate in 2010, as the percentage of our cost of revenues denominated in NIS and Canadian dollars is higher than the percentage of revenues denominated in NIS and Canadian dollars. Research and development expenses, net. Research and development expenses, net decreased by 18.9% from $5.1 million for the year ended December 31, 2009 to $4.1 million for the year ended December 31, 2010. The decrease in research and development expenses is primarily attributable to the shutdown of our U.S. subsidiary’s research and development department due to the consolidation of the North American business into one unit in the second quarter of 2009 and a reduction in number of employees in our research and development staff in Canada and Israel. Research and development expenses, net amounted to 9.3% of revenues in 2009, compared to 8.3% in 2010, due to our lower revenues in 2010. Selling and marketing expenses, net. Selling and marketing expenses, net increased by 4.1% from $10.9 million for the year ended December 31, 2009 to $11.3 million for the year ended December 31, 2010. The increase in selling and marketing expenses in 2010 was primarily due to increased sales commissions which derive from the different mix of revenues in 2010 compared with 2009, as well as selling expenses incurred by our Colombian subsidiary, which started its operation in 2010. The increase is also attributable to the appreciation of the NIS and the Canadian dollar against the U.S. dollar in 2010, which increased the U.S. dollar value of our NIS and Canadian dollar denominated expenses. The increase in selling and marketing expenses was offset in part by the reduction in employees in our Canadian subsidiary. Selling and marketing expenses, net amounted to 19.8% and 22.7% of revenues in 2009 and 2010, respectively. General and administrative expenses. General and administrative expenses decreased by 6.3% from $8.1 million for the year ended December 31, 2009 to $7.6 million for the year ended December 31, 2010. The decrease in general and administrative expenses in 2010 was primarily due to the consolidation of the North American business into one unit in the second quarter of 2009, a decrease in legal and accounting expenses and a decrease in stock option expenses. The decrease was partially offset by the appreciation of the NIS and Canadian dollar against the U.S. dollar in 2010, which increased the U.S. dollar value of our NIS and Canadian dollar denominated expenses, and expenses incurred by our Colombian subsidiary, which started its operation in 2010. General and administrative expenses amounted to 14.8% of revenues in 2009 compared to 15.3% in 2010. Impairment of goodwill and other intangible assets. We did not record any impairment of goodwill and other intangible assets for the years ended December 31, 2009 and 2010. Operating loss. We had an operating loss of $2.9 million for the year ended December 31, 2009 compared to an operating loss of $4.7 million for the year ended December 31, 2010. The operating losses of our business segments for the years ended December 31, 2009 and 2010 are as follows: Perimeter products Turnkey projects Eliminations Total Year Ended December 31, 2010 2009 $ $ (In thousands) (1,053) (1,812) $ - (2,865) (1,641) (2,716) (303) (4,660) The operating loss of our perimeter products segment increased from $1.1 million for the year ended December 31, 2009 to $1.6 million for the year ended December 31, 2010, primarily as a result of a lower volume of revenues while a significant amount of our expenses with respect to such segment’s operations are fixed as well as an increase in the U.S. dollar value of our non- U.S. dollar denominated expenses due to changes in foreign currency exchange rates in 2010. The operating loss of our turnkey projects segment increased from $1.8 million for the year ended December 31, 2009 to $2.7 million for the year ended December 31, 2010, primarily as a result of a less profitable mix of projects in 2010 as well as an increase in the U.S. dollar value of our non- U.S. dollar denominated expenses due to changes in foreign currency exchange rates in 2010. - 33 - Financial expenses, net. Financial expenses, net, decreased from $1.6 million for the year ended December 31, 2009 to $1.0 million for the year ended December 31, 2010, a decrease of 38.3%. The decrease was primarily due to foreign exchange losses, net that was offset in part by interest on a related party loan. Income taxes. We recorded income tax expense of $0.9 million for the year ended December 31, 2009 compared to income tax expense of $0.6 million for the year ended December 31, 2010. The decrease in income taxes was primarily as a result of reversing in the 2009 valuation allowance on deferred taxes relating to carry forward tax losses, which was offset in part by increased tax expenses relating to our profitable foreign subsidiaries in Mexico, Colombia and Germany. Seasonality Our operating results are characterized by a seasonal pattern, with a higher volume of revenues towards the end of the year and lower revenues in the first part of the year. This pattern, which is expected to continue, is mainly due to two factors: • • our customers are mainly budget-oriented organizations with lengthy decision processes, which tend to mature late in the year; and due to harsh weather conditions in certain areas in which we operate during the first quarter of the calendar year, certain projects and services are put on hold and consequently payments are delayed. However, in 2011 this pattern was due in great measure to the revenues generated from the 2012 Africa Cup of Nations in Gabon which were recognized mainly in the second half of 2011. Our revenues are dependent on government procurement procedures and practices, and because we receive large product orders from a relatively small number of customers, our revenues and operating results are subject to substantial periodic variations. Impact of Inflation and Currency Fluctuations on Results of Operations, Liabilities and Assets We sell most of our products in Africa, Latin America, 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 and Canada may be adversely affected by the appreciation of the NIS and the Canadian dollar 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 and the Canadian dollar 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 and the Canadian dollar 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 or in Canadian dollars (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 and Canadian dollars or receivables payable in NIS or Canadian dollars (unless such receivables are linked to the U.S. dollar). In addition, the U.S. dollar value of revenues and expenses denominated in NIS or Canadian dollars 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. - 34 - The following table presents information about the rate of inflation in Israel, the rate of devaluation or appreciation of the NIS against the dollar, and the rate of inflation in Israel adjusted for the devaluation: Year ended December 31, 2007 2008 2009 2010 2011 Israeli inflation rate % NIS devaluation (appreciation) rate % Israeli inflation adjusted for devaluation (appreciation) % 3.4 3.8 3.9 2.7 2.2 (9.0) (1.1) (0.7) (6.0) 7.7 12.4 4.9 4.6 8.7 (5.5) 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 2009 and 2010 the Canadian dollar appreciated against the U.S. dollar by 16.6% and 4.9%, respectively, and in 2011 the Canadian dollar depreciated against the U.S. dollar by 2.3%. We recorded foreign currency exchange losses, net of $1,138,000 and $199,000 for the years ended December 31, 2009 and 2010, respectively. In 2011, foreign currency fluctuations had a positive impact on our results of operations and we recorded foreign exchange income, net of $1,394,000. We cannot assure you that in the future our results of operations may not be materially affected by currency fluctuations. To manage this risk, from time to time, we have entered into forward exchange contracts to hedge some of our foreign currency exposure relating to bank deposits and unbilled accounts receivable denominated in foreign currencies. We did not record any financial expenses attributable to forward exchange contract transactions for the years ended December 31, 2009, 2010 and 2011. 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 were generally subject to corporate tax at the rate of 24% in 2011. On December 5, 2011, the Knesset passed the Law for Tax Burden Reform (Legislative Amendments), 2011 ("the Tax Burden Law") which, among others, cancels effective from 2012, the scheduled progressive reduction in the corporate tax rate and increases the corporate tax rate and capital gains tax to 25% in 2012 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 is entitled to 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). - 35 - 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, 2011, we had net deferred tax asset of $303,000 attributable to our subsidiaries. We had total estimated available carryforward tax losses of $12.9 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, 2011, our subsidiaries had estimated total available carryforward tax losses of $9.0 million, which may be used as an offset against future taxable income for periods ranging between 2 and 18 years. As of December 31, 2011, 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. Trade Relations Israel is a member of the United Nations, the International Monetary Fund, the International Bank for Reconstruction and Development and the International Finance Corporation. Israel is a member of the World Trade Organization and is a signatory to the General Agreement on Tariffs and Trade. In addition, Israel has been granted preferences under the Generalized System of Preferences from the United States, Australia, Canada and Japan. These preferences allow Israel to export the products covered by such programs either duty-free or at reduced tariffs. In June 2010, Israel joined the Organization for Economic Co-operation and Development, or the OECD, an international organization whose members are governments of mostly developed economies. The OECD’s main goal is to promote policies that will improve the economic and social well-being of people around the world. Israel and the European Union Community, known as the “European Union,” concluded a Free Trade Agreement in July 1975 that confers some advantages with respect to Israeli exports to most European countries and obligates Israel to lower its tariffs with respect to imports from these countries over a number of years. In 1985, Israel and the United States entered into an agreement to establish a Free Trade Area. The Free Trade Area has eliminated all tariff and some non-tariff barriers on most trade between the two countries. On January 1, 1993, an agreement between Israel and the European Free Trade Association, known as the “EFTA,” established a free-trade zone between Israel and the EFTA nations. In November 1995, Israel entered into a new agreement with the European Union, which includes a redefinition of rules of origin and other improvements, such as allowing Israel to become a member of the Research and Technology programs of the European Union. In recent years, Israel has established commercial and trade relations with a number of other nations, including Russia, China, India, Turkey and other nations in Eastern Europe and the Asia-Pacific region. In addition, Israel has entered into a free trade agreement with the MercoSur countries (Brazil, Paraguay, Argentina and Uruguay) which became effective in June 2010 with respect to Brazil, Paraguay and Uruguay and in September 2011 with respect to Argentina. Generally, the purpose of this agreement is to reduce the custom rates between Israel and these countries and to abolish them completely in certain cases. Israel is the first country outside of Latin America to enter into such an agreement with the MercoSur countries. Recently Issued Accounting Standards In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (ASU 2011-04). This newly issued accounting standard clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This ASU is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011. The adoption of this standard is not expected to have a material impact on our financial position or results of operations. In June 2011, the FASB issued ASU No. 2011-05, Topic 220 - Presentation of Comprehensive Income (“ASU 2011-05”), which requires an entity to present total comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements and eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. This guidance is effective for fiscal years and interim periods beginning after December 15, 2011. The adoption of ASU 2011-05 is not expected to have an impact on our financial position or results of operations. - 36 - In September 2011, the FASB issued ASU No. 2011-08, Topic 350 - Intangibles - Goodwill and Other ("ASU 2011-08"), which amends Topic 350 to allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based the qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This guidance is effective for annual and interim goodwill tests performed for years beginning after December 15, 2011. Early adoption is permitted. The adoption of ASU 2011-08 is not expected to have an impact on our financial statements. In December 2011, the FASB issued ASU No. 2011-11, Topic 2010 - Balance Sheet ("ASU 2011-11"), which contains new disclosure requirements regarding the nature of an entity's rights of set off and related arrangements associated with its financial instruments and derivative instruments. Under U.S. GAAP, certain derivative and repurchase agreement arrangements are granted exceptions from the general off-setting model. To facilitate comparison between financial statements prepared under U.S. GAAP and IFRS, the new disclosure requirement will provide financial statement users information regarding both gross and net exposures. This guidance is effective for annual and interim financial statements beginning on or after January 1, 2013. Retrospective application is required. We do not set off related arrangements associated with our financial instruments and derivative instruments. As such the adoption of ASU 2011-11 is not expected to have an impact on our consolidated results of operations or financial condition. In December 2011, the FASB issued Accounting Standards Update ("ASU") No. 2011-12, Topic 220 - Comprehensive Income ("ASU 2011-12"), which indefinitely deferred certain provisions of ASU 2011-05, including the requirement to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented. This amendment is effective for both annual and interim financial statements beginning after December 15, 2011. The adoption of ASU 2011-12 is not expected to have a material impact on our financial position or results of operations. B. Liquidity and Capital Resources. From our inception until our initial public offering in March 1993, we financed our activities mainly through cash flow from operations and bank loans. In March 1993, we received proceeds of $9.8 million from an initial public offering of 1,380,000 ordinary shares. In February 1997, we raised $9.4 million from a follow-on offering of 2,085,000 ordinary shares, in April 2005, we raised an additional $14.9 million from a follow-on offering of 1,700,000 ordinary shares, and in July and August 2011, we raised $16.2 million in connection with a rights offering of 5,273,274 ordinary shares and a private placement of 150,000 of our 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 for the sale, including repayment in full of Euro 1.8 million of loans granted by us to the European subsidiary. In addition, Euro 620,000 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. - 37 - We expect that our total research and development expenses in 2012 will be approximately $4.5 million. Our research and development plan for 2012 covers the following main areas: • • • Sensor development - We intend to continue the development of new and innovative sensors based on existing, new and hybrid technologies. Most of the development will be based on in-house competencies, however we may acquire some know-how externally. Sensor improvements – We are conducting an ongoing program of improvement of our existing sensors in order to enhance performance, reliability and capability to source and produce and reduce cost. Security Management Systems – We intend to continue to develop our two levels of security management systems: o High-end systems – Physical security information management systems, mainly used as part of a turnkey solution, as a comprehensive command and control solution, designed for entities requiring management of security, safety, site management and dispatching. These systems are designed to manage both daily routines and crisis situations. o Low-end systems – Basic SMS typically used for managing and controlling the PIDS of a site. We are also developing an interface package to facilitate integration of our sensors into a third party SMS/command and control system. o Video systems – We will continue to develop our video management software to improve the IVA and cope with advanced video protocols such as regular IP streaming, megapixel and high definition video cameras. To allow us to begin to implement our 2010 strategic plan, on September 8, 2010, Ki Corporation, a company affiliated with Mr. Nathan Kirsh, our principal shareholder and a director, provided us with a bridge loan in the principal amount of $10.0 million. To repay the loan and to raise permanent capital for general working capital purposes, including facilitating the implementation of our new business strategy, during 2011 we effectuated a private placement and a rights offering. On June 17, 2011, we completed a private placement of 150,000 of our ordinary shares to Ki Corporation at an initial price per share of $3.04, which was equal to the closing price of our ordinary shares on the NASDAQ Global Market on June 16, 2011. Upon the record date of the rights offering, the price per share paid by Ki Corporation was adjusted to $3.05, which was the closing price of our ordinary shares on the NASDAQ Global Market on the date prior to the record date of the rights offering. The private placement consideration from Ki Corporation was paid to us by means of a partial offset against its outstanding loan to us. The private placement was approved by our shareholders at an extraordinary general meeting so that Ki Corporation could fully participate in the rights offering in compliance with Israeli law. The net proceeds from the rights offering was approximately $15.8 million, after deducting expenses related to the rights offering payable by us of approximately $207,000. In September 2010, we sold a 20,000 square foot facility in Fremont, California that formerly served as a manufacturing and sales facility for aggregate proceeds of $2.1 million. Our working capital at December 31, 2010 and 2011, was $26.6 million and $40.5 million, respectively. Cash and cash equivalents amounted to $16.6 million at December 31, 2010 compared to $32.6 million at December 31, 2011. Short-term and long-term bank deposits, restricted bank deposits and escrow deposits amounted to $4.9 million at December 31, 2010 compared to $7.5 million at December 31, 2011. Our cash and cash equivalents, short and long-term bank deposits are held in various banks, mainly in U.S. dollars, Euros and NIS. As a result of our recent financings, we believe that our cash and cash equivalents, bank facilities, bank deposits and our expected cash flows from operations in 2012 will be sufficient to meet our cash requirements through 2013. 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. - 38 - Cash Flows The following table summarizes our cash flows for the periods presented: Net cash provided by (used in) continuing operations Net cash (used in) provided by discontinued operations Net cash provided by (used in) operating activities Net cash provided by (used in) investing activities Net cash provided by (used in) financing activities Effect of exchange rate changes on cash and cash equivalents Increase (decrease) in cash and cash equivalents Cash and cash equivalents at the beginning of the year Cash and cash equivalents at the end of the year $ 2009 5,651 120 5,771 3,988 (14,514) (211) (4,966) 16,835 11,869 Year ended December 31, 2010 (in thousands) $ (3,980) $ (17) 2011 (3,997) (1,116) 8,709 1,131 4,727 11,869 16,596 20,418 - 20,418 (3,611) 1,833 (2,614) 16,026 16,596 32,622 Net cash provided by operating activities was approximately $20.4 million in the year ended December 31, 2011 compared to net cash used in operating activities of $4 million in the year ended December 31, 2010 and net cash provided by operating activities of $5.7 million in the year ended December 31, 2009. Net cash provided by operating activities in the year ended December 31, 2011 was primarily attributable to $1.2 million of depreciation and amortization expense, $0.4 million of stock based compensation, a decrease in trade accounts receivables and inventories of $1.2 million and $0.2 million, respectively, an increase of $6.1 million in other accounts payable and accrued expenses, an increase of $3.2 million in trade payables, an increase of $3.9 million in customer advances and an increase of $0.3 million in accrued severance pay. This was offset in part by an increase of $2.4 million in unbilled accounts receivables, an increase of $3.3 million in other accounts receivable and prepaid expenses, an increase of $0.2 million in accrued interest and exchange differences on short term and long term deposits and long term loans and an increase in deferred income taxes of $0.1 million. The significant increase in net cash provided by operating activities was due in part to the special terms and timing of the receipts and payments of projects performed in 2011 and may not be indicative of future operating performance. Net cash used in operating activities in the year ended December 31, 2010 was primarily attributable to an increase of $2.8 million in trade receivables, an increase of $1.2 million in other accounts receivable and prepaid expenses, an increase of $0.5 million in accrued interest and exchange differences on short term and long term deposits and long term loans, an increase in deferred income taxes of $0.2 million and a decrease of $0.3 million in trade payables. This was offset in part by $1.1 million of depreciation and amortization expense, a decrease in unbilled accounts receivables and long term trade receivables of $3.2 million and $0.3 million, respectively, $0.9 million of stock based compensation, a decrease of $1 million in inventory, a $0.2 million write-off of long term loans and an increase of $0.4 million in other accounts payable and accrued expenses. 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 an increase 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 accounts payable and accrued expenses and by a gain from discontinued operations of $4.2 million. Net cash used in investing activities was approximately $3.6 million for the year ended December 31, 2011 compared to net cash used in investing activities of approximately $1.1 million for the year ended December 31, 2010 and net cash provided by investing activity of approximately $4.0 million for the year ended December 31, 2009. In the year ended December 31, 2011, our investments in restricted long term and short term bank deposits were $2.0 million and $3.2 million, respectively and we purchased $1.2 million and $28,000, respectively, of property and equipment and know-how and patents. These amounts were offset in part by the sale of short term bank deposits of $31,000, the realization of $2.8 million from the release of funds from a restricted deposit and proceeds of $50,000 from sale of property and equipment. - 39 - In the year ended December 31, 2010, our investments in restricted long term and short term bank deposits were $2.1 million and $3 million, respectively and we purchased $0.4 million and $24,000, respectively, of property and equipment and know-how and patents. These amounts were offset in part by the sale of short term bank deposits of $1.9 million, the realization of $0.5 million from the release of funds from a restricted deposit and proceeds of $2.1 million from sale of property and equipment. 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, 2011, net cash provided by financing activities was $1.8 million, primarily attributable to the $16.2 million derived from the rights offering and the private placement that were effectuated during 2011. This was offset by the repayment of a $10.4 million bridge loan received from Ki Corporation, a company affiliated with Mr. Nathan Kirsh, our principal shareholder, and the repayment of short term and long term bank credit of $3.5 million and $0.5 million, respectively. In the year ended December 31, 2010, net cash provided by financing activities was $8.7 million, primarily attributable to the $10 million bridge loan that we received from Ki Corporation, a company affiliated with Mr. Nathan Kirsh, our principal shareholder and a director and an increase in short term bank credit of $0.5 million, which amounts were offset in part by the repayment of long term loans of $1.9 million. 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. We had capital expenditures of approximately $2.0 million, $0.4 million and $1.2 million in the years ended December 31, 2009, 2010 and 2011, 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 2012 will total approximately $0.9 million, 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 and changes in the demand for our products. Credit Lines and Other Debt Short-term and long-term bank credit at December 31, 2010 and 2011 was $9.9 million and $5.4 million, respectively. Our highest level of short-term and long-term bank borrowings in the years ended December 31, 2010 and 2011, was $10.6 million and $9.9 million, respectively. We currently have credit lines with Bank Leumi Le-Israel B.M., or Bank Leumi, Union Bank of Israel Ltd., or Union Bank, and Bank Hapoalim B.M. totaling $19.4million in the aggregate (of which $9.5 million is reserved exclusively for guarantees) and $7.6 million was available at December 31, 2011. 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 charge 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 NIS. As of December 31, 2011, we were 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 the Royal Bank of Canada and Deutsche Bank, totaling $5.2 million in the aggregate, of which $3.1 million was available at December 31, 2011. 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 $10.0 million. As of December 31, 2011, our Canadian subsidiary was in compliance with these ratios and terms. - 40 - As of December 31, 2011, our outstanding balances under our credit lines in Israel consisted of: • • • • Short-term NIS-denominated loans of approximately $5.3 million, bearing interest at an average rate of 4.7%; Long-term NIS-denominated loans of approximately $0.07 million, bearing interest at an average rate of 4.3%; and Short-term Euro-denominated bank credit of approximately $0.09 million, bearing interest at an average rate of 8.4%; and Several bank performance and advance payment guarantees totaling approximately $6.4 million, at an annual cost of 1%-1.5%. As of December 31, 2011, the outstanding balances under the credit lines of our subsidiaries consisted of several bank performance and advance payment guarantees totaling approximately $2.1 million, at an annual cost of 1.5% -1.8%. 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, 2009, 2010 and 2011. We are obligated to pay royalties to the OCS amounting to 3.5% 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, 2009, 2010 and 2011, we paid the OCS royalties in the amount of $172,000, $0 and $68, respectively. These royalties related to sales of perimeter security products and management security systems. As of December 31, 2011, we had a contingent obligation to pay royalties to the OCS in the amount of approximately $1.3 million upon the successful sale of perimeter security products developed under 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 between the year the grant was received and the years after, up to the amount of the grants we received. During the years ended December 31, 2009, 2010 we did not pay any royalties. During 2011, we paid $82,000 which was the entire remaining balance and extinguished our liability so as of December 31, 2011, had a no remaining contingent obligation to the Fund. 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, 2009, 2010 and 2011, our Canadian subsidiary recognized $167,000, $239,000 and $268,000, respectively, of investment tax credits. In addition, as of December 31, 2011, our Canadian and U.S. subsidiaries had available investment tax credits of approximately $1.2 million to reduce future federal and provincial income taxes payable. These credits will expire in 2026 through 2031. As of December 31, 2011, our subsidiaries made a full valuation allowance in respect of such investment tax credits. - 41 - D. Trend Information. We returned to profitability in 2011 after three years of losses that were primarily attributable to the global economic slowdown and the reduction in government spending that began in the latter part of 2008. During 2011, delayed orders and new projects in certain territories were reinstated, which allowed us to increase our revenues. To the extent this reversal continues in 2012, we believe that the combination of increased revenues and the impact of the cost saving measures we initiated in 2009 and 2010 will result in profitable operations. As of December 31, 2011, our backlog amounted to approximately $50.1 million, of which approximately $43.1 million is expected to be delivered by the end of 2012 and $7.0 million is expected to be delivered thereafter. This amount is consistent with our backlog of $50.2 million as of December 31, 2010. 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, 2011 and the effect we expect them to have on our liquidity and cash flow in future periods. Contractual Obligations Total Less than 1 year Long-term bank debt obligations Operating lease obligations Purchase obligations Other long-term liabilities reflected on our balance sheet under U.S. GAAP Total $ $ $ $ $ 71 2,848 1,034 3,605 7,558 $ $ $ $ Payments due by period 1-2 years (in thousands) 38 $ 902 $ - 33 827 1,034 - 1,894 $ - 940 3-5 years More than 5 years $ $ - 315 - $ - 315 $ $ - 804 - 3,605 4,409 In addition, we have guaranteed advance payments, the performance of our work and provided warranties for the performance of our work to certain of our customers (usually governmental 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 performance guarantees typically expire soon after certain milestones are met and warranty guarantees typically expire at the end of the warranty period. The maximum potential amount of future payments we could be required to make under our guarantees at December 31, 2011 was $8.5 million. 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 an airport project in Eastern Europe. See Item 8.A - “Consolidated Statements and Other Financial Information-Legal Proceedings.” ITEM 6. Directors, Senior Management and Employees A. Directors and Senior Management. Set forth below are the name, age, principal position and a biographical description of each of our directors and executive officers: - 42 - Name Jacob Perry(1) Eitan Livneh Hagai Katz Asaf Even-Ezra Yehonatan Ben-Hamozeg Ilan Ovadia Jacob Even-Ezra (1) Mark Rosenberg Shaul Kobrinsky(1)(2)(3) Zeev Livne(1) Jacob Nuss(3) Barry Stiefel Liza Singer (1)(2)(3) ______________ (1) Member of our mergers and acquisitions committee. (2) Member of our audit committee. (3) Member of our investment committee. Age 68 58 60 45 53 45 81 47 59 66 63 61 41 Position Chairman of the Board of Directors President and Chief Executive Officer Senior Vice President – Marketing and Business Development Senior Vice President –Worldwide Sales Senior Vice President – Product Development and Projects Senior Vice President – Finance, Chief Financial Officer and Secretary Director Director External Director Director Director Director External Director 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. Mr. Perry previously served as the president and chief executive officer 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. Mr. Perry 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 and 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 senior vice president - marketing and business development since July 2010, and previously served as our general manager, Israel division and corporate vice president - marketing and products from 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 a 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. - 43 - 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 Israel Defense Forces, or 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. Previously, Mr. Ovadia served as the chief financial officer and vice president of Operations of Elgo Irrigation Ltd. and as financial manager of Shapir Marine and Civil Engineering Ltd., an infrastructure and contracting 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. Jacob Even-Ezra has served as a director since 1984 and from 1984 until December 2007, Mr. Even-Ezra served as the chairman of our board of directors. From 1984 until 2006, Mr. Even- Ezra 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. 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. Shaul Kobrinsky has served as an outside director since July 2004 and is the chairman of our Audit 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 also served as senior managing director of Alagem Capital Group, a Beverly Hills based investment group. Previously, Mr. Kobrinsky served as chief executive officer of Cargal Ltd., an Israeli company that manufactures corrugates and as deputy managing director of Clal Industries Ltd., a holding and investment company. Mr. Kobrinsky holds a B.A. degree in Economics from Tel Aviv University. Mr. Kobrinsky is a member of the Antitrust Court of the State of Israel. 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, Mr. Livne served as the Defense Attaché to the United States and Canada, Military Secretary to the Prime Minister of Israel and Ground Force Commander. He also 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. Jacob Nuss has served as a director since 1993. Mr. Nuss has served as the vice president - internal auditing of Israel Aircraft Industries Ltd., or IAI, since 2004. He previously served as IAI’s deputy vice president - internal auditing, director of finance of IAI’s electronics group and as assistant to the chairman of the board of directors of IAI. 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. Mark Rosenberg has served as a director since 2011 and as an alternate director on behalf of Mr. Kirsh on the Board of Directors since 2008. Since May 2007, Mr. Rosenberg has served in various senior positions with the Kirsh Family Office. From 2001 until 2007, Mr. Rosenberg served as the managing director of JDR Reactive Limited, a property maintenance company that he founded and subsequently sold. Previously, Mr. Rosenberg served as Director of New Business Development and legal officer of Leaf (Pty) Ltd., a South African mobile telecommunications company, Director of the Private Equity, M&A and Black Empowerment Investment Division of Fusion Capital Limited, a South African listed financial services group and as a Senior Manager, Investment Banking Division of Standard Bank of SA Limited. Mr. Rosenberg also served as an Articled Clerk and then as a senior professional with Edward Nathan & Friedland, Attorneys in South Africa and was a University Law Lecturer. Mr. Rosenberg holds a Bachelor of Commerce degree, a Bachelor of Law degree and a Higher Diploma in Company Law, all of which were granted by the University of the Witwatersrand in South Africa. - 44 -  Barry Stiefel has served as a director since November 2008. Mr. Stiefel is the Manager of the Kirsh Family Office in London, England. The Kirsh Family Office administers and monitors the investments made by the Kirsh Group worldwide. Ki Corporation, which is owned by the Kirsh Group, is the largest shareholder of our company. 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 number of companies, including Premedia Limited and its subsidiaries. Previously, Mr. Stiefel was the chief executive officer of Meridian VAT Reclaim Group, which he founded, as a consultant in the field of trade finance and 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 the Witwatersrand. Mr. Stiefel is a chartered accountant in South Africa and is registered as an auditor (not in public practice) in the United Kingdom. Liza Singer has served as an external director since June 2010. Ms. Singer has served since 2003 as the owner’s representative of the Lewis Trust Group, an investment assessment and development entity that focuses on tourist projects and the development of marine and hotels resorts. During 2007, Ms. Singer also served as the chief operating officer and country manager of Brack Capital Real Estate. Previously, Ms. Singer served as the Vice President of Business Development of the Baran Group, a provider of engineering and construction services, as investment director of Syntek Capital, a private-equity investment company and as an associate at APAX Partners & Co., a venture capital fund. Ms. Singer was also an accountant at Kesselman & Kesselman, the Israeli member firm of PriceWaterhouseCoopers. Ms. Singer has an LLB degree, a B.A. degree in accounting and an M.B.A. degree, all from Tel Aviv University. Ms. Singer is a certified public accountant (Israel) and a registered lawyer with the Israeli Bar Association. All of our directors were elected at our 2011 annual general meeting held on August 31, 2011. Messrs. Perry, Even-Ezra, Kirsh, Livne, Nuss and Stiefel will serve as directors until our 2012 annual general meeting of shareholders. Mr. Kobrinsky and Ms. Singer, who were elected to serve as external directors within the meaning of the Israeli Companies Law, will serve for three year terms. B. Compensation. During the year ended December 31, 2011, our executive officers and directors as a group (consisting of 13 persons) earned aggregate compensation of approximately $3.5 million for their services as officers and directors, of which $1.8 million was paid in 2011. As of December 31, 2011, 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 $1.9 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. We pay Mr. Perry, the chairman of our board of directors, a monthly salary of NIS 50,000 (approximately $14,088). Such compensation is linked to the Israeli consumer price index and is adjusted every six months. As of March 31, 2011, the adjusted salary amounted to NIS 54,295 (approximately $14,210). Mr. Perry is also entitled to an annual bonus equal to 5% of our company’s annual income before taxes, but in any event not more than $500,000 per year, provided that our senior management is entitled to receive performance bonuses for the given year. In addition, Mr. Perry is entitled to the following benefits: an executive level car, mobile phone, daily newspaper and reimbursement of home communication expenses up to NIS 1,000 a month (approximately $262) against receipts. However, we will not be obliged to provide such benefits to the extent that such benefits are provided to Mr. Perry by another employer. Currently Mr. Perry’s car, mobile phone, 60% of his home communication expenses and a daily newspaper are provided to Mr. Perry by another employer. 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 66,870 (approximately $17,501) and a fee of NIS 2,490 (approximately $652) 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 2010 and February 2011. - 45 - As of December 31, 2011, our directors and executive officers as a group, then consisting of 13 persons, held options to purchase an aggregate of 868,000 ordinary shares, having exercise prices ranging from $3.48 to $7.59. Generally, the options vest over a two to four years period. Of such options, options to purchase 83,336 ordinary shares expire in August 2014; 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, 48,500 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 ordinary shares expire in each of 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 Stock Market 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. 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. Liza Singer has the requisite “accounting and financial expertise.” We do not follow the requirements of the NASDAQ Stock Market 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 as well as a sibling, brother, sister or parent of the foregoing relatives. 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. Furthermore, if the company does not have a controlling shareholder or a shareholder holding at least 25% of the voting rights, “affiliation” also includes a relationship, at the time of the appointment, with the chairman of the board, the chief executive officer, a substantial shareholder or the most senior financial officer of such company. 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 - 46 - At least one of the elected external directors must have “accounting and financial expertise” and any other external director must have “accounting and financial expertise” or “professional qualification,” as such terms are defined by regulations promulgated under the Israeli Companies Law. However, Israeli companies listed on certain stock exchanges outside Israel, including The NASDAQ Global Market, such as our company, are not required to appoint an external director with “accounting and financial expertise” if a director with accounting and financial expertise who qualifies as an independent director for purposes of audit committee membership under the laws of the foreign country in which the stock exchange is located serves on its board of directors. All of the external directors of such a company must have “professional qualification.” The external directors are elected by shareholders at a general meeting. The shareholders voting in favor of their election must include at least simple majority of the shares voted by shareholders other than controlling shareholders or shareholders who have a personal interest in the election of the outside director (unless such personal interest is not related to such persons relationship with the controlling shareholder). This majority requirement will not be required if the total number of shares of such non-controlling shareholders and disinterested shareholders who vote against the election of the outside director represent 2% or less of the voting rights in the company. In general, under the Israeli Companies Law external directors serve for a three-year term and may be reelected to two (2) additional three-year terms. 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. Pursuant to the Israeli Companies Law the term of office of an external director may be extended by the shareholders following the initial three year term for two additional three years terms, at the nomination of either the board of directors or any shareholder(s) holding at least 1% of the voting rights in the company. If the board of directors proposed the nominee, the reelection must be approved by the shareholders in the same manner required to appoint external directors for an initial term, as described above. If such reelection is proposed by shareholders, such reelection requires the approval of the majority of the shareholders voting on the matter, excluding the votes of any controlling shareholder and other shareholders having a personal interest in the matter as a result of their relationship with the controlling shareholder(s), provided that, the aggregate votes cast by shareholders who are not controlling shareholders and do not have a personal interest in the matter as a result of their relationship with the controlling shareholder(s) who voted in favor of the nominee constitute more than 2% of the voting rights in 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 and the Financial Statements Review 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. - 47 - Independent Directors. In general, NASDAQ Stock Market 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 Stock Market 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 Stock Market 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. 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. Our board of directors has determined that Ms. Singer and Mr. Kobrinsky qualify both as independent directors under the requirements of the Securities and Exchange Commission and NASDAQ and as external directors under the requirements of the Israeli Companies Law. Our board of directors has further determined that Messrs. Nuss and Livne qualify as independent directors under the requirements of the Securities and Exchange Commission and NASDAQ. Audit Committee Under the Israeli Companies Law, the board of directors of any public company must establish an audit committee. The audit committee must consist of at least three directors and must include all of the external directors, the majority of which must be independent directors. Such independent directors must meet all of the standards required of an external director and may not serve as a director for more than consecutive nine years (a cessation of service as a director for up to two years during any nine year period will not be deemed to interrupt the nine year period). 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; a controlling shareholder or any of the controlling shareholder’s relatives; and any director who rendered services to the controlling shareholder or an entity controlled by the controlling shareholder. Any person who is not permitted to be a member of the audit committee may not be present in the meetings of the audit committee unless the chairman of the audit committee determines that such person’s presence is necessary in order to present a specific matter. However, an employee who is not a controlling shareholder or relative of a controlling shareholder may participate in the audit committee’s discussions but not in any vote, and at the request of the audit committee, the secretary of the company and its legal counsel may be present during the meeting. The responsibilities of the audit committee include, among others, identifying irregularities in the management of the company’s business, approving related party transactions as required by law, review of the internal controls of the company, the internal auditor’s audit plan and the independent auditor’s engagement and compensation. The audit committee is also required to establish and monitor whistleblower procedures. 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 Stock Market 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 is currently composed of Messrs. Shaul Kobrinsky and Jacob Nuss and Ms. Liza Singer, who satisfy the respective “independence” requirements of the Securities and Exchange Commission and NASDAQ. Mr. Kobrinsky and Ms. Singer also comply with requirements of independence under the Israeli law for audit committee members. The audit committee meets at least once each quarter. Our audit committee charter is available on our website at www.magal-s3.com. - 48 - 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 Kobrinsky and Ms. Singer. 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, Livne and 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. 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. - 49 - Under the Israeli Companies Law, all arrangements as to compensation of office holders who are not directors require the approval of the audit committee (or the compensation committee to the extent the company has established such a committee) prior, and in addition, to the approval of the board of directors. However, the approval of the board of directors is not required if the new arrangement only modifies an existing arrangement and the audit committee determines that such modification is not material. The compensation of office holders who are directors must be approved by the 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 also 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, board of directors and shareholders. The shareholder approval for such a transaction must include at least a simple majority of the shareholders voted on the matter, excluding the votes of shareholders who have a personal interest in such transaction. This majority requirement will not apply if the total number of shares of disinterested shareholders who vote against the approval of the transaction represent less than 2% of the voting rights in the company. Under the Companies Regulations (Relief from Related Party Transactions), 5760-2000, promulgated under the Israeli Companies Law, as amended, certain extraordinary transactions between a public company and its controlling shareholder(s) do not require shareholder approval. In addition, under such regulations, directors’ compensation and employment arrangements in a public company do not require the approval of the shareholders if both the audit committee and the board of directors agree that such arrangements are solely for the benefit of the company. Also, employment and compensation arrangements for an office holder that is a controlling shareholder of a public company do not require shareholder approval if certain criteria are met. The foregoing exemptions from shareholder approval will not apply if one or more shareholders holding at least 1% of the issued and outstanding share capital of the company or of the company’s voting rights, objects to the use of these exemptions provided that such objection is submitted to the company in writing not later than fourteen days from the date of the filing of a report regarding the adoption of such resolution by the company. If such objection is duly and timely submitted, then the transaction or compensation arrangement of the directors will require shareholders’ approval as detailed above. In addition, a private placement of securities requires the approval of the board of directors and shareholders of the company if (i) the private placement will cause a person to become a controlling shareholder or (ii) 20% or more of the company’s outstanding share capital prior to the private placement are offered and the payment for which (in whole or in part) is not in cash or registered securities or that is not under market terms, and the private placement will increase the relative holdings of a shareholder that holds 5% or more of the company’s outstanding share capital or will cause any person to become a holder of more than 5% of the company’s outstanding share capital. Other than as described, under Israeli law private placements require the approval of the board of directors. - 50 - The Israeli Companies Law provides that an acquisition of shares in a public company must be made by means of a tender offer if as a result of the acquisition the purchaser would become a 25% or greater shareholder of the company. This rule does not apply if there is already another 25% or greater shareholder of the company. Similarly, the Israeli Companies Law provides that an acquisition of shares in a public company must be made by means of a tender offer if as a result of the acquisition the purchaser would hold greater than a 45% interest in the company, unless there is another shareholder holding more than a 45% interest in the company. These requirements do not apply if, in general, (i) the acquisition was made in a private placement that received shareholder approval, (ii) was from a 25% or greater shareholder of the company which resulted in the acquirer becoming a 25% or greater shareholder of the company, if there is not already a 25% or greater shareholder of the company, or (iii) was from a shareholder holding a 45% interest in the company which resulted in the acquirer becoming a holder of a 45% interest in the company if there is not already a 45% or greater shareholder of the company. If, as a result of an acquisition of shares, the acquirer will hold more than 90% of a public company’s outstanding shares or a class of shares, the acquisition must be made by means of a tender offer for all of the outstanding shares or a class of shares. If less than 5% of the outstanding shares are not tendered in the tender offer, all the shares that the acquirer offered to purchase will be transferred to the acquirer. If more than 5% of the outstanding shares are not tendered in the tender offer, then the acquirer may not acquire shares in the tender offer that will cause his shareholding to exceed 90% of the outstanding shares. The Israeli Companies Law provides for appraisal rights if any shareholder files a request in court within six months following the consummation of a full tender offer. However, in the event of a full tender offer, the offeror may determine that any shareholder who accepts the offer will not be entitled to appraisal rights. Such determination will be effective only if the offeror or the company has timely published all the information that is required to be published in connection with such full tender offer pursuant to all applicable laws. Exculpation, Indemnification and Insurance of Directors and Officers Exculpation of Office Holders. The Israeli Companies Law provides that an Israeli company cannot exculpate an office holder from liability with respect to a breach of his or her fiduciary duty. If permitted by its articles of association, a company may exculpate in advance an office holder from his or her liability to the company, in whole or in part, with respect to a breach of his or her duty of care. However, a company may not exculpate in advance a director from his or her liability to the company with respect to a breach of his duty of care in the event of distributions. Office Holders’ Insurance. Israeli law provides that a company may, if permitted by its articles of association, enter into a contract to insure its office holders for liabilities incurred by the office holder with a respect to an act performed in his or her capacity as an office holder, as a result of: (i) a breach of the office holder’s duty of care to the company or another person; (ii) a breach of the office holder’s fiduciary duty to the company, provided that the office holder acted in good faith and had reasonable cause to assume that the act would not prejudice the company’s interests; and (iii) a financial liability imposed upon the office holder in favor of another person. Indemnification of Office Holders. Under Israeli law a company may, if permitted by its articles of association, indemnify an office holder for acts performed by the office holder in such capacity for (i) a monetary liability imposed upon the office holder in favor of another person by any court judgment, including a settlement or an arbitration award approved by a court; (ii) reasonable litigation expenses, including attorney’s fees, actually incurred by the office holder as a result of an investigation or proceeding instituted against him by a competent authority, provided that such investigation or proceeding concluded without the filing of an indictment against the office holder or the imposition of any monetary liability in lieu of criminal proceedings, or concluded without the filing of an indictment against the office holder and a monetary liability was imposed on him or her in lieu of criminal proceedings with respect to a criminal offense that does not require proof of criminal intent; and (iii) reasonable litigation expenses, including attorneys’ fees, actually incurred by the office holder or imposed upon the office holder by a court: in an action, suit or proceeding brought against the office holder by or on behalf of the company or another person, or in connection with a criminal action in which the office holder was acquitted, or in connection with a criminal action in which the office holder was convicted of a criminal offence that does not require proof of criminal intent. Israeli law provides that a company’s articles of association may permit the company to (a) indemnify an office holder retroactively, following a determination to this effect made by the company after the occurrence of the event in respect of which the office holder will be indemnified; and (b) undertake in advance to indemnify an office holder, except that with respect to a monetary liability imposed on the office holder by any judgment, settlement or court-approved arbitration award, the undertaking must be limited to types of occurrences, which, in the opinion of the company’s board of directors, are, at the time of the undertaking, foreseeable due to the company’s activities and to an amount or standard that the board of directors has determined is reasonable under the circumstances. - 51 - Limitations on Exculpation, Insurance and Indemnification. The Israeli Companies Law provides that neither a provision of the articles of association permitting the company to enter into a contract to insure the liability of an office holder, nor a provision in the articles of association or a resolution of the board of directors permitting the indemnification of an office holder, nor a provision in the articles of association exculpating an office holder from duty to the company shall be valid, where such insurance, indemnification or exculpation relates to any of the following: (i) a breach by the office holder of his fiduciary duty unless, with respect to insurance coverage or indemnification, the office holder acted in good faith and had a reasonable basis to believe that the act would not prejudice the company; (ii) a breach by the office holder of his duty of care if such breach was committed intentionally or recklessly, unless the breach was committed only negligently; (iii) any act or omission done with the intent to unlawfully yield a personal benefit; or (iv) any fine or forfeiture imposed on the office holder. Pursuant to the Israeli Companies Law, exculpation of, procurement of insurance coverage for, and an undertaking to indemnify or indemnification of, our office holders must be approved by our audit committee and board of directors and, if the office holder is a director, also by our shareholders. Our Articles of Association allow us to insure, indemnify and exempt our office holders to the fullest extent permitted by Israeli law. We maintain a directors’ and officers’ liability insurance policy with a per claim and aggregate coverage limit of $20 million, including legal costs incurred in Israel. In addition, our audit committee, board of directors and shareholders resolved to indemnify our office holders, pursuant to a standard indemnification agreement that provides for indemnification of an office holder in an amount up to $5 million. To date, we have provided letters of indemnification to certain of our officers and directors. Pursuant to the Law for Efficient Enforcement Process in the Securities Authority (Legislation Amendment) 5771-2011, or the Enforcement Law, the Israel Securities Authority, or ISA, may impose fines on public companies, their senior office holders and employees, for certain actions or omissions stipulated in the Enforcement Law. In addition, pursuant to the Companies Law the ISA has administrative and enforcement authority with respect to certain breaches of corporate governance rules enumerated in the Israeli Companies Law, and the restrictions and limitations on insurance and indemnification of officeholders apply also to proceedings conducted by the ISA pursuant to the Israeli Companies Law. Generally, the Enforcement Law applies only to companies whose shares are listed on the TASE, including dual listed companies. Although we are currently listed only on the NASDAQ Global Market, ISA has enforcement authority pursuant to the Enforcement Law with respect to the period in which we were dual listed. While almost all of the enumerated actions and omissions that are subject to fines do not apply to dual listed companies, the ISA may impose fines on us or our office holders if we did not make a public filing in Israel of any information or report that was publicly filed with the Securities and Exchange Commission, or if we did not furnish any information that was required by the ISA. Furthermore, since our rights offerings was also made pursuant to a prospectus under the Israeli Securities Law, ISA has full enforcement authority with respect to the disclosure made by us in such prospectus. Pursuant to the Enforcement Law, a company may not purchase, directly or indirectly, insurance for these proceedings and such insurance if purchased is void. The Enforcement Law further provides that a company or its controlling shareholder may not, directly or indirectly, indemnify the office holders or employee against, or otherwise pay, fines that were imposed on them pursuant to the Enforcement Law. However, under the Enforcement Law, if permitted by a company’s articles of association, a company is entitled to purchase insurance and indemnify for payment of damages to any injured person and for expenses incurred by office holders or employees in connection with proceedings conducted against them, including reasonable litigation expenses such as legal fees. A company may undertake to provide such indemnification in advance. Accordingly, at our 2011 annual general meeting, our shareholders approved amendments to our Articles of Association allowing us to indemnify and insure our office holders against certain expenses and payments incurred by them or imposed on them as a result regulatory administrative enforcement actions, and also approved an amended indemnification letter to our office holders to implement such changes. - 52 - D. Employees. As of December 31, 2011, we employed 279 full-time employees, of whom 39 were employed in general management and administration, 45 were employed in selling and marketing, 16 were employed in production management, 140 were employed in production, installation and maintenance, and 39 were employed in engineering and research and development. Of such full- time employees, 130 were located in Israel, 12 were in the United States, 82 were in Canada and 55 were in various other countries. As of December 31, 2010, we employed 252 full-time employees, of whom 38 were employed in general management and administration, 36 were employed in selling and marketing, 16 were employed in production management, 128 were employed in production, installation and maintenance, and 34 were employed in engineering and research and development. Of such full- time employees, 120 were located in Israel, 10 were in the United States, 77 were in Canada and 45 were in various other countries. As of December 31, 2009, we employed 282 full-time employees, of whom 40 were employed in general management and administration, 36 were employed in selling and marketing, 21 were employed in production management, 145 were employed in production, installation and maintenance, and 40 were employed in engineering and research and development. Of such full- time employees, 152 were located in Israel, 14 were in the United States, 76 were in Canada and 40 were in various other countries. Our relationships with our employees in Israel are governed by Israeli labor legislation and regulations, extension orders of the Israeli Ministry of Labor and personal employment agreements. We are subject to various Israeli labor laws, collective bargaining agreements entered into from time to time between the Manufacturers Association and the Histadrut, as well as collective bargaining arrangements. Such laws, agreements and arrangements cover a wide range of areas, including minimum employment standards, such as working hours, minimum wages, vacation, procedures for dismissing employees, severance pay and pension plans and special issues, such as equal pay for equal work, equal opportunity in employment and employment of youth and army veterans. Certain of our employees are parties to individual employment agreements. We generally provide our employees with benefits and working conditions beyond the required minimums. Each of our subsidiaries provides a benefits package and working conditions which are competitive with other companies in their area of operations. Israeli law requires severance pay upon certain circumstances, including upon the retirement or death of an employee or termination of employment without due cause. Furthermore, Israeli employees and employers are required to pay predetermined sums to the National Insurance Institute, which is similar to the U.S. Social Security Administration, which amounts also include payments for national health insurance. E. Share Ownership. The following table sets forth certain information regarding the ownership of our ordinary shares by our directors and executive officers as of March 30, 2012. Name Jacob Perry (3)(4) Eitan Livneh (5) Hagai Katz Asaf Even-Ezra (6) Yehonatan Ben-Hamozeg Ilan Ovadia Jacob Even-Ezra (7) Shaul Kobrinsky Zeev Livne Jacob Nuss Mark Rosenberg Barry Stiefel Liza Singer All directors and executive officers as a group (13 persons) - 53 - Number of Ordinary Shares Owned(1) 268,166 234,802 73,500 242,126 67,000 59,140 712,862 - - - - - 14,000 1,671,596 Percentage of Outstanding Ordinary Shares(2) 1.68% 1.48% * 1.53% * * 4.50% - - - - - * 10.54% _______________ * Less than 1% (1) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Ordinary shares relating to options or convertible debenture notes currently exercisable or exercisable within 60 days of the date of this table are deemed outstanding for computing the percentage of the person holding such securities but are not deemed outstanding for computing the percentage of any other person. Except as indicated by footnote, the persons named in the table above have sole voting and investment power with respect to all shares shown as beneficially owned by them. (2) The percentages shown are based on 15,827,682 ordinary shares issued and outstanding as of March 30, 2012. (3) Includes 200,000 ordinary shares issuable upon the exercise of currently exercisable options granted by our company, having an exercise price of $7.59 per share that expire in two equal installments in August 2013 and August 2014. (4) Includes 66,666 ordinary shares issuable upon the exercise of currently exercisable options granted to Mr. Perry by Ki Corporation. Ki Corporation granted Mr. Perry the right to purchase 100,000 ordinary shares upon the same terms and conditions that apply to the exercise of the options granted to him under his employment agreement. Mr. Perry has the right to purchase the shares in three equal annual installments commencing on August 20, 2010 at a price of $7.59 per share. The right to purchase each installment expires after three years. (5) Includes 83,336 ordinary shares issuable upon the exercise of currently exercisable options, having an exercise price of $4.35 per share that expire in August 2014, 20,833 ordinary shares issuable upon the exercise of currently options, having an exercise price of $4.35 per share that expire in November 2014, 20,833 ordinary shares issuable upon the exercise of currently exercisable options, having an exercise price of $4.35 per share that expire in February 2015 and 20,833 ordinary shares issuable upon the exercise of currently exercisable options, having an exercise price of $4.35 per share that expire in May 2015, 20,833 ordinary shares issuable upon the exercise of currently exercisable options, having an exercise price of $4.35 per share that expire in August 2015, 20,833 ordinary shares issuable upon the exercise of currently exercisable options, having an exercise price of $4.35 per share that expire in November 2015 and 20,833 ordinary shares issuable upon the exercise of currently exercisable options, having an exercise price of $4.35 per share that expire in February 2016 and 20,833 ordinary shares issuable upon the exercise of currently exercisable options, having an exercise price of $4.35 per share that expire in May 2016. (6) Includes 24,000 ordinary shares issuable upon the exercise of currently exercisable options, having an exercise price of $3.53 per share that expire in April 2015, 24,000 ordinary shares issuable upon the exercise of currently exercisable options, having an exercise price of $3.53 per share that expire in April 2016 and 22,000 ordinary shares issuable upon the exercise of currently exercisable options, having an exercise price of $3.53 per share that expire in April 2017. (7) Includes 77,975 ordinary shares held by a trustee. Share Option Plans 2003 Israeli Share Option Plan On October 27, 2003, our board of directors adopted our 2003 Israeli Share Option Plan, or the 2003 Plan, which was approved by our shareholders in July 2004. Under the 2003 Plan, stock options could be granted to our employees, directors, officers and consultants, in accordance with the decision of our board of directors. Our board of directors had the authority to determine the vesting schedule of such options and the exercise price. Under the 2003 Plan, unless determined otherwise by the Board, no option may be exercised before the second anniversary of the date on which it was granted. Pursuant to the 2003 Plan, any options that are cancelled or not exercised within the option period will become available for future grants. Our board of directors has elected to allot options to Israeli employees under Israel’s capital gain tax treatment. Pursuant to the provisions of the 2003 Plan, if we issue a stock dividend, the number of shares purchasable by any grantee upon the exercise of options that were granted prior to the issuance of the stock dividend will be correspondingly increased. In May 2008, our board of directors approved an amendment to the 2003 Plan, which was approved by our shareholders in August 2008, pursuant to which the number of ordinary shares available for issuance under the 2003 Plan was increased by 1,000,000 shares and the termination of the 2003 Plan was extended from October 2013 to October 2018. - 54 - As of December 31, 2011, options to purchase 1,108,000 ordinary shares were outstanding under the 2003 Plan, exercisable at an average exercise price of $5.28 per share. No options awarded under the 2003 Plan were exercised during 2011. Following the adoption of our 2010 Israeli Share Option Plan in June 2010, no additional options will be granted under the 2003 Plan. 2010 Israeli Share Option Plan In June 2010, we adopted our 2010 Israeli Share Option Plan, or the 2010 Plan. Under the 2010 Plan, stock options may be periodically granted to our employees, officers, directors and consultants of our company and subsidiaries. An aggregate 450,575 ordinary shares that remained available for futures option grants under the 2003 Plan as of the date of the adoption of the 2010 Plan and any ordinary shares that become available in the future under the 2003 Plan as a result of expiration, cancellation or relinquishment of any option outstanding under the 2003 Plan will be rolled over to the 2010 Plan. The 2010 Plan has a term of ten years. The 2010 Plan is designed to allow the grantees to benefit from the tax benefits under Section 102 of the Israeli Income Tax Ordinance [New Version], 1961. Our Board of Directors has resolved that all options that will be granted to Israeli residents under the 2010 Plan will be taxable under the “capital gains route.” Pursuant to this route, the profit realized by an employee is taxed as a capital gain (25%) if the options or underlying shares are held by a trustee for at least 24 months from their date of the grant or issuance. Any difference between the exercise price of the options and the average price of the company’s shares during the 30 trading days before the date of grant of the options will be treated as ordinary income and will be taxed according to the employee’s marginal tax rates plus social contribution. If the underlying shares are sold before the elapse of such period, the profit is re-characterized as ordinary income. The Board of Directors or a committee of the Board of Directors, the Committee, if appointed, will administer the 2010 Plan. The Board of Directors or the Committee will have the full power and authority to, subject to limitation under the terms and provisions of any applicable law and subject to changes according to the Board’s decisions: • • • • • • • • determine the persons who will receive option awards; determine the terms and provisions of the respective option agreements (which need not be identical), including, but not limited to, provisions concerning the time and the extent to which the options may be exercised and the nature and duration of restrictions as to the transferability or restrictions constituting substantial risk of forfeiture and to cancel or suspend awards, as necessary; determine the purchase price of each share subject to an option; designate the type of options; alter any restrictions and conditions of any options or shares subject to any options; interpret the provisions and supervise the administration of the 2010 Plan; accelerate the right of an optionee to exercise in whole or in part, any previously granted option; prescribe, amend and rescind rules and regulations relating to the 2010 Plan; and • make all other determinations deemed necessary or advisable for the administration of the 2010 Plan. However, the Board of Directors or the Committee may not, without the consent of the optionee, alter or in any way impair the rights of such optionee under any award previously granted. - 55 - Options are not assignable or transferable by the optionee. No option or any right with respect to an option may be assignable, transferable or given as collateral or any right with respect to it given to any third party whatsoever, except as specifically allowed under the 2010 Plan, and during the lifetime of the optionee each optionee’s rights to purchase shares may only be exercised by the optionee. Generally, an option may be exercised as long as the optionee is employed by, or providing services to, the company or any of its affiliates, to the extent the options have vested. Options granted under the 2010 Plan may be exercised for cash, however the Board of Directors or the Committee may resolve to allow for a cashless exercise of the options. In the event that we will pay cash dividends, the exercise price of the options will be adjusted to reflect such payment. As of December 31, 2011, options to purchase 510,575 ordinary shares were outstanding under the 2010 Plan. No options awarded under the 2010 Plan during 2011. ITEM 7. Major Shareholders and Related Party Transactions A. Major Shareholders. The following table sets forth certain information as of March 30, 2012 regarding the beneficial ownership of our ordinary shares, by each person or entity known to us to own beneficially 5.0% or more of our ordinary shares. Name Nathan Kirsh (3) BMI Capital Corporation (4) Grace & White, Inc. (5) ____________________ Number of Ordinary Shares Beneficially Owned (1) Percentage of Outstanding Ordinary Shares(2) 5,981,585 1,954,267 1,053,606 37.81% 12.25% 6.66% (1) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Ordinary shares relating to options or convertible notes currently exercisable or exercisable within 60 days of the date of this table are deemed outstanding for computing the percentage of the person holding such securities but are not deemed outstanding for computing the percentage of any other person. Except as indicated by footnote, the persons named in the table above have sole voting and investment power with respect to all shares shown as beneficially owned by them. (2) The percentages shown are based on 15,827,682 ordinary shares issued and outstanding as of March 30, 2012. (3) Based upon a Schedule 13D/A filed with the Securities and Exchange Commission on August 9, 2011 and other information available to the company. All of the ordinary shares held of record by Ki Corporation, are held by its wholly-owned subsidiary, Mira Mag, Inc. a company organized under the laws of Liberia. The Eurona Foundation holds 100% of Ki Corporation, which is a Jersey, Channel Islands corporation. The Eurona Foundation is a Liechtenstein trust controlled by Mr. Kirsh, who also serves as its trustee. Mr. Kirsh may be deemed to have beneficial ownership of the ordinary shares held of record by Ki Corporation. (4) Based solely upon, and qualified in its entirety with reference to, a Schedule 13G filed with the Securities and Exchange Commission on January 31, 2012. The Schedule 13G indicates that BMI Capital Corporation is a registered investment adviser. (5) Based solely upon, and qualified in its entirety with reference to, a Schedule 13G/A filed with the Securities and Exchange Commission on February 6, 2012. The Schedule 13G/A indicates that Grace & White, Inc. is a registered investment adviser. - 56 - Significant Changes in the Ownership of Major Shareholders On January 10, 2008, Mr. Nathan Kirsh filed a Schedule 13D/A with the SEC reflecting beneficial ownership of 1,913,601, or 18.41% of our ordinary shares. On April 24, 2008, Mr. Kirsh filed a Schedule 13D/A with the SEC reflecting beneficial ownership of 2,191,162, or 21.08% of our ordinary shares. On April 25, 2008, Mr. Kirsh filed a Schedule 13D/A with the SEC reflecting beneficial ownership of 2,191,162, or 21.08% of our ordinary shares. On January 16, 2009, Mr. Kirsh filed a Schedule 13D/A with the SEC reflecting beneficial ownership of 2,516,268, or 24.20% of our ordinary shares. On May 17, 2010, Mr. Kirsh filed a Schedule 13D/A with the SEC reflecting beneficial ownership of 2,516,267, or 24.20% of our ordinary shares. On August 9, 2011, Mr. Kirsh filed a Schedule 13D/A with the SEC reflecting beneficial ownership of 5,981,585, or 24.20%, of our ordinary shares. On February 11, 2008, Clough Capital Partners, L.P. filed an amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 712,269 or 6.85% of our ordinary shares. On February 10, 2009, Clough Capital Partners, L.P. filed with the SEC an amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 770,842 or 7.41% of our ordinary shares. On February 1, 2010, Clough Capital Partners, L.P. filed with the SEC an amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 738,542 or 7.10% of our ordinary shares. On June 17, 2010, Clough Capital Partners, L.P. filed with the SEC a Schedule 13D reflecting beneficial ownership of 704,042 or 6.8% of our ordinary shares. On March 23, 2011, Clough Capital Partners, L.P. filed with the SEC an amendment to Schedule 13G, on Schedule 13G/A, reflecting that it ceased to beneficially own any of our ordinary shares. On February 2, 2007, Diker GP, LLC, Diker Management LLC, or Diker Management, Messrs. Charles M. Diker and Mark N. Diker filed a Schedule 13G with the SEC reflecting beneficial ownership of 1,007,601 or 9.70% of our ordinary shares. On February 12, 2008, the foregoing reporting persons filed with the SEC an amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 1,014,425, or 9.76%, of our ordinary shares. On February 17, 2009, the foregoing reporting persons filed with the SEC an amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 968,468 or 9.32% of our ordinary shares. On February 16, 2010, the foregoing reporting persons filed with the SEC an amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 786,854 or 7.57% of our ordinary shares. On June 21, 2010, the foregoing reporting persons filed with the SEC a Schedule 13D reflecting beneficial ownership of 604,495 or 5.8% of our ordinary shares. On February 14, 2011, the foregoing reporting persons filed with the SEC an amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of less than 5% of our ordinary shares. On February 4, 2008, Grace & White, Inc. filed a Schedule 13G with the SEC reflecting beneficial ownership of 574,254 or 5.52% of our ordinary shares. On February 10, 2009, Grace & White, Inc. filed with the SEC an amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 596,148 or 5.73% of our ordinary shares. On February 1, 2010, Grace & White, Inc. filed with the SEC an amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 607,526 or 5.84% of our ordinary shares. On January 31, 2011, Grace & White, Inc. filed with the SEC an amendment to its Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 521,102 or 5.01% of our ordinary shares. On February 6, 2012, Grace & White, Inc. filed with the SEC an amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 1,053,606, or 6.06% of our ordinary shares. On February 14, 2008, Prescott Capital, Prescott Group Aggressive Small Cap, L.P., Prescott Group Aggressive Small Cap II, L.P. and Mr. Phil Frohlich filed a Schedule 13G with the SEC reflecting beneficial ownership of 539,097 or 5.19% of our ordinary shares. On February 10, 2009, the foregoing reporting persons filed with the SEC an amendment to the Schedule 13G, on Schedule 13G/A, reflecting beneficial ownership of 547,127 or 5.3% of our ordinary shares. On June 14, 2010, the foregoing reporting persons and Prescott Group Capital Management, L.L.C. filed with the SEC a Schedule 13D reflecting beneficial ownership of 544,427 or 5.2% of our ordinary shares. On January 28, 2011, the foregoing reporting persons filed with the SEC an amendment to the Schedule 13D, on Schedule 13D/A, reflecting beneficial ownership of less than 5% of our ordinary shares. On February 13, 2012, Prescott Group Capital Management, L.L.C. did not reflect ownership of any of our ordinary shares. On January 31, 2012, BMI Capital Corporation filed a Schedule 13G with the SEC reflecting beneficial ownership of 1,954,267 or 12.25% of our ordinary shares. - 57 - Major Shareholders Voting Rights The voting rights of our major shareholders do not differ from the voting rights of other holders of our ordinary shares. Record Holders Based on a review of the information provided to us by our transfer agent, as of March 30, 2012, there were 49 holders of record of our ordinary shares, of which 40 record holders holding approximately 89.5% of our ordinary shares had registered addresses in the United States. These numbers are not representative of the number of beneficial holders of our shares nor is it representative of where such beneficial holders reside since many of these ordinary shares were held of record by brokers or other nominees, including CEDE & Co., the nominee for the Depositary Trust Company (the central depositary for the U.S. brokerage community), which held approximately 89.3% of our outstanding ordinary shares as of such date. B. Related Party Transactions. On August 21, 2008, we entered into an agreement with Mr. Jacob Perry, in connection with his services as the chairman of our board of directors, which was amended effective as of January 1, 2010 pursuant to the approval of our shareholders at our 2010 annual general meeting. Pursuant to the terms of the agreement, as amended, Mr. Perry agreed to serve as the chairman of our board of directors on a part time basis and has undertaken to devote 50%-60% of his business time and attention to the development of our business. Mr. Perry’s service as the chairman of our board of directors is for an unlimited period, however each party may terminate the agreement without cause by giving 90 days’ notice to the other party. Mr. Perry is entitled to receive as compensation for his services as chairman of our board of directors a monthly salary of NIS 50,000 (approximately $13,086). Such compensation is linked to the Israeli consumer price index and is adjusted every six months. As of March 31, 2012, the adjusted monthly salary amounted to NIS 54,295 (approximately $14,210). In addition, Mr. Perry is entitled to an annual bonus equal to 5% of our company’s annual income before taxes, but in any event not more than $500,000 per year, provided that our senior management is entitled to receive performance bonuses for the given year. In addition, Mr. Perry is entitled to the following benefits: an executive level car, mobile phone, daily newspaper and reimbursement of home communication expenses up to NIS 1,000 a month (approximately $262) against receipts. However, we will not be obliged to provide such benefits to the extent that such benefits are provided to Mr. Perry by another employer. Currently Mr. Perry’s car, mobile phone, 60% of his home communication expenses and a daily newspaper are provided to Mr. Perry by another employer. Mr. Perry is also entitled to receive all customary social benefits such as managers insurance and education fund, such amount will be paid to him or to third parties for his benefit. Mr. Perry was also granted options to purchase 300,000 ordinary shares of our company, exercisable at a price of $7.59 per share. The options vested in three equal installments of 100,000 ordinary shares each on August 20, 2010, August 20, 2011 and August 20, 2012. Each tranche will expire three years after the applicable vesting date. On May 13, 2008, Ki Corporation, a company beneficially owned by Mr. Nathan Kirsh, our controlling shareholder, granted to Mr. Jacob Perry, the executive chairman of our Board of Directors, the right to purchase 100,000 shares held by such entity, upon the same terms and conditions that apply to the exercise of the options to purchase 300,000 of our ordinary shares granted to Mr. Perry under his employment agreement. Accordingly, Mr. Perry has the right to purchase the shares in three equal annual installments commencing on August 20, 2010 at a price of $7.59 per share. The right to purchase each installment expires after three years. We have entered into retirement agreements with certain of our officers, pursuant to which we made post-employment and retirement payments in the aggregate amount of approximately $0.3 and $1.9 million for the years ended December 31, 2008 and 2009, respectively. Of such amount, in the year ended December 31, 2009, we paid approximately $1.5 million to Mr. Izhar Dekel, our former President and chief executive officer, who had been employed by our company and served in various positions from 1984 until February 2009. Such payment includes consideration for a non-compete undertaking as well as severance payments and other retirement related payments in accordance with Mr. Dekel’s retirement agreement and Israeli law. - 58 - On September 8, 2010, Ki Corporation Limited, a company affiliated with Mr. Nathan Kirsh, our principal shareholder and a director, provided us with a bridge loan in the principal amount of $10.0 million. The loan agreement provided that if it was not repaid within 180 days, the bridge loan would begin to accrue interest at the rate of LIBOR + 4% per year, calculated from the date of the loan and accumulated on a quarterly basis. However, if the rights offering that we intend to initiate during 2011 occurs within 240 days from the date of the loan, the loan will not bear any interest. We used part of the proceeds from the private placement and rights offering that were completed in 2011 and on August 8, 2011, after deduction of the consideration due to us pursuant to the private placement of our ordinary shares, we have repaid $9.9 million in full satisfaction of the Bridge Loan and the interest accrued thereupon. On October 2010, we entered into an agreement with Mr. Nathan Kirsh, our controlling shareholder, for the supply of a perimeter security solution for his private property in France for the aggregate consideration of Euro 233,000 (approximately $310,000). Our Audit Committee and Board of Directors approved the terms of the transaction. On June 17, 2011, we completed a private placement of 150,000 of our ordinary shares to Ki Corporation, a company owned by Mr. Nathan Kirsh, at an initial price per share of $3.04, which was equal to the closing price of our ordinary shares on the NASDAQ Global Market on the date prior to the private placement. Upon the record date of the rights offering, the price per share paid by Ki Corporation was adjusted to $3.05, which was the closing price of our ordinary shares on the NASDAQ Global Market on the date prior to the record date of the rights offering. The private placement consideration from Ki Corporation was paid to us by means of a partial offset against the outstanding principal amount and accrued interest under the bridge loan that it provided to us on September 8, 2010. The private placement was approved by our shareholders at an extraordinary general meeting held on August 12, 2010 as a private placement that allowed Mr. Kirsh and his affiliates to hold more than 25% of our outstanding share capital. As a result, Ki Corporation was permitted to subscribe for the maximum number of shares allowable under the terms of the rights offering. C. Interests of Experts and Counsel. Not applicable. ITEM 8. Financial Information A. Consolidated Statements and Other Financial Information. Consolidated Financial Statements See the consolidated financial statements included under Item 18, “Financial Statements.” Export Sales In the years ended December 31, 2009, 2010 and 2011, the total amount of our revenues from our facilities located outside of Israel to customers outside of Israel was approximately $30.1 million, $36.9 million and $35.6 million, respectively, or 56.7%, 74.3% and 40.2% of our total revenues, respectively. In the years ended December 31, 2009, 2010 and 2011, the total amount of our export revenues from our Israeli facilities to countries outside of Israel was approximately $10.7 million, $2.9 million and $42.9 million, respectively, or 19.6%, 5.9% and 48.4% of our total revenues, respectively. Legal Proceedings In May 2005, we entered into an agreement to supply comprehensive security solutions for a sensitive site in Eastern Europe. We commenced the project and delivered some of the equipment and other deliverables to the customer in 2005. In April 2006, the customer informed us that it was canceling the agreement due to errors in the design documents that we had submitted. In addition, the customer did not make payments required under the agreement. We denied all of the allegations and the case was referred to arbitration. In March 2010, the Court of Arbitration determined that the customer is liable for certain expenses incurred by us in connection with the negotiation and execution of the agreement due to the customer’s wrongful behavior during the negotiations. In addition, the Court of Arbitration determined that the customer is liable for damages caused to us due to the customer’s unjust enrichment resulting from its failure to pay for certain deliveries made by us. Accordingly, on October 25, 2011 we collected an arbitration award of approximately $2.5 million and recorded income of $2.3 million from the arbitration, net of legal expenses. A review of public record indicates that the customer filed a claim to vacate the judgment, however, such claim has not yet been served on us. In the opinion of our legal counsel the chances that judgment will be vacated are low. - 59 - In addition, we are subject to legal proceedings arising in the normal course of business. Based on the advice of our legal counsel, management believes that these proceedings will not have a material adverse effect on our financial position or results of operations. Dividend Distribution Policy We currently intend to retain future earnings for use in our business and do not anticipate paying cash dividends on our ordinary shares in the foreseeable future. Future dividend distributions are subject to the discretion of our board of directors and will depend on a number of factors, including our operating results, future capital resources available for distribution, capital requirements, financial condition, the tax implications of dividend distributions on our income, future prospects and any other factors our board of directors may deem relevant. The distribution of dividends also may be limited by Israeli law, which permits the distribution of dividends only out of profits (as defined by the Israeli Companies Law) or otherwise upon the permission of the court, and only if the Board of Directors determines that such distribution will not jeopardize the ability of the company to repay its debts on the due date thereof. “Profits’’ are defined in the Israeli Companies Law as the balance of surpluses, or the surpluses accumulated over the past two years, whichever is the greater, in accordance with the latest adjusted financial statements, audited or reviewed, prepared by the company, provided that the date in respect of which the statements were prepared is no earlier than six months prior to the date of distribution. ‘‘Surplus’’ means sums included in a company’s shareholders’ equity originating from the net profit of the company, as determined according to generally accepted accounting principles, and sums other than share capital or premiums that are included in shareholders’ equity under generally accepted accounting principles and that the Minister of Justice has prescribed to be considered surplus. B. Significant Changes. Since the date of the annual consolidated financial statements included in this annual report, no significant changes have occurred. ITEM 9. The Offer and Listing A. Offer and Listing Details. Annual Stock Information The following table sets forth, for each of the years indicated, the high and low market prices of our ordinary shares on the NASDAQ Global Market and the Tel Aviv Stock Exchange. We delisted our shares from the Tel Aviv Stock Exchange on November 30, 2011: 2007 2008 2009 2010 2011 NASDAQ Global Market High Low Tel Aviv Stock Exchange Low High 12.00 9.30 6.40 4.70 5.10 $ $ $ $ $ 6.26 4.61 3.08 2.50 2.18 NIS 51.00 NIS 32.44 NIS 24.50 NIS 16.86 NIS 17.55 NIS 23.50 NIS 18.60 NIS 13.00 NIS 9.61 NIS 8.45 $ $ $ $ $ - 60 - Quarterly Stock Information The following table sets forth, for each of the full financial quarters in the years indicated and any subsequent period, the high and market prices of our ordinary shares on the NASDAQ Global Market and the Tel Aviv Stock Exchange: 2010 First Quarter Second Quarter Third Quarter Fourth Quarter 2011 First Quarter Second Quarter Third Quarter Fourth Quarter Monthly Stock Information NASDAQ Global Market High Low Tel Aviv Stock Exchange Low High $ $ $ $ $ $ $ $ 4.70 4.00 3.28 3.68 $ $ $ $ 3.29 3.56 3.16 5.10 $ $ $ $ 3.50 2.50 2.70 2.89 2.63 2.94 2.18 2.30 NIS 16.86 NIS 15.14 NIS 12.00 NIS 12.50 NIS 11.66 NIS 12.70 NIS 10.82 NIS 17.55 NIS 13.70 NIS 9.61 NIS 10.00 NIS 10.45 NIS 10.18 NIS 10.05 NIS 8.45 NIS 8.57 The following table sets forth, for each of the most recent six months, the high and low market prices of our ordinary shares on the NASDAQ Global Market and the Tel Aviv Stock Exchange: October 2011 November 2011 December 2011 January 2012 February 2012 March 2012 B. Plan of Distribution. Not applicable. C. Markets. NASDAQ Global Market High Low Tel Aviv Stock Exchange Low High $ $ $ $ $ $ 2.54 4.84 5.10 4.68 4.90 4.88 $ $ $ $ $ $ 2.30 2.38 3.30 3.51 3.74 3.82 NIS 9.15 NIS 17.35 N/A N/A N/A N/A NIS 8.57 NIS 8.72 N/A N/A N/A N/A Our ordinary shares have traded on the NASDAQ Global Market under the symbol “MAGS” since our initial public offering in 1993. Our ordinary shares have also traded on the Tel Aviv Stock Exchange under the symbol “MAGS” since July 1, 2001. On August 31, 2011 our Board of Directors resolved to delist our ordinary shares from trading on the Tel Aviv Stock Exchange, and effective November 30, 2011, all outstanding ordinary shares, including those previously traded on the TASE, are traded on the NASDAQ Global Market. D. Selling Shareholders. Not applicable. E. Dilution. Not applicable. F. Expenses of the Issue. Not applicable. - 61 - ITEM 10. Additional Information A. Share Capital. Not applicable. B. Memorandum and Articles of Association. Purposes and Objects of the Company We are a public company registered with the Israeli Companies Registrar and have been assigned company number 52-003892-8. Section 2 of our memorandum of association provides, among other things, that we were established for the purposes of acquiring from IAI a plant, known as the Magal Plant, engaged in the development, manufacture, sale and support of alarm devices and dealing in the development, manufacturing and support of security alarm devices and other similar products. In addition, the purpose of our company is to be eligible to perform and act in connection with any right or obligation of whatever kind or nature permissible under Israeli law. Board of Directors The strategic management of our business (as distinguished from the daily management of our business affairs) is vested in our board of directors, which may exercise all such powers and do all such acts as our company is authorized to exercise and do, and which are not required to be exercised by a resolution of the general meeting of our shareholders. The board of directors may, subject to the provisions of the Israeli Companies Law, delegate some of its powers to committees, each consisting of one or more directors, provided that at least one member of such committee is an external director. According to the Israeli Companies Law, we may stipulate in our articles of association that the general meeting of shareholders is authorized to assume the responsibilities of the board of directors. In the event the board of directors is unable to act or exercise its powers, the general meeting of shareholders is authorized to exercise the powers of the board of directors, even if the articles of association do not stipulate so. Our board of directors has the power to assume the responsibilities of our chief executive officer if he is unable to act or exercise his powers or if he fails to fulfill the instructions of the board of directors with respect to a specific matter. Our articles of association do not impose any mandatory retirement or age limit requirements on our directors and our directors are not required to own shares in our company in order to qualify to serve as directors. The authority of our directors to enter into borrowing arrangements on our behalf is not limited, except in the same manner as any other transaction by us. For a discussion of Israeli law concerning a director’s fiduciary duties and the approval of transactions with office holders, see Item 6.C. “Directors, Senior Management and Employees- Board Practices - Approval of Related Party Transactions under Israeli Law.” Rights Attached to Shares Our authorized share capital consists of NIS 39,748,000 ordinary shares, par value NIS 1.00 each. All our ordinary shares have the same rights, preferences and restrictions, some of which are detailed below. At the general meeting of shareholders, our shareholders may, subject to certain provisions detailed below, create different classes of shares, each class bearing different rights, preferences and restrictions. The rights attached to the ordinary shares are as follows: Dividends Rights. Holders of ordinary shares are entitled to participate in the payment of dividends in accordance with the amounts paid-up or credited as paid up on the nominal value of such ordinary shares at the time of payment (without taking into account any premium paid thereon). However, under article 13 of our articles of association no shareholder will be entitled to receive any dividends until the shareholder has paid all calls then currently due and payable on each ordinary share held by such shareholder. - 62 - The board of directors may declare interim dividends and propose the final dividend with respect to any fiscal year only out of the retained earnings, in accordance with the provisions of the Israeli Companies Law. Declaration of a final dividend requires the approval by ordinary resolution of our shareholders at a general meeting of shareholders. Such resolution may reduce but not increase the dividend amount recommended by the board of directors. Dividends may be paid, in whole or in part, by way of distribution of dividends in kind. See “Item 8A. Financial Information – Consolidated Statements and Other Financial Information – Dividend Distributions Policy.” Voting Rights. Holders of ordinary shares are entitled to one vote for each share held of record on all matters submitted to a vote of shareholders. Such voting rights may be affected by the grant of any special voting rights to the holders of a class of shares with preferential rights that may be authorized in the future. Generally, resolutions are adopted at the general meeting of shareholders by an ordinary resolution, unless the Israeli Companies Law or our articles of association require an extraordinary resolution. An ordinary resolution, such as a resolution approving the declaration of dividends or the appointment of auditors, requires approval by the holders of a simple majority of the shares represented at the meeting, in person or by proxy, and voting on the matter. An extraordinary resolution requires approval by the holders of at least 75% of the shares represented at the meeting, in person or by proxy, and voting on the matter. The primary resolutions required to be adopted by an extraordinary resolution of the general meeting of shareholders are resolutions to: • • • amend the memorandum of association or articles of association; change the share capital, for example by increasing or canceling the authorized share capital or modifying the rights attached to shares; and approve mergers, consolidations or winding up of our company. Our articles of association do not contain any provisions regarding a classified board of directors or cumulative voting for the election of directors. Pursuant to our articles of association, our directors (except the external directors) are elected at our annual general meeting of shareholders by a vote of the holders of a majority of the voting power represented and voting at such meeting and hold office until the next annual general meeting of shareholders and until their successors have been elected. All the members of our board of directors (except the external directors) may be reelected upon completion of their term of office. For information regarding the election of external directors, see “Item 6C. Directors, Senior Management and Employees – Directors and Senior Management - Board Practices - External and Independent Directors - External Directors.” Rights to Share in the Company’s Profits. Our shareholders have the right to share in our profits distributed as a dividend or any other permitted distributions. See this Item 10B. “Additional Information – Memorandum and Articles of Association – Rights Attached to Shares – Dividend Rights.” Liquidation Rights. Article 111 of our articles of association provides that upon any liquidation, dissolution or winding-up of our company, our remaining assets shall be distributed pro-rata to our ordinary shareholders. Redemption. Under Article 38 of our articles of association, we may issue redeemable stock and redeem the same. Capital Calls. Under our memorandum of association and the Israeli Companies Law, the liability of our shareholders is limited to the par value of the shares held by them. Substantial limitations on shareholders. See Item 6.C. “Directors, Senior Management and Employees-Board Practices–Approval of Related Party Transactions.” Modifications of Share Rights The rights attached to a class of shares may be altered by an extraordinary resolution of the general meeting of shareholders, provided the holders of 75% of the issued shares of that class approve such change by the adoption of an extraordinary resolution at a separate meeting of such class, subject to the terms of such class. The provisions of the articles of association pertaining to general meetings of shareholders also apply to a separate meeting of a class of shareholders. Shares which confer preferential or subordinate rights relating to, among other things, dividends, voting, and payment of capital may be created only by an extraordinary resolution of the general meeting of shareholders. - 63 - General Meetings of Shareholders Under the Israeli Companies Law a company must convene an annual meeting of shareholders at least once every calendar year and within 15 months of the last annual meeting. Depending on the matter to be voted upon, notice of at least 21 days or 35 days prior to the date of the meeting is required. Our board of directors may, in its discretion, convene additional meetings as “special general meetings.” In addition, the board must convene a special general meeting upon the demand of two of the directors, 25% of the nominated directors, one or more shareholders having at least 5% of the outstanding share capital and at least 1% of the voting power in the company, or one or more shareholders having at least 5% of the voting power in the company. See this Item 10B. “Additional Information - Memorandum and Articles of Association- Rights Attached to Shares-Voting Rights.” A shareholder present, in person or by proxy, at the commencement of a general meeting of shareholders may not seek the cancellation of any proceedings or resolutions adopted at such general meeting of shareholders on account of any defect in the notice of such meeting relating to the time or the place thereof. Shareholders who are registered in our register of shareholders at the record date may vote at the general meeting of shareholders. The record date is set in the resolution to convene the general meeting of shareholders, provided, however, that such record date must be between 14 to 21 days or, in the event of a vote by ballots, between 28 to 40 days prior the date the general meeting of shareholders is held. The quorum required for a general meeting of shareholders consists of at least two record shareholders, present in person or by proxy, who hold, in the aggregate, at least one third of the voting power of our outstanding shares. A general meeting of shareholders will be adjourned for lack of a quorum after half an hour from the time appointed for such meeting to the same day in the following week at the same time and place or any other time and place as the board of directors designates in a notice to the shareholders. At such reconvened meeting, if a quorum is not present within half an hour from the time appointed for such meeting, two or more shareholders, present in person or by proxy, will constitute a quorum. The only business that may be considered at an adjourned general meeting of shareholders is the business that might have been lawfully considered at the general meeting of shareholders originally convened and the only resolutions that may be adopted are the resolutions that could have been adopted at the general meeting of shareholders originally convened. Limitations on the Right to Own Our Securities Neither our memorandum or articles of association nor the laws of the State of Israel restrict in any way the ownership or voting of our ordinary shares by non-residents, except that the laws of the State of Israel may restrict the ownership of ordinary shares by residents of countries that are in a state of war with Israel. Provisions Restricting a Change in Control of Our Company The Israeli Companies Law requires that mergers between Israeli companies be approved by the board of directors and general meeting of shareholders of both parties to the transaction. The approval of the board of directors of both companies is subject to such boards’ confirmation that there is no reasonable doubt that after the merger the surviving company will be able to fulfill its obligations towards its creditors. Each company must notify its creditors about the contemplated merger. Under our articles of association, such merger must be approved by a resolution of the shareholders, as explained above. The approval of the merger by the general meetings of shareholders of the companies is also subject to additional approval requirements as specified in the Israeli Companies Law and regulations promulgated thereunder. For purposes of the shareholders approval, the merger shall not be deemed as granted unless the court determines otherwise, if it is not supported by the 75% of the shares represented and voting at the general meeting, provided that such majority includes a simple majority of the non-interested shareholders. See also Item 6C. “Directors, Senior Management and Employees – Board Practices – Approval of Related Party Transactions Under Israeli Law.” The Israeli Companies Law also provides that an acquisition of shares of a public company must be made by means of a special tender offer if as a result of the acquisition the purchaser would become a 25% or greater shareholder of the company and there is no existing 25% or greater shareholder in the company. An acquisition of shares of a public company must also be made by means of a tender offer if as a result of the acquisition the purchaser would become a 45% or greater shareholder of the company and there is no existing 45% or greater shareholder in the company. These requirements do not apply if the acquisition (i) was made through a private placement that received shareholder approval, (ii) was from a 25% shareholder of the company and resulted in the acquirer becoming a 25% shareholder of the company or (iii) was from a 45% shareholder of the company and resulted in the acquirer becoming a 45% shareholder of the company. The special tender offer must be extended to all shareholders but, the offer may include explicit limitations allowing the offeror not to purchase shares representing more than 5% of the voting power attached to the company’s outstanding shares, regardless of how many shares are tendered by shareholders. The special tender offer may be effected only if (i) at least 5% of the voting power attached to the company’s outstanding shares will be acquired by the offeror and (ii) the number of shares tendered in the offer exceeds the number of shares whose holders objected to the offer. - 64 - If, as a result of an acquisition of shares, the acquirer will hold more than 90% of the outstanding shares, the acquisition must be made by means of a tender offer for the entire outstanding shares. In such event, if less than 5% of the outstanding shares are not tendered in the tender offer, all the shares of the company will be deemed as tendered and sold. However, if more than 5% of the outstanding shares are not tendered in the tender offer, then the acquirer may not acquire any shares at all. The law provides for appraisal allowing any shareholder to file a motion to the court within six months following the consummation of a full tender offer. However, in the event of a full tender offer, the offeror may determine that any shareholder who accepts the offer will not be entitled to appraisal rights. Such determination shall be effective only if the offeror or the company has timely published all the information that is required to be published in connection with such full tender offer pursuant to all applicable laws. In addition, the purchase of 25% or more of the outstanding share capital of a company or the purchase of substantial assets of a company requires, under certain conditions, the approval of the Restrictive Practices Authority. Furthermore if the target company has received tax incentives of grants from the Office of the Chief Scientist, changes in ownership may require also the approval of the tax authorities or the Office of the Chief Scientist, as applicable. C. Material Contracts. In April 2010, we signed a $13.5 million contract with Mexican Federal Prisons Authority, or SSP, for the modernization and upgrade of the indoor security systems of three high-security prisons in Mexico. Nearly half of the project was executed in 2010, and it is expected to be completed during the first quarter of 2012. In December 2010, we signed a contract with the Port Authority of Kenya valued at $21.4 million to secure the port of Mombasa. The project began in 2011 and is expected to be completed in 2013. In May 2011, we signed a $35.5 million turnkey project to provide a fully integrated security system, covering multiple sites, for the African Cup of Nations Football Championship to be held in January 2012 in the Gabonese Republic. In June 2011, we received a $5.6 million order to modify and extend an existing PIDS as a result of expansion at an Eastern European airport. D. Exchange Controls. Israeli law and regulations do not impose any material foreign exchange restrictions on non-Israeli holders of our ordinary shares. In May 1998, a new “general permit” was issued under the Israeli Currency Control Law, 1978, which removed most of the restrictions that previously existed under such law, and enabled Israeli citizens to freely invest outside of Israel and freely convert Israeli currency into non-Israeli currencies. Non-residents of Israel who purchase our ordinary shares will be able to convert dividends, if any, thereon, and any amounts payable upon our dissolution, liquidation or winding up, as well as the proceeds of any sale in Israel of our ordinary shares to an Israeli resident, into freely repatriable dollars, at the exchange rate prevailing at the time of conversion, provided that the Israeli income tax has been withheld (or paid) with respect to such amounts or an exemption has been obtained. - 65 - E. Taxation. The following is a discussion of Israeli and United States tax consequences material to us and to our shareholders. To the extent that the discussion is based on new tax legislation which has not been subject to judicial or administrative interpretation, the views expressed in the discussion might not be accepted by the tax authorities in question. The discussion is not intended, and should not be construed, as legal or professional tax advice and does not exhaust all possible tax considerations. Holders of our ordinary shares should consult their own tax advisors as to the United States, Israeli or other tax consequences of the purchase, ownership and disposition of ordinary shares, including, in particular, the effect of any foreign, state or local taxes. ISRAELI TAX CONSIDERATIONS The following is a summary of the material Israeli tax laws applicable to us, and some Israeli Government programs benefiting us. This section also contains a discussion of material Israeli tax consequences concerning the ownership of and disposition of our ordinary shares. This summary does not discuss all the acts of Israeli tax law that may be relevant to a particular investor in light of his or her personal investment circumstances or to some types of investors subject to special treatment under Israeli law. Examples of this kind of investor include residents of Israel or traders in securities who are subject to special tax regimes not covered in this discussion. Since some parts of this discussion are based on new tax legislation that has not yet been subject to judicial or administrative interpretation, we cannot assure you that the appropriate tax authorities or the courts will accept the views expressed in this discussion. The discussion below should not be construed as legal or professional tax advice and does not cover all possible tax considerations. Potential investors are urged to consult their own tax advisors as to the Israeli or other tax consequences of the purchase, ownership and disposition of our ordinary shares, including in particular, the effect of any foreign, state or local taxes. General Corporate Tax Structure Generally, Israeli companies are subject to “Corporate Tax” on their taxable income at the rate of 24% for the 2011 tax year and 25% for the 2012 tax year. Following an amendment to the Tax Ordinance, which came into effect on January 1, 2012, the Corporate Tax rate is scheduled to remain at a rate of 25% for future tax years. Israeli companies are generally subject to Capital Gains Tax at the corporate tax rate. However, the effective tax rate payable by a company which derives income from an approved enterprise (as further discussed below) may be considerably less. See “–Tax Benefits under the Law for the Encouragement of Capital Investments, 1959.” Israeli Transfer Pricing Regulations On November 29, 2006, Income Tax Regulations (Determination of Market Terms), 2006, promulgated under Section 85A of the Israeli Tax Ordinance, came into effect, or the TP Regs. Section 85A of the Tax Ordinance and the TP Regs generally require that all cross-border transactions carried out between related parties be conducted on an arm’s length principle basis and will be taxed accordingly. The TP Regs are not expected to have a material affect on us. Tax Benefits for Research and Development Israeli tax law allows, under specified conditions, a tax deduction for expenditures, including capital expenditures, in the year incurred relating to scientific research and development projects, if the expenditures are approved by the relevant Israeli Government ministry, determined by the field of research, and the research and development is for the promotion of the company and is carried out by or on behalf of the company seeking such deduction. However, the amount of such deductible expenses shall be reduced by the sum of any funds received through government grants for the finance of such scientific research and development projects. Expenditures not so approved are deductible over a three-year period - 66 - Encouragement of Capital Investments Law, 5719-1959 The Investments Law Prior to the 2005 Amendment The Law for the Encouragement of Capital Investments, 1959, or the Investments Law, as in effect prior to April 1, 2005 provided that a proposed capital investment in eligible facilities may, upon application to the Investment Center of the Ministry of Industry and Commerce of the State of Israel, be designated as an approved enterprise. The Investment Center based its decision as to whether or not to approve an application, among other things, on the criteria set forth in the Investments Law and regulations, the then prevailing policy of the Investment Center, and the specific objectives and financial criteria of the applicant. Each certificate of approval for an approved enterprise relates to a specific investment program delineated both by its financial scope, including its capital sources, and by its physical characteristics, such as the equipment to be purchased and utilized pursuant to the program. The Investments Law provides that an approved enterprise is eligible for tax benefits on taxable income derived from its approved enterprise programs. The tax benefits under the Investments Law also apply to income generated by a company from the grant of a usage right with respect to know-how developed by the approved enterprise, income generated from royalties, and income derived from a service which is auxiliary to such usage right or royalties, provided that such income is generated within the approved enterprise’s ordinary course of business. If a company has more than one approval enterprise or only a portion of its capital investments are approved, its effective tax rate is the result of a weighted average of the applicable rates. The tax benefits under the Investments Law are not, generally, available with respect to income derived from products manufactured outside of Israel. In addition, the tax benefits available to an approved enterprise are contingent upon the fulfillment of conditions stipulated in the Investments Law and regulations and the criteria set forth in the specific certificate of approval, as described above. In the event that a company does not meet these conditions, it would be required to refund the amount of tax benefits, plus a consumer price index linkage adjustment and interest. The Investments Law also provides that an approved enterprise is entitled to accelerated depreciation on its property and equipment that are included in an approved enterprise program. Taxable income of a company derived from an approved enterprise is subject to corporate tax at the maximum rate of 25%, rather than the regular corporate tax rate, for the benefit period. This period is ordinarily seven years commencing with the year in which the approved enterprise first generates taxable income (after the commencement of production), and is limited to 12 years from commencement of production or 14 years from the date of approval, whichever is earlier, referred to as the “Years Limitation.” A company may elect to receive an alternative package of benefits. Under the alternative package of benefits, a company’s undistributed income derived from the approved enterprise will be exempt from corporate tax for a period of between two and ten years from the first year the company derives taxable income under the program, depending on the geographic location of the approved enterprise within Israel, and such company will be eligible for a reduced tax rate for the remainder of the benefits period. The Years Limitation does not apply to the exemption period. A company that has elected the alternative package of benefits, such as us, that subsequently pays a dividend out of income derived from the approved enterprise during the tax exemption period will be subject to corporate tax in respect of the gross amount distributed, including any taxes thereon, at the rate which would have been applicable had it not elected the alternative package of benefits, generally 10%-25%, depending on the percentage of the company’s ordinary shares held by foreign shareholders. The dividend recipient is subject to withholding tax at the rate of 15% applicable to dividends from approved enterprises, if the dividend is distributed during the tax exemption period or within twelve years thereafter. The company must withhold this tax at source. A company that has an approved enterprise program is eligible for further tax benefits if it qualifies as a foreign investors’ company. A foreign investors’ company is a company which more than 25% of its share capital and combined share and loan capital is owned by non-Israeli residents. A company that qualifies as a foreign investors’ company and has an approved enterprise program is eligible for tax benefits for a ten-year benefit period. As specified above, depending on the geographic location of the approved enterprise within Israel, income derived from the approved enterprise program may be exempt from tax on its undistributed income for a period of between two to ten years, and will be subject to a reduced tax rate for the remainder of the benefits period. The tax rate for the remainder of the benefits period will be 25%, unless the level of foreign investment exceeds 49%, in which case the tax rate will be 20% if the foreign investment is more than 49% and less than 74%; 15% if more than 74% and less than 90%; and 10% if 90% or more. - 67 - Subject to applicable provisions concerning income under the alternative package of benefits, dividends paid by a company are considered to be attributable to income received from the entire company and the company’s effective tax rate is the result of a weighted average of the various applicable tax rates, excluding any tax-exempt income. Under the Investments Law, a company that has elected the alternative package of benefits is not obliged to distribute retained profits, and may generally decide from which year’s profits to declare dividends. We currently intend to reinvest any income derived from our approved enterprise program and not to distribute such income as a dividend. The Israeli government may reduce or eliminate tax benefits available to approved enterprise programs in the future. We cannot assure you that our approved program and the benefits thereunder shall continue in the future at its current level or at any level. Currently, we have two valid expansion programs that were granted approved enterprise status under the Investments Law prior to its amendment. 2005 Amendment to the Investments Law An amendment to the Investments Law, which was published on April 1, 2005, or the Amendment, has changed certain provisions of the Investments Law. As a result of the Amendment, a company is no longer obliged to acquire approved enterprise status in order to receive the tax benefits previously available under the alternative benefits provisions, and therefore generally there is no need to apply to the Investment Center for this purpose (approved enterprise status remains mandatory for companies seeking grants). Rather, a company may claim the tax benefits offered by the Investments Law directly in its tax returns, provided that its facilities meet the criteria for tax benefits set out by the Amendment. A company is also granted a right to approach the Israeli Tax Authority for a pre-ruling regarding their eligibility for benefits under the Amendment. Tax benefits are available under the Amendment to production facilities (or other eligible facilities), which are generally required to derive more than 25% of their business income from export, referred to as a “Benefited Enterprise.” In order to receive the tax benefits, the Amendment states that the company must make an investment in the Benefited Enterprise exceeding a certain percentage or a minimum amount specified in the Investments Law. Such investment may be made over a period of no more than three years ending at the end of the year in which the company requested to have the tax benefits apply to the Benefited Enterprise, referred to as the Year of Election. Where the company requests to have the tax benefits apply to an expansion of existing facilities, then only the expansion will be considered a Benefited Enterprise and the company’s effective tax rate will be the result of a weighted combination of the applicable rates. In this case, the minimum investment required in order to qualify as a Benefited Enterprise is required to exceed a certain percentage or a minimum amount of the company’s production assets before the expansion. The duration of tax benefits is subject to a limitation of the earlier of seven to ten years from the commencement year, or 12 years from the first day of the Year of Election. The tax benefits granted to a Benefited Enterprise are determined, as applicable to its geographic location within Israel, according to one of the following new tax routes, which may be applicable to us: • Similar to the currently available alternative route, exemption from corporate tax on undistributed income for a period of two to ten years, depending on the geographic location of the Benefited Enterprise within Israel, and a reduced corporate tax rate of 10% to 25% for the remainder of the benefits period, depending on the level of foreign investment in each year. Benefits may be granted for a term of seven to ten years, depending on the level of foreign investment in the company. If the company pays a dividend out of income derived from the Benefited Enterprise during the tax exemption period, such income will be subject to corporate tax at the applicable rate (10%-25%) with respect to the gross amount of dividend distributed. The company is required to withhold tax at the source at a rate of 15% from any dividends distributed from income derived from the Benefited Enterprise; and - 68 - • A special tax route, which enables companies owning facilities in certain geographical locations in Israel to pay corporate tax at the rate of 11.5% on income of the Benefited Enterprise. The benefits period is ten years. Upon payment of dividends, the company is required to withhold tax at source at a rate of 15% for Israeli residents and at a rate of 4% for foreign residents. Generally, a company that is “Abundant in Foreign Investment,” as defined in the Investments Law, is entitled to an extension of the benefits period by an additional five years, depending on the rate of its income that is derived in foreign currency. The Amendment changes the definition of “foreign investment” in the Investments Law so that the definition now requires a minimal investment of NIS 5 million by foreign investors. Furthermore, such definition now also includes the purchase of shares of a company from another shareholder, provided that the company’s outstanding and paid-up share capital exceeds NIS 5 million. Such changes to the aforementioned definition are retroactive from 2003. The Amendment applies to approved enterprise programs in which the year of election under the Investments Law is 2004 or later, unless such programs received “Approved Enterprise” approval from the Investment Center on or prior to December 31, 2004, in which case the Amendment provides that terms and benefits included in any certificate of approval already granted will remain subject to the provisions of the Investments Law as they were on the date of such approval. Should we elect to utilize tax benefits under the Amendment to the Investments Law, any such tax exempt profits might be subject to future taxation on the corporate level upon distribution to shareholders by a way of dividend or liquidation. Accordingly, we may be required to recognize deferred tax liability with respect to such tax exempt profits. A substantial portion of our taxable operating income is derived from our approved enterprise program and we expect that a substantial portion of any taxable operating income that we may realize in the future will be also derived from such program. There is no assurance that our facilities will continue to enjoy such status in the future. On March 3, 2007, we received a pre-ruling from the Israeli Tax Authority confirming that our most recent development program will be deemed a Benefiting Enterprise under the amended Investments Law. Our income from this program is tax-exempt for a period of two years, and is subject to a reduced tax rate of 10%-25 for a period of five to eight years (depending upon the percentage of foreign ownership of the Company). We have not enjoyed any tax benefits under this program to date. Reform of the Investments Law On December 29, 2010, the Israeli Parliament approved an amendment to the Investments Law, effective as of January 1, 2011, which constitutes a reform of the incentives regime under such law. This amendment revises the objectives of the Investments Law to focus on achieving enhanced growth in the business sector, improving the Israeli industry’s competitiveness in international markets and creating employment and development opportunities in remote areas of Israel. The amendment allows enterprises meeting certain required criteria to enjoy grants as well as tax benefits. The amendment also introduces certain changes to the map of geographic development areas for purposes of the Investments Law, which will take effect in future years. The amendment generally abolishes the previous tax benefit routes that were afforded under the Investment Law, specifically the tax-exemption periods previously allowed, and introduces new tax benefits for industrial enterprises meeting the criteria of the law, which include the following: • A reduced corporate tax rate for industrial enterprises, provided that more than 25% of their annual income is derived from export, which will apply to the enterprise’s entire preferred income so that in the tax years 2011 and 2012 the reduced tax rate will be 10% for preferred income derived from industrial facilities located in development area A and 15% for those located elsewhere in Israel, in the tax years 2013 and 2014 the reduced tax rate will be 7% for development area A and 12.5% for the rest of Israel, and in the tax year 2015 and onwards the reduced tax rate will be 6% for development area A and 12% for the rest of Israel; - 69 -  • • • • The reduced tax rates will no longer be contingent upon making a minimum qualifying investment in productive assets; A definition of “preferred income” was introduced into the Investments Law to include certain types of income that are generated by the Israeli production activity of a preferred enterprise; A reduced dividend withholding tax rate of 15% will apply to dividends paid from preferred income to both Israeli and non-Israeli investors, with an exemption from such withholding tax applying to dividends paid to an Israeli company; and A special tax benefits route will be granted to certain industrial enterprises entitling them to a reduced tax rate of 5% for preferred income derived from industrial facilities located in development area A and 8% for those located elsewhere in Israel, provided certain threshold requirements are met and such enterprise can demonstrate its significant contribution to Israel’s economy and promotion of national market objectives; A “Preferred Company” (as defined in the Investments Law) may generally elect to apply the provisions of the amendment to preferred income produced or generated by it commencing on January 1, 2011. The amendment provides various transition provisions which allow, under certain circumstances, to apply the new regime to investment programs previously approved or elected under the Investments Law in its previous form. Encouragement of Industry (Taxes) Law, 5729-1969 Under the Encouragement of Industry (Taxes) Law, 5729-1969, or the Industry Encouragement Law, “Industrial Companies” are entitled to certain corporate tax benefits, including, among others: • • • • Amortization, under certain conditions, of purchases of know-how and patents and of rights to use a patent and know-how which are used for the development or advancement of the company, over an eight-year period for tax purposes; Right to elect, under specified conditions, to file a consolidated tax return with additional related Israeli industrial companies; and Accelerated depreciation rates on equipment and buildings; and Deductions over a three-year period of expenses in connection with the issuance and listing of shares on a recognized stock market. Eligibility for benefits under the Industry Encouragement Law is not subject to the prior approval of any governmental authority. Under the Industry Encouragement Law, an “Industrial Company” is a company resident in Israel, at least 90% of the income of which, in any tax year, determined in Israeli currency, exclusive of income from government loans, capital gains, interest and dividends, is derived from an “Industrial Enterprise” owned by it. An “Industrial Enterprise” is an enterprise owned by an Industrial Company, whose major activity in a given tax year is industrial production activity. We believe that we currently qualify as an industrial company as defined by the Industry Encouragement Law. We cannot assure you that we will continue to qualify as an industrial company or that the benefits described above will be available to us in the future. Encouragement of Industrial Research and Development Law, 5744-1984 Under the Encouragement of Industrial Research and Development Law, 5744-1984, or the Research Law, research and development programs that meet specified criteria and are approved by a governmental committee of the Office of the Chief Scientist of the Israeli Ministry of Industry, Trade and Labor, or the OCS, are eligible for grants between 20%-50% of certain of the project’s expenditures, as determined by the research committee of the OCS. In exchange, the recipient of such grants is required to pay the OCS royalties from the revenues derived from products incorporating technology developed within the framework of the approved research and development program or derived from such program (including ancillary services in connection with such program), usually up to 100% of the U.S. dollar-linked value of the total grants received in respect of such program, plus LIBOR interest. - 70 - The terms of the Israeli government participation also require a declaration regarding the location of manufacturing of supported products by the recipients of the grants. Under regulations promulgated under the Research Law, upon the approval of the OCS, some of the manufacturing volume may be transferred outside of Israel, beyond the aforementioned declared rate of production abroad, provided that the grant recipient pays royalties at an increased rate and in addition may incur an increased payment cap of up to 300% of the received grant, depending on the percentage of manufacturing being transferred abroad. The Research Law also provides that know-how developed under an approved research and development program and any derivatives of this know-how may not be transferred to third parties in Israel without the prior approval of the research committee of the OCS. The Research Law further provides that the know- how developed under an approved research and development program may not be transferred to any third parties outside Israel. No approval is required for the sale or export of any products resulting from such research and development. In June 2005, an amendment to the Research Law became effective, which amendment was intended to make the Research Law more compatible with the global business environment by, among other things, relaxing restrictions on the transfer of manufacturing rights outside Israel and on the transfer of OCS funded know-how outside of Israel. The amendment permits the OCS, among other things, to approve the transfer of manufacturing rights outside Israel in exchange for an import of different manufacturing into Israel as a substitute, in lieu of demanding the recipient to pay increased royalties as described above. The amendment further permits, under certain circumstances and subject to the OCS’s prior approval, the transfer outside Israel of know- how that has been funded by OCS, generally in the following cases: (a) the grant recipient pays to the OCS a portion of the consideration paid for such funded know-how (according to certain formulas), (b) the grant recipient receives know-how from a third party in exchange for its funded know-how, or (c) such transfer of funded know-how arises in connection with certain types of cooperation in research and development activities. The Research Law imposes reporting requirements with respect to certain changes in the ownership of a grant recipient. The law requires the grant recipient and its controlling shareholders and interested parties to notify the OCS and obtaining the approval of the OCS for any change in control of the recipient or a change in the holdings of the means of control of the recipient that results in a foreign resident becoming an interested party directly in the recipient and requires the new interested party to undertake to the OCS to comply with the Research Law. In addition, the rules of the OCS may require prior approval of the OCS or additional information or representations in respect of certain of such events. For this purpose, “control” is defined as the ability to direct the activities of a company other than any ability arising solely from serving as an officer or director of the company. A person is presumed to have control if such person holds 50% or more of the means of control of a company. “Means of control” refers to voting rights or the right to appoint directors or the chief executive officer. An “interested party” of a company includes a holder of 5% or more of its outstanding share capital or voting rights, its chief executive officer and directors, someone who has the right to appoint its chief executive officer or at least one director, and a company with respect to which any of the foregoing interested parties owns 25% or more of the outstanding share capital or voting rights or has the right to appoint 25% or more of the directors. Accordingly, any foreign resident who acquires 5% or more of our ordinary shares will be required to notify the OCS that it has become an interested party and to sign an undertaking to comply with the Research Law. The Israeli authorities have indicated that the government may reduce or abolish grants from the OCS in the future. Even if these grants are maintained, we cannot assure you that we will receive OCS grants in the future. In addition, each application to the OCS is reviewed separately, and grants are based on the program approved by the research committee. Generally, expenditures supported under other incentive programs of the State of Israel are not eligible for grants from the OCS. Taxation under Inflationary Conditions The Income Tax (Inflationary Adjustments) Law, 5745-1985, generally referred to as the Inflationary Adjustments Law, represents an attempt to overcome the problems presented to a traditional tax system by an economy undergoing rapid inflation. The Inflationary Adjustments Law is highly complex. Its features which are material to us can be described as follows: • There is a special tax adjustment for the preservation of equity whereby some corporate assets are classified broadly into fixed assets and non-fixed assets. - 71 - • • Where a company’s equity, as defined in such law, exceeds the depreciated cost of fixed assets, a deduction from taxable income that takes into account the effect of the applicable annual rate of inflation on such excess is allowed up to a ceiling of 70% of taxable income in any single tax year, with the unused portion permitted to be carried forward on a linked basis. If the depreciated cost of fixed assets exceeds a company’s equity, then such excess multiplied by the applicable annual rate of inflation is added to taxable income. Subject to specified limitations, depreciation deductions on fixed assets and losses carried forward are adjusted for inflation based on the increase in the Israeli consumer price index. The Inflationary Adjustments Law was abolished, effective as of January 1 2008, and subject to transitional provisions and special provisions to prevent a distortion in the tax calculations. In February 2008, the Knesset passed an amendment to the Income Tax (Inflationary Adjustments) Law, 1985, which limits the scope of the law with effect from 2008 and thereafter. From 2008, the results for tax purposes will be measured in nominal values, excluding certain adjustments for changes in the Israeli consumer price index carried out in the period up to December 31, 2007. The amended law includes, among other things, the elimination of the inflationary additions and deductions and the additional deduction for depreciation with effect from 2008. Capital Gains Tax on Sales of Our Ordinary Shares by Foreign Holders Israeli law generally imposes a capital gains tax on the sale of any capital assets by residents of Israel, as defined for Israeli tax purposes, and on the sale of assets located in Israel, including shares in Israeli companies, by non-residents of Israel, unless a specific exemption is available or unless a tax treaty between Israel and the shareholder’s country of residence provides otherwise. The law distinguishes between real gain and inflationary surplus. The inflationary surplus is a portion of the total capital gain which is equivalent to the increase of the relevant asset’s purchase price which is attributable to the increase in the Israeli consumer price index or, in certain circumstances, a foreign currency exchange rate, between the date of purchase and the date of sale. The real gain is the excess of the total capital gain over the inflationary surplus. Generally, as of January 1, 2012, the tax rate applicable to capital gains derived from the sale of shares, whether listed on a stock market or not, is 25% for Israeli individuals, unless such shareholder claims a deduction for financing expenses in connection with such shares, in which case the gain will generally be taxed at a rate of 30%. Additionally, if such shareholder is considered a “significant shareholder” at any time during the 12-month period preceding such sale, i.e., such shareholder holds directly or indirectly, including with others, at least 10% of any means of control in the company, the tax rate shall be 30%. However, the foregoing tax rates do not apply to: (i) dealers in securities; and (ii) shareholders who acquired their shares prior to an initial public offering (that may be subject to a different tax arrangement). Israeli companies are subject to the Corporate Tax rate on capital gains derived from the sale of listed shares. The tax basis of our ordinary shares acquired prior to January 1, 2003 will generally be determined in accordance with the average closing share price in the three trading days preceding January 1, 2003. However, a request may be made to the tax authorities to consider the actual adjusted cost of the shares as the tax basis if it is higher than such average price. Non-Israeli residents are exempt from Israeli capital gains tax on any gains derived from the sale of shares of Israeli companies publicly traded on a recognized stock exchange or regulated market outside of Israel, provided however that such capital gains are not derived from a permanent establishment in Israel and such shareholders did not acquire their shares prior to an initial public offering. However, non-Israeli corporations will not be entitled to such exemption if Israeli residents (i) have a controlling interest of 25% or more in such non-Israeli corporation, or (ii) are the beneficiaries or are entitled to 25% or more of the revenues or profits of such non-Israeli corporation, whether directly or indirectly. In some instances where our shareholders may be liable to Israeli tax on the sale of their ordinary shares, the payment of the consideration may be subject to the withholding of Israeli tax at the source. - 72 - Pursuant to the Convention Between the government of the United States of America and the government of Israel with Respect to Taxes on Income, as amended, or the U.S.-Israel Tax Treaty, the sale, exchange or disposition of ordinary shares by a person who (i) holds the ordinary shares as a capital asset, (ii) qualifies as a resident of the United States within the meaning of the U.S.-Israel Tax Treaty, or a Treaty U.S. Resident, and (iii) is entitled to claim the benefits afforded to such person by the U.S.-Israel Tax Treaty, generally, will not be subject to the Israeli capital gains tax. Such exemption will not apply if (i) such Treaty U.S. Resident holds, directly or indirectly, shares representing 10% or more of our voting power during any part of the 12-month period preceding such sale, exchange or disposition, subject to certain conditions, or (ii) the capital gains from such sale, exchange or disposition can be allocated to a permanent establishment in Israel. In such case, the sale, exchange or disposition of ordinary shares would be subject to Israeli tax, to the extent applicable; however, under the U.S.-Israel Tax Treaty, such Treaty U.S. Resident would be permitted to claim a credit for such taxes against the U.S. federal income tax imposed with respect to such sale, exchange or disposition, subject to the limitations in U.S. laws applicable to foreign tax credits. The U.S.-Israel Tax Treaty does not relate to U.S. state or local taxes. Taxation of Dividends paid to Non-Resident Holders of Shares Non-residents of Israel are subject to income tax on income accrued or derived from sources in Israel. Such sources of income include passive income such as dividends. On distributions of dividends other than bonus shares or stock dividends, income tax is applicable at the rate of 25%, or 30% for a shareholder that is considered a “significant shareholder” at any time during the 12-month period preceding such distribution, unless a different rate is provided in a treaty between Israel and the shareholder’s country of residence. However, under the Investments Law, dividends generated by an Approved Enterprise (or Benefited Enterprise) are taxed at the rate of 15%. Under the U.S.-Israel Tax Treaty, the maximum tax on dividends paid to a holder of ordinary shares who is a Treaty U.S. Resident is 25%. However, if the income out of which the dividend is paid is not generated by an Approved Enterprise (or Benefited Enterprise), and not more than 25% of our gross income consists of interest or dividends, dividends paid to a U.S. corporation holding at least 10% of our issued voting power during the part of the tax year which precedes the date of payment of the dividend and during the whole of its prior tax year, are generally taxed at a rate of 12.5%. Dividends generated by an Approved Enterprise (or Benefited Enterprise) are taxed at the rate of 15% under the U.S.-Israel Tax Treaty. UNITED STATES FEDERAL INCOME TAX CONSEQUENCES The following is a summary of material U.S. federal income tax consequences that apply to U.S. Holders who hold ordinary shares as capital assets. This summary is based on the United States Internal Revenue Code of 1986, as amended (the “Code”), Treasury regulations promulgated thereunder, judicial and administrative interpretations thereof, and the U.S.-Israel Tax Treaty, all as in effect on the date hereof and all of which are subject to change either prospectively or retroactively. This summary does not address all tax considerations that may be relevant with respect to an investment in ordinary shares. This summary does not discuss all the tax consequences that may be relevant to a U.S. Holder in light of such holder's particular circumstances or U.S. Holders subject to special rules, including persons that are non-U.S. Holders, broker-dealers, financial institutions, certain insurance companies, investors liable for alternative minimum tax, tax-exempt organizations, regulated investment companies, taxpayers whose functional currency is not the U.S. dollar, persons who hold the ordinary shares through partnerships or other pass-through entities, persons who acquired their ordinary shares through the exercise or cancellation of employee stock options or otherwise as compensation for services, investors that actually or constructively own 10 percent or more of our voting shares, and investors holding ordinary shares as part of a straddle or appreciated financial position or as part of a hedging or conversion transaction. For purposes of this summary, the term "U.S. Holder" means an individual who is a citizen or, for U.S. federal income tax purposes, a resident of the United States, a corporation or other entity taxable as a corporation created or organized in or under the laws of the United States or any political subdivision thereof, an estate whose income is subject to U.S. federal income tax regardless of its source, or a trust that (a) is subject to the primary supervision of a court within the United States and the control of one or more U.S. persons or (b) has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person. If a partnership or an entity treated as a partnership for U.S. federal income tax purposes owns ordinary shares, the U.S. federal income tax treatment of a partner in such a partnership will generally depend upon the status of the partner and the activities of the partnership. A partnership that owns ordinary shares and the partners in such partnership should consult their tax advisors about the U.S. federal income tax consequences of holding and disposing of common shares. - 73 - This summary does not address the effect of any U.S. federal taxation other than U.S. federal income taxation. In addition, this summary does not include any discussion of state, local or foreign taxation. This summary is not a legal opinion and cannot be used for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable U.S. state or local laws. You are urged to consult your tax advisors regarding the foreign and United States federal, state and local tax considerations of an investment in ordinary shares. Taxation of Dividends Subject to the discussion below under the heading “Passive Foreign Investment Companies,” the gross amount of any distributions received with respect to ordinary shares, including the amount of any Israeli taxes withheld therefrom, will constitute dividends for U.S. federal income tax purposes, to the extent of our current and accumulated earnings and profits as determined for U.S. federal income tax purposes. You will be required to include this amount of dividends in gross income as ordinary income. Distributions in excess of our current and accumulated earnings and profits will be treated as a non-taxable return of capital to the extent of your tax basis in the ordinary shares and any amount in excess of your tax basis will be treated as gain from the sale of ordinary shares. See "Disposition of Ordinary Shares" below for the discussion on the taxation of capital gains. Dividends will not qualify for the dividends received deduction generally available to corporations under Section 243 of the Code. Dividends that we pay in NIS, including the amount of any Israeli taxes withheld therefrom, will be included in your income in a U.S. dollar amount calculated by reference to the exchange rate in effect on the day such dividends are received. A U.S. Holder who receives payment in NIS and converts NIS into U.S. dollars at an exchange rate other than the rate in effect on such day may have a foreign currency exchange gain or loss that would be treated as ordinary income or loss. U.S. Holders should consult their own tax advisors concerning the U.S. tax consequences of acquiring, holding and disposing of NIS. Subject to complex limitations, any Israeli withholding tax imposed on such dividends will be a foreign income tax eligible for credit against a U.S. Holder's U.S. federal income tax liability (or, alternatively, for deduction against income in determining such tax liability). The limitations set out in the Code include computational rules under which foreign tax credits allowable with respect to specific classes of income cannot exceed the U.S. federal income taxes otherwise payable with respect to each such class of income. Dividends generally will be treated as foreign source passive category income for United States foreign tax credit purposes. Further, there are special rules for computing the foreign tax credit limitation of a taxpayer who receives dividends subject to a reduced rate of tax, see discussion below. A U.S. Holder will be denied a foreign tax credit with respect to Israeli income tax withheld from dividends received on the ordinary shares to the extent such U.S. Holder has not held the ordinary shares for at least 16 days of the 31-day period beginning on the date which is 15 days before the ex-dividend date or to the extent such U.S. Holder is under an obligation to make related payments with respect to substantially similar or related property. Any days during which a U.S. Holder has substantially diminished its risk of loss on the ordinary shares are not counted toward meeting the 16-day holding period required by the statute. The rules relating to the determination of the foreign tax credit are complex, and you should consult with your personal tax advisors to determine whether and to what extent you would be entitled to this credit. Subject to certain limitations, “qualified dividend income” received by a noncorporate U.S. Holder in tax years beginning on or before December 31, 2011 will be subject to tax at a reduced maximum tax rate of 15 percent. Distributions taxable as dividends paid on the ordinary shares should qualify for the 15 percent rate provided that either: (i) we are entitled to benefits under the income tax treaty between the United States and Israel (the “Treaty”) or (ii) the ordinary shares are readily tradable on an established securities market in the United States and certain other requirements are met. We believe that we are entitled to benefits under the Treaty and that the ordinary shares currently are readily tradable on an established securities market in the United States. However, no assurance can be given that the ordinary shares will remain readily tradable. The rate reduction does not apply unless certain holding period requirements are satisfied. With respect to the ordinary shares, the U.S. Holder must have held such shares for at least 61 days during the 121-day period beginning 60 days before the ex-dividend date. The rate reduction also does not apply to dividends received from a passive foreign investment company, see discussion below, or in respect of certain hedged positions or in certain other situations. The legislation enacting the reduced tax rate contains special rules for computing the foreign tax credit limitation of a taxpayer who receives dividends subject to the reduced tax rate. U.S. Holders of ordinary shares should consult their own tax advisors regarding the effect of these rules in their particular circumstances. - 74 - Disposition of Ordinary Shares If you sell or otherwise dispose of ordinary shares, you will recognize gain or loss for U.S. federal income tax purposes in an amount equal to the difference between the amount realized on the sale or other disposition and your adjusted tax basis in the ordinary shares. Subject to the discussion below under the heading "Passive Foreign Investment Companies," such gain or loss generally will be capital gain or loss and will be long-term capital gain or loss if you have held the ordinary shares for more than one year at the time of the sale or other disposition. In general, any gain that you recognize on the sale or other disposition of ordinary shares will be U.S.-source for purposes of the foreign tax credit limitation; losses will generally be allocated against U.S. source income. Deduction of capital losses is subject to certain limitations under the Code. In the case of a cash basis U.S. Holder who receives NIS in connection with the sale or disposition of ordinary shares, the amount realized will be based on the U.S. dollar value of the NIS received with respect to the ordinary shares as determined on the settlement date of such exchange. A U.S. Holder who receives payment in NIS and converts NIS into United States dollars at a conversion rate other than the rate in effect on the settlement date may have a foreign currency exchange gain or loss that would be treated as ordinary income or loss. An accrual basis U.S. Holder may elect the same treatment required of cash basis taxpayers with respect to a sale or disposition of ordinary shares, provided that the election is applied consistently from year to year. Such election may not be changed without the consent of the Internal Revenue Service (the “IRS”). In the event that an accrual basis U.S. Holder does not elect to be treated as a cash basis taxpayer (pursuant to the Treasury regulations applicable to foreign currency transactions), such U.S. Holder may have a foreign currency gain or loss for U.S. federal income tax purposes because of differences between the U.S. dollar value of the currency received prevailing on the trade date and the settlement date. Any such currency gain or loss would be treated as ordinary income or loss and would be in addition to gain or loss, if any, recognized by such U.S. Holder on the sale or disposition of such ordinary shares. Passive Foreign Investment Companies For U.S. federal income tax purposes, we will be considered a passive foreign investment company, or PFIC, for any taxable year in which either (i) 75% or more of our gross income is passive income, or (ii) at least 50% of the average value of all of our assets for the taxable year produce or are held for the production of passive income. For this purpose, passive income includes dividends, interest, royalties, rents, annuities and the excess of gains over losses from the disposition of assets which produce passive income. If we were determined to be a PFIC for U.S. federal income tax purposes, highly complex rules would apply to U.S. Holders owning, directly or indirectly, ordinary shares. Accordingly, you are urged to consult your tax advisors regarding the application of such rules. Based on our current and projected income, assets and activities, we believe that we are not currently a PFIC nor do we expect to become a PFIC in the foreseeable future. However, because the determination of whether we are a PFIC is based upon the composition of our income and assets from time to time, there can be no assurances that we will not become a PFIC in this or any future taxable year. If we are treated as a PFIC for any taxable year, dividends would not qualify for the reduced maximum tax rate, discussed above, you would be required to file an annual return on IRS Form 8621, and, unless you elect either to treat your investment in ordinary shares as an investment in a "qualified electing fund," or a QEF election, or to "mark to market" your ordinary shares, as described below: • • you would be required to allocate income recognized upon receiving certain dividends or gain recognized upon the disposition of ordinary shares ratably over the holding period for such ordinary shares, the amount allocated to each year during which we are considered a PFIC other than the year of the dividend payment or disposition would be subject to tax at the highest individual or corporate tax rate, as the case may be, in effect for that year and an interest charge would be imposed with respect to the resulting tax liability allocated to each such year, and - 75 - • the amount allocated to the current taxable year and any taxable year before we became a PFIC would be taxable as ordinary income in the current year. If you make either a timely QEF election or a timely mark-to-market election in respect of your ordinary shares, you would not be subject to the rules described above. If you make a timely QEF election, you would be required to include in your income for each taxable year your pro rata share of our ordinary earnings as ordinary income and your pro rata share of our net capital gain as long-term capital gain, whether or not such amounts are actually distributed to you. You would not be eligible to make a QEF election unless we comply with certain applicable information reporting requirements. Alternatively, if the ordinary shares are considered "marketable stock" and if you elect to "mark-to-market" your ordinary shares, you will generally include in income any excess of the fair market value of the ordinary shares at the close of each tax year over your adjusted basis in the ordinary shares. If the fair market value of the ordinary shares had depreciated below your adjusted basis at the close of the tax year, you may generally deduct the excess of the adjusted basis of the ordinary shares over its fair market value at that time. However, such deductions generally would be limited to the net mark-to-market gains, if any, that you included in income with respect to such ordinary shares in prior years. Income recognized and deductions allowed under the mark-to-market provisions, as well as any gain or loss on the disposition of ordinary shares with respect to which the mark-to-market election is made, is treated as ordinary income or loss (except that loss on a disposition of ordinary shares is treated as capital loss to the extent the loss exceeds the net mark-to-market gains, if any, that you included in income with respect to such ordinary shares in prior years). Gain or loss from the disposition of ordinary shares (as to which a mark-to-market election was made) in a year in which we are no longer a PFIC, will be capital gain or loss. Additional Tax on Investment Income In addition to the taxes on dividends and dispositions of our ordinary shares described above, recently enacted legislation requires certain U.S. Holders that are individuals, estates or trusts to pay up to an additional 3.8% tax on net investment income, which may include dividends and capital gains, for taxable years beginning after December 31, 2012. Backup Withholding and Information Reporting Payments in respect of ordinary shares may be subject to information reporting to the U.S. Internal Revenue Service and to U.S. backup withholding tax at a rate (currently) of 28%. Backup withholding will not apply, however, if you (i) are a corporation or come within certain exempt categories, and demonstrate the fact when so required, or (ii) furnish a correct taxpayer identification number and make any other required certification. Backup withholding is not an additional tax. Amounts withheld under the backup withholding rules may be credited against a U.S. Holder’s U.S. tax liability, and a U.S. Holder may obtain a refund of any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the IRS. Beginning with the 2011 tax year, US individuals that hold certain specified foreign financial assets, including stock in a foreign corporation, with values in excess of certain thresholds are required to file Form 8938 with their US Federal income tax return. Such Form requires disclosure of information concerning such foreign assets, including the value of the assets. Failure to file the form when required is subject to penalties. An exemption from reporting applies to foreign assets held through a US financial institution, generally including a non-US branch or subsidiary of a US institution and a US branch of a non-US institution. Investors are encouraged to consult with their own tax advisors regarding the possible application of this disclosure requirement to their investment in ordinary shares. Any U.S. holder who holds 10% or more in vote or value of our ordinary shares will be subject to certain additional United States information reporting requirements. - 76 - F. Dividends and Paying Agents. Not applicable. G. Statements by Experts. Not applicable. H. Documents on Display. We are subject to certain of the reporting requirements of the Securities and Exchange Act of 1934, as amended, or the Exchange Act, as applicable to “foreign private issuers” as defined in Rule 3b-4 under the Exchange Act. As a foreign private issuer, we are exempt from certain provisions of the Exchange Act. Accordingly, our proxy solicitations are not subject to the disclosure and procedural requirements of Regulation 14A under the Exchange Act, and transactions in our equity securities by our officers and directors are exempt from reporting and the “short-swing” profit recovery provisions contained in Section 16 of the Exchange Act. In addition, we are not required under the Exchange Act to file periodic reports and financial statements as frequently or as promptly as U.S. companies whose securities are registered under the Exchange Act. However, we file with the Securities and Exchange Commission an annual report on Form 20-F containing financial statements audited by an independent accounting firm. We also submit to the Securities and Exchange Commission reports on Form 6-K containing (among other things) press releases and unaudited financial information. We post our annual report on Form 20-F on our website (www.magal-s3.com) promptly following the filing of our annual report with the Securities and Exchange Commission. The information on our website is not incorporated by reference into this annual report. This annual report and the exhibits thereto and any other document we file pursuant to the Exchange Act may be inspected without charge and copied at prescribed rates at the Securities and Exchange Commission public reference room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. You may obtain information on the operation of the Securities and Exchange Commission’s public reference room in Washington, D.C. by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Exchange Act file number for our Securities and Exchange Commission filings is 000-21388. The Securities and Exchange Commission maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding registrants that make electronic filings with the Securities and Exchange Commission using its EDGAR (Electronic Data Gathering, Analysis, and Retrieval) system. The documents concerning our company that are referred to in this annual report may also be inspected at our executive offices in Israel. In addition, since we were also listed on the Tel Aviv Stock Exchange until November 30, 2011, we submitted copies of all our filings with the SEC to the Israeli Securities Authority and Tel Aviv Stock Exchange. Such copies can be retrieved electronically through the Tel Aviv Stock Exchange’s internet messaging system (www.maya.tase.co.il) and through the MAGNA distribution site of the Israeli Securities Authority (www.magna.isa.gov.il). I. Subsidiary Information. Not applicable. - 77 - ITEM 11. Quantitative and Qualitative Disclosures about Market Risk We are exposed to a variety of risks, including changes in interest rates and foreign currency fluctuations. Interest Rate Risk Our exposure to market risk for changes in interest rates is related to our short-term loans. Our financial expenses are sensitive to prime interest rate, since our short-term loans as well as our long-term loans, bear prime-based interest rates. The table below presents principal amounts and related weighted average interest rates by date of maturity for our loans: Interest Rate Sensitivity Principal Amount by Expected Maturity Date and Weighted Average Interest Rate (U.S. dollars in thousands) Liabilities Short-term loans Weighted average interest rate (%) Long-term loans Weighted average interest rate (%) $ $ Foreign Currency Exchange Risk 2012 2013 2014 2015 Total Fair Value at December 31, 2011 5,357 4.75 33 4.3 $ - - 33 4.3 $ - - 5 4.3 $ $ - - - - $ $ 5,357 4.75 71 4.3 5,357 - 71 - We sell most of our products in North America, Europe, Africa, Latin America 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 2009 and 2010, the NIS appreciated by approximately 0.7% and 6.0%, respectively, against the U.S. dollar, while in 2011 the NIS depreciated by approximately 7.7% against the U.S. dollar.. In 2010 and 2011, the Euro depreciated against the U.S. dollar by 7.4% and 3.3%, respectively, while in 2009 the Euro appreciated against the U.S. dollar by 3.5%. 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 2009 and 2010 the Canadian dollar appreciated against the U.S. dollar by 16.6% and 4.9%, respectively, while in 2011 the Canadian dollar depreciated by approximately 2.3% against the U.S. dollar. During the years ended December 31, 2009, 2010 and 2011, foreign currency fluctuations had an adverse impact on our results of operations and we recorded foreign exchange losses, net of $1,138,000 and $199,000, respectively. In 2011, foreign currency fluctuations had a positive impact on our results of operations and we recorded foreign exchange income, net of $1,394,000. We cannot assure you that in the future our results of operations may not be materially affected by currency fluctuations. We try to use natural hedges in order protect against fluctuations in the exchange rates. From time to time, we have entered into forward contracts to hedge portions of balances denominated in currencies other than our functional currency. In 2010, we had no forward contracts. In 2011, we entered into forward “extra” contracts. These forward contracts are a combination of the purchase of a foreign exchange option and the sale of a foreign exchange option with a “knock in.” A foreign exchange option with a “knock in” is a product that gives the holder the right but not the obligation to exchange one currency for another at a predetermined rate once an agreed “knock in” rate trades. During 2011, these forward “extra” transactions had no impact on our results as none of the “knock in” rates were met. - 78 - 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 $0 of financial expenses related to forward contracts transactions in 2009, 2010 and 2011. ITEM 12. Description of Securities Other Than Equity Securities Not applicable. ITEM 13. Defaults, Dividend Arrearages and Delinquencies Not applicable. ITEM 14. Material Modifications to the Rights of Security Holders and Use of Proceeds PART II Not applicable. ITEM 15. Controls and Procedures Disclosure Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in its Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our chief executive officer and chief financial officer to allow timely decisions regarding required disclosure. Our management, including our chief executive officer and chief financial officer, conducted an evaluation of our disclosure controls and procedures, as defined under Exchange Act Rule 13a-15(e), as of the end of the period covered by this Annual Report on Form 20-F. Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective. Management's Report on Internal Control over Financial Reporting Our management, including our chief executive officer and chief financial officer, is responsible for establishing and maintaining adequate internal control over financial reporting, as defined under Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. - 79 - Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2010. In conducting its assessment of internal control over financial reporting, management based its evaluation on the framework in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations, or the COSO, of the Treadway Commission. Based on that assessment, our management has concluded that our internal control over financial reporting was effective as of December 31, 2011. Changes in Internal Control over Financial Reporting During the period covered by this Annual Report on Form 20-F, no changes in our internal control over financial reporting have occurred that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. ITEM 16A. Audit Committee Financial Expert Our board of directors has determined that Ms. Liza Singer, an external and independent director, meets the definition of an audit committee financial expert, as defined by rules of the Securities and Exchange Commission. For a brief description of Ms. Singer’s relevant experience, see Item 6.A. “Directors, Senior Management and Employees - Directors and Senior Management.” ITEM 16B. Code of Ethics On April 11, 2010, we adopted an amended and restated code of ethics that revised the provisions of our previous code of ethics. The amended and restated code of ethics applies to our chief executive officer and all senior financial officers of our company, including our chief financial officer, chief accounting officer or controller, and persons performing similar functions. The amended and restated code of ethics reflects our growing emphasis on international operations and better addresses issues related with such activities by providing clear instructions in connection with commercial international activities. The code of ethics is publicly available on our website at www.magal-s3.com. Written copies are available upon request. If we make any substantive amendment to the code of ethics or grant any waivers, including any implicit waiver, from a provision of the code of ethics, we will disclose the nature of such amendment or waiver on our website. ITEM 16C. Principal Accountant Fees and Services Independent Public Accountant Fees and Services The following table sets forth, for each of the years indicated, the fees billed by our principal independent registered public accounting firm, Kost Forer Gabbay & Kasierer. All of such fees were pre-approved by our Audit Committee. Services Rendered Audit (1) Tax (2) Other (3) Total Year Ended December 31 2011 2010 $ $ 369,000 $ 45,000 43,000 457,000 $ 373,600 93,000 29,300 495,900 ______________ (1) (2) (3) Audit fees are for audit services for each of the years shown in the table, including fees associated with the annual audit (including audit of our internal control over financial reporting), consultations on various accounting issues and audit services provided in connection with other statutory or regulatory filings. Tax fees are for professional services rendered by our auditors for tax compliance, tax planning and tax advice on actual or contemplated transactions, tax consulting associated to international taxation, tax assessment deliberation, transfer pricing and withholding tax assessments. Other fees primarily relate to out of pocket reimbursement of expenses, primarily traveling expenses of our auditors. In 2010 and 2011, these fees also relate to fees associated with the rights offering we completed in 2011. Pre-Approval Policies and Procedures Our audit committee has adopted a policy and procedures for the pre-approval of audit and non-audit services rendered by our independent public accounting firm, Kost Forer Gabbay & Kasierer and their affiliates. Pre-approval of an audit or non-audit service may be given as a general pre-approval, as part of the audit committee’s approval of the scope of the engagement of our independent auditor, or on an individual basis. Any proposed services exceeding general pre-approved levels also require specific pre-approval by our audit committee. The policy prohibits retention of the independent public accountants to perform the prohibited non-audit functions defined in Section 201 of the Sarbanes-Oxley Act or the rules of the SEC, and also requires the audit committee to consider whether proposed services are compatible with the independence of the public accountants. - 80 - ITEM 16D. Exemptions from the Listing Standards for Audit Committees Not applicable. ITEM 16E. Purchase of Equity Securities by the Issuer and Affiliated Purchasers On June 17, 2011, we completed a private placement of 150,000 of our ordinary shares to Ki Corporation, a company owned by Mr. Nathan Kirsh, our controlling shareholder, at an initial price per share of $3.04, which was equal to the closing price of our ordinary shares on the NASDAQ Global Market on the date prior to the private placement. Upon the record date of the rights offering, the price per share paid by Ki Corporation was adjusted to $3.05, which was the higher of the price per share in the rights offering and the closing price of our ordinary shares on the NASDAQ Global Market on the date prior to the record date of the rights offering, but in any event not less than the initial purchase price paid in the private placement. The private placement was approved by our shareholders at an extraordinary general meeting held on August 12, 2010 as a private placement that allowed Mr. Kirsh and his affiliates to hold more than 25% of our outstanding share capital. ITEM 16F. Changes In Registrant’s Certifying Accountant None. ITEM 16G. Corporate Governance Under NASDAQ Stock Market Rule 5615(a)(3), foreign private issuers, such as our company, are permitted to follow certain home country corporate governance practices instead of certain provisions of NASDAQ Stock Market Rules. A foreign private issuer that elects to follow a home country practice instead of any of such 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. On July 7, 2005, we notified NASDAQ that we do not comply with the following NASDAQ requirements, and instead follow Israeli law and practice in respect of such requirements: • • • the requirement regarding the process of nominating directors. Instead, we follow Israeli law and practice in accordance with which our directors are recommended by our board of directors for election by our shareholders. See Item 6.C. “Directors, Senior Management and Employees - Board Practices - Election of Directors.” the requirement regarding the compensation of our chief executive officer and all other executive officers. Instead, we follow Israeli law and practice in accordance with which our board of directors must approve all compensation arrangements for our chief executive officer and all compensation arrangements for officers are subject to the chief executive officer’s approval. See Item 6.C. “Directors, Senior Management and Employees - Compensation.” the requirement that our independent directors have regularly scheduled meetings at which only independent directors are present. Under Israeli law independent directors are not required to hold executive sessions. In addition, on June 30, 2006, we provided NASDAQ with a notice of non-compliance with respect to the requirement to maintain a majority of independent directors, as defined under NASDAQ Stock Market 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. - 81 - ITEM 16H. MINE SAFETY DISCLOSURE Not applicable. ITEM 17. Financial Statements PART III We have elected to furnish financial statements and related information specified in Item 18. ITEM 18. Financial Statements The financial statements required by this item are found at the end of this annual report, beginning on page F-1. Index to Financial Statements Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Operations Statements of Changes in Shareholders’ Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Schedule of Valuation and Qualifying Accounts ITEM 19. Exhibits Exhibit No. Description F-1 F-2 F-3 - F-4 F-5 F-6 - F-7 F-8-F-10 F-11-F-50 84 1.1 1.2 2.1 2.2 2.3 2.4 4.1 8.1 12.1 12.2 Memorandum of Association of the Registrant (1) Articles of Association of the Registrant (2) Specimen Share Certificate for Ordinary Share (3) Registrant’s 2003 Israeli Share Option Plan (4) Registrant’s 2010 Israeli Share Option Plan (5) Amended and Restated Term Sheet between the Registrant and Nathan Kirsh, originally entered into on July 20, 2010 and amended on September 6, 2010, and further amended on November 3, 2010 (6) Agreement between the Kenya Port Authority and the Registrant for the Plant Design, Supply, Delivery, Installation and Commissioning of an Integrated Security System dated December 10, 2010 (7) List of Subsidiaries of the Registrant Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act, as amended Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act, as amended - 82 - Exhibit No. Description 13.1 13.2 15.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Consent of Kost Forer Gabbay & Kasierer 101.INS XBRL Instance Document.* 101.SCH XBRL Taxonomy Extension Schema Document.* 101.CAL XBRL Taxonomy Calculation Linkbase Document.* 101.LAB XBRL Taxonomy Label Linkbase Document.* 101.PRE XBRL Taxonomy Presentation Linkbase Document.* 101.DEF XBRL Taxonomy Extension Definition Linkbase Document.* _______________ * (1) (2) (3) (4) (5) (6) (7) Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for the purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections. Filed as an exhibit to our Registration Statement on Form F-1 (File No. 33-57438), filed with the Securities and Exchange Commission on January 26, 1993, as amended, and incorporated herein by reference. Filed as an exhibit to our Registration Statement on Form F-1 (No. 33-57438), filed with the Securities and Exchange Commission on January 26, 1993, as amended, and incorporated herein by reference, as amended by an amendment filed as an exhibit to our Registration Statement on Form S-8 (File No. 333-6246), filed with the Commission on January 7, 1997 and incorporated herein by reference, and as further amended by an amendment filed as an exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 2000, filed with the Securities and Exchange Commission on June 29, 2001 and incorporated herein by reference. Filed as an exhibit to our Registration Statement on Form 8-A, filed with the Securities and Exchange Commission on March 18, 1993, as amended, and incorporated herein by reference. Filed as Exhibit 4.3 to the Registrant’s Registration Statement on Form S-8 (File No. 333-127340), filed with the Securities and Exchange Commission on August 9, 2005, and incorporated herein by reference. Filed as Exhibit 2.3 to the Registrant's Annual Report on Form 20-F for the year ended December 31, 2010, filed with the Commission on April 11, 2011, and incorporated herein by reference. Filed as Exhibit 4.9 to the Registrant’s Registration Statement on Form F-1 (File No. 333-171320), filed with the Securities and Exchange Commission on December 21, 2010, and incorporated herein by reference. Filed as Exhibit 4.1 to the Registrant's Annual Report on Form 20-F for the year ended December 31, 2010, filed with the Commission on April 11, 2011, and incorporated herein by reference. - 83 - MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2011 IN U.S. DOLLARS INDEX Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Operations Statements of Changes in Shareholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements F - 1 Page F - 2 F - 3 - F - 4 F - 5 F - 6 – F - 7 F - 8 – F - 10 F - 11 – F - 50 Kost Forer Gabbay & Kasierer 3 Aminadav St. Tel-Aviv 67067, Israel Tel: 972 (3)6232525 Fax: 972 (3)5622555 www.ey.com REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of MAGAL SECURITY SYSTEMS LTD. We have audited the accompanying consolidated balance sheets of Magal Security Systems Ltd. and subsidiaries ("the Company") as of December 31, 2010 and 2011, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, based on our audits, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2010 and 2011, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles. Tel-Aviv, Israel April 4, 2012 /s/ Kost Forer Gabbay & Kasierer KOST FORER GABBAY & KASIERER A Member of Ernst & Young Global F - 2 CONSOLIDATED BALANCE SHEETS U.S. dollars in thousands ASSETS CURRENT ASSETS: Cash and cash equivalents Short-term bank deposits Restricted deposit Trade receivables (net of allowance for doubtful accounts of $ 919 and $ 1,112 at December 31, 2010 and 2011, respectively) Unbilled accounts receivable Other accounts receivable and prepaid expenses (Note 3) Deferred income taxes (Note 14) Inventories (Note 4) $ Total current assets LONG-TERM INVESTMENTS AND RECEIVABLES: Long-term trade receivables Long-term deposits and restricted bank deposits Severance pay fund Total long-term investments and receivables PROPERTY AND EQUIPMENT, NET (Note 5) OTHER INTANGIBLE ASSETS, NET (Note 6) GOODWILL (Note 2l,7) Total assets The accompanying notes are an integral part of the consolidated financial statements. F - 3 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES December 31, 2010 2011 $ 16,596 - 2,692 15,106 2,927 2,630 474 10,340 50,765 1,568 2,196 2,148 5,912 6,794 213 2,026 32,622 3,005 2,299 13,230 4,855 5,438 508 9,664 71,621 1,423 2,202 2,121 5,746 6,460 190 1,970 $ 65,710 $ 85,987 CONSOLIDATED BALANCE SHEETS U.S. dollars in thousands (except share and per share data) LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Short-term bank credit (Note 8) Current maturities of long-term bank debt (Note 10) Trade payables Customer advances Other accounts payable and accrued expenses (Note 9) Total current liabilities LONG-TERM LIABILITIES: Long-term bank debt (Note 10) Loan from related party (Note 16c) Deferred income taxes (Note 14) Accrued severance pay Total long-term liabilities COMMITMENTS AND CONTINGENT LIABILITIES (Note 11) SHAREHOLDERS' EQUITY (Note 12): Share capital - Ordinary shares of NIS 1 par value - Authorized: 19,748,000 shares at December 31, 2010 and 39,748,000 shares at December 31, 2011; Issued and outstanding: 10,396,548 shares at December 31, 2010 and 15,819,822 shares at December 31, 2011 Additional paid-in capital Accumulated other comprehensive income Foreign currency translation adjustments (Company's stand alone financial statements) Accumulated deficit Total shareholders' equity Total liabilities and shareholders' equity The accompanying notes are an integral part of the consolidated financial statements. F - 4 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES December 31, 2010 2011 $ $ 9,327 503 3,937 2,428 7,958 24,153 50 9,907 190 3,394 13,541 3,225 49,971 5,075 3,400 (33,655) 28,016 $ 65,710 $ 5,357 33 6,724 5,877 13,137 31,128 38 - 205 3,605 3,848 4,813 64,920 4,486 603 (23,811) 51,011 85,987 CONSOLIDATED STATEMENTS OF OPERATIONS U.S. dollars in thousands (except per share data) Revenues Cost of revenues Gross profit Operating expenses: Research and development, net Selling and marketing General and administrative Other income (Note 11f) Total operating expenses Operating income (loss) Financial expenses (income), net (Note 18) Income (loss) before income taxes Income taxes (Note 14) Income (loss) from continuing operations Income from discontinued operations, net (Note 15) Net income (loss) Less: loss (income ) attributable to non-controlling interests Income (loss) attributable to Magal shareholders' Basic and diluted net earnings (loss) per share from continuing operations Basic and diluted net earnings per share from discontinued operations Basic and diluted net earnings (loss) per share (Note 13) The accompanying notes are an integral part of the consolidated financial statements. F - 5 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES 2009 Year ended December 31, 2010 2011 $ $ 54,518 33,404 $ 49,699 31,400 21,114 18,299 5,059 10,820 8,100 - 23,979 (2,865) 1,568 (4,433) 864 (5,297) 4,216 (1,081) (54) 4,105 11,261 7,593 - 22,959 (4,660) 967 (5,627) 602 (6,229) - (6,229) 24 $ $ $ (1,135) $ (6,205) $ (0.52) $ 0.41 (0.60) $ - (0.11) $ (0.60) $ 88,591 49,089 39,502 3,898 19,415 8,682 (2,304) 29,691 9,811 (756) 10,567 723 9,844 - 9,844 - 9,844 0.78 - 0.78 STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY U.S. dollars in thousands (except share data) Number of shares Ordinary shares Additional paid-in capital Accumulated other comprehensive income (loss) Foreign currency translation adjustment - the Company Retained earnings (accumulated deficit) Non- controlling interests Total comprehensive income (loss) Total shareholders' equity MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES 10,396,548 - $ $ 3,225 - $ 48,043 542 $ 2,472 - $ 3,293 - (26,315) $ - Balance as of January 1, 2009 Stock-based compensation Stock-based compensation – granted by related party Foreign currency translation adjustments Comprehensive income (loss): Loss Realized foreign currency translation adjustments from sale of subsidiary Foreign currency translation adjustments Total comprehensive income Balance as of December 31, 2009 Stock-based compensation Stock-based compensation – granted by related party Capital fund on loan granted by a related party Purchase of non-controlling interests Foreign currency translation adjustments Comprehensive income (loss): Loss Foreign currency translation adjustments Total comprehensive income - - - - - - - - - - 10,396,548 - 3,225 - - - - - - - - - - - - - 156 - - - - 48,741 833 100 297 - - - - - - - (789) 2,166 - 597 - - 3,849 - 3,890 - - - - (490) - - - - - - - - - $ 30,718 542 156 597 - - (1,135) 54 $ (1,081) (1,081) - - (27,450) - - - - - (789) 2,166 296 - - - - $ - - 54 - - - (30) - (789) 2,166 32,309 833 100 297 (30) (490) (6,229) 1,226 - (6,205) (24) $ (6,229) 1,226 - 1,226 (5,003) $ - - $ 28,016 Balance as of December 31, 2010 10,396,548 $ 3,225 $ 49,971 $ 5,075 $ 3,400 $ (33,655) $ The accompanying notes are an integral part of the consolidated financial statements. F - 6 STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY U.S. dollars in thousands (except share data) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Number of shares Ordinary shares Additional paid-in Capital Accumulated other comprehensive income (loss) Foreign currency translation - the Company Retained earnings (accumulated deficit) Non- controlling interest Total comprehensive income (loss) Total shareholders' equity Balance as of December 31, 2010 Issuance of share capital, net Stock-based compensation Stock-based compensation – granted by related party Loan granted by a related party Foreign currency translation adjustments- the Company Comprehensive income (loss): Net Income Foreign currency translation adjustments Total comprehensive income $ 10,396,548 5,423,274 - $ 3,225 1,588 - $ 49,971 14,640 344 $ 5,075 - - $ 3,400 - - (33,655) $ - - - - - - - - - - - - 54 (89) - - - - - - - (589) - - (2,797) - - - - - 9,844 - Balance as of December 31, 2011 $ 15,819,822 $ 4,813 $ 64,920 $ 4,486 $ 603 $ (23,811) $ The accompanying notes are an integral part of the consolidated financial statements. F - 7 28,016 16,228 344 54 (89) (2,797) 9,844 (589) - - - - - - $ - - - - - - $ 9,844 (589) $ 9,255 - - $ 51,011 CONSOLIDATED STATEMENTS OF CASH FLOWS U.S. dollars in thousands Cash flows from operating activities: MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES 2009 Year ended December 31, 2010 2011 Net income (loss) Adjustments required to reconcile net income (loss) to net cash provided by (used in) operating activities: $ (1,081) $ (6,229) $ 9,844 Income from discontinued operations Depreciation and amortization Loss (gain) on sale of property and equipment Decrease (increase) in accrued interest and exchange differences on marketable securities, short-term and long-term bank deposits and long-term loans Write off of long term loan Stock based compensation Decrease (increase) in trade receivables, net Decrease (increase) in unbilled accounts receivable Decrease (increase) in other accounts receivable and prepaid expenses Decrease (increase) in deferred income taxes Decrease in inventories Decrease in long-term trade receivables Increase (decrease) in trade payables Increase (decrease) in other accounts payable and accrued expenses Increase (decrease) in customer advances Accrued severance pay, net Net cash provided by (used in) continuing operations Net cash provided by (used in) discontinued operations Net cash provided by (used in) operating activities The accompanying notes are an integral part of the consolidated financial statements. F - 8 (4,216) 1,204 268 2 319 698 3,889 (582) 1,984 793 3,888 95 (899) (1,640) 551 378 5,651 120 5,771 - 1,062 48 (510) 206 933 (2,809) 3,161 (1,164) (168) 995 282 (258) 391 (7) 87 (3,980) (17) (3,997) - 1,219 (36) (221) - 398 1,208 (2,361) (3,273) (66) 159 36 3,209 6,086 3,867 349 20,418 - 20,418 CONSOLIDATED STATEMENTS OF CASH FLOWS U.S. dollars in thousands Cash flows from investing activities: Purchase of short-term deposits Proceeds from sale of short-term bank deposits Escrow deposit Investment in long-term bank deposits and restricted deposit Proceeds from sale of marketable securities Release of long-term bank deposits and restricted deposit Proceeds from sale of property and equipment Purchase of property and equipment Investment in know-how and patents Proceeds from sale of subsidiary (a) Net cash provided by (used in) continuing activities Net cash provided by discontinued operations Net cash provided by (used in) investing activities Cash flows from financing activities: Short-term bank credit, net Proceeds from long-term bank loans Principal payment of long-term bank loans Proceeds from related party loan Repayment of related party loan Proceeds from issuance of shares, net of issuance costs of $ 207 Net cash provided by (used in) continuing operations Net cash provided by (used in) discontinued operations Net cash provided by (used in) financing activities Effect of exchange rate changes on cash and cash equivalents Increase (decrease) in cash and cash equivalents Cash and cash equivalents at the beginning of the year MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES 2009 Year ended December 31, 2010 2011 - 1,316 920 (13) 918 - 64 (2,025) (27) 2,850 4,003 (15) 3,988 (14,553) 97 (829) - - - (15,285) 771 (14,514) (211) (4,966) 16,835 - 1,857 - (5,149) - 483 2,080 (363) (24) - (1,116) - (1,116) 536 - (1,827) 10,000 - - 8,709 - 8,709 1,131 4,727 11,869 (3,212) 31 - (2,043) - 2,776 50 (1,185) (28) - (3,611) - (3,611) (3,530) - (477) - (10,388) 16,228 1,833 - 1,833 (2,614) 16,026 16,596 32,622 Cash and cash equivalents at the end of the year $ 11,869 $ 16,596 $ The accompanying notes are an integral part of the consolidated financial statements. F - 9 CONSOLIDATED STATEMENTS OF CASH FLOWS U.S. dollars in thousands Supplemental disclosures of cash flows activities: Cash paid during the year for: Interest Income taxes (a) Proceeds from the sale of a subsidiary Working capital, net Property and equipment Accrued severance pay Customer related intangible assets Deferred taxes Capital gain MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES 2009 Year ended December 31, 2010 2011 881 $ 431 $ 463 $ 389 $ 905 964 (3,227) 339 (418) 2,614 (715) 4,257 $ $ $ The accompanying notes are an integral part of the consolidated financial statements. $ 2,850 F - 10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 1:- GENERAL MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES a. b. c. d. Magal Security Systems Ltd. ("the Parent Company") and its subsidiaries (together - "the Company") are international solutions providers of safety, security, site management and intelligence gathering and compilation solutions and products The Company's systems are used in more than 75 countries around the world. As for major customer data, see Notes 1d, 17b. The Company completed a rights offering according to which it distributed to all holders of its ordinary shares at no charge, as of the close of business on June 29, 2011, subscription rights to purchase up to an aggregate of 5,273,274 ordinary shares. The net proceeds from the rights offering was approximately $16,000 after deducting expenses related to the rights offering of $207. On June 17, 2011 the Company completed a private placement of 150,000 of its ordinary shares to Ki Corporation, a company beneficially owned by Mr. Nathan Kirsh, at an initial price per share of $3.04, which was equal to the closing price of its ordinary shares on the NASDAQ Global Market on the date prior to the private placement. Upon the record date of the rights offering, the price per share paid by Ki Corporation was adjusted to $3.05, which was the closing price of its ordinary shares on the NASDAQ Global Market on the date prior to the record date of the rights offering. During the year ended December 31, 2011, the Company engaged in a project to secure the 2012 Africa Cup of Nations in the Gabonese Republic. Revenues attributable to such project accounted for 34.8% ($30,800) of the Company’s revenues during 2011. The project was completed during the first quarter of 2012. F - 11 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES The consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles ("U.S. GAAP"). a. Use of estimates: The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The most significant assumptions are employed in estimates used in determining values of goodwill and identifiable intangible assets, revenue recognition, tax assets and tax positions, legal contingencies, and stock-based compensation costs. Actual results could differ from those estimates. b. Financial statements in U.S. dollars: The Parent Company's revenues are generated in NIS, U.S. dollars and Euros. In addition, most of the Parent Company's costs are incurred in NIS. The Parent Company's management believes that the NIS is the primary currency of the economic environment in which the Parent Company operates. In accordance with U.S. Securities and Exchange Commission Regulation S-X, Rule 3-20, the Company has determined its reporting currency to be the U. S. dollar. The measurement process of Rule 3-20 is conceptually consistent with that of ASC 830. Therefore, the functional currency of the Company is the NIS and its reporting currency is the U.S. dollar. The functional currency of the Company's foreign subsidiaries is the local currency in which each subsidiary operates. ASC 830 "Foreign Currency Matters" sets the standards for translating foreign currency financial statements of consolidated subsidiaries. The first step in the translation process is to identify the functional currency for each entity included in the financial statements. The accounts of each entity are then measured in its functional currency. All transaction gains and losses from the measurement of monetary balance sheet items are reflected in the statement of operations as financial income or expenses, as appropriate. After the 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). F - 12 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) c. Principles of consolidation: MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES The consolidated financial statements include the accounts of the Parent Company and its subsidiaries. Intercompany transactions and balances including profits from intercompany sales not yet realized outside the Company, have been eliminated upon consolidation. Starting January 1, 2009, changes in the Parent Company's ownership interest with no change of control are treated as equity transactions, rather than step acquisitions or dilution gains or losses. d. Cash equivalents: Cash equivalents are short-term highly liquid investments that are readily convertible into cash with original maturities of three months or less at the date acquired. e. Marketable securities: The Company accounts for investments in debt securities in accordance with ASC 320 Investments - Debt and Equity Securities. Management determines the appropriate classification of its investments in debt securities at the time of purchase and reevaluates such determinations at each balance sheet date. The debt securities are classified as "available-for-sale" since the Company does not have the intent to hold the securities to maturity, and are stated at fair value. Available-for-sale securities are carried at fair value with unrealized gains and losses reported net of tax in accumulated "other comprehensive income" as a separate component of shareholders equity. Realized gains and losses on sales of investments, as determined on a specific identification basis, are included in financial income, net, together with accretion (amortization) of discount (premium), and interest. The Company recognizes an impairment charge when a decline in the fair value of its investments below the cost basis is judged to be other-than-temporary. The Company sold all its remaining securities in 2009. f. Short-term and long-term bank deposits: Short-term bank deposits are deposits with maturities of more than three months and less than one year, and are presented at their cost. A bank deposit with a maturity of more than one year is included in long-term bank deposits, and presented at cost. F - 13 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) g. Inventories: MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Inventories are stated at the lower of cost or market value. The Company periodically evaluates the quantities on hand relative to historical and projected sales volumes, current and historical selling prices and contractual obligations to maintain certain levels of parts. Based on these evaluations, inventory write-offs are provided to cover risks arising from slow-moving items, discontinued products, excess inventories, market prices lower than cost and adjusted revenue forecasts. Cost is determined as follows: Raw materials, parts and supplies: using the "first-in, first-out" method. Work in progress and finished products: on the basis of direct manufacturing costs with the addition of allocable indirect cost, representing allocable operating overhead expenses and manufacturing costs. During 2009, 2010 and 2011, the Company recorded inventory write-offs from continued operations in the amounts of $ 1,391, $ 309 and $ 960, respectively. Such write-offs were included in cost of revenues. h. Long-term trade receivables: Long-term trade and other receivables with long term payment terms are recorded at their estimated present values. i. Property and equipment: Property and equipment are stated at cost, net of accumulated depreciation. Depreciation is calculated by the straight-line method over the estimated useful lives of the assets at the following annual rates: Buildings Machinery and equipment Motor vehicles Promotional displays Office furniture and equipment Leasehold improvements F - 14 % 3 – 4 10 - 33 (mainly 10%) 15 25 - 50 6 – 33 By the shorter of the term of the lease or the useful life of the assets NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) j. Intangible assets: MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Intangible assets are amortized over their useful lives using a method of amortization that reflects the pattern in which the economic benefits of the intangible assets are consumed or otherwise used up, in accordance with ASC 350 “Intangibles - Goodwill and Other.” Intangible assets were amortized based on the straight line method. Know-how is amortized over five to ten years, patents are amortized over a period of ten years and technology is amortized over eight years. k. Impairment of long-lived assets: The Company's long-lived assets and certain identifiable intangibles are reviewed for impairment in accordance with ASC 360 “Property, Plant, and Equipment” 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. In 2009, 2010 and 2011, the Company did not record any impairment charges attributable to long-lived assets. l. Goodwill: Goodwill has been recorded as a result of past acquisitions and represents excess of the costs over the net fair value of the assets of the businesses acquired. Goodwill is allocated to one reporting unit within the Perimeter Products segment. The Company follows ASC 350, "Intangibles - Goodwill and Other." 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. The Company performs its goodwill annual impairment test at December 31 of each year, or more often if indicators of impairment are present. F - 15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES 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 the Company believes 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 reporting units. The material assumptions used for the income approach for 2011 were five years of projected net cash flows, a weighted average cost of capital rate of 14.9% and a long- term growth rate of 1%. The Company considered historical rates and current market conditions when determining the discount and growth rates to use in its analyses. If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for its goodwill. For 2009, 2010 and 2011, the Company did not record any impairment charges. m. Revenue recognition: The Company generates its revenues mainly from (1) installation of comprehensive security systems for which revenues are generated from long-term fixed price contracts; (2) sales of security products; and (3) services and maintenance, which are performed either on a fixed-price basis or as time-and-materials based contracts. F - 16 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES 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," using contract accounting on a percentage of completion method. Accounting for long-term contracts using the percentage-of-completion method stipulates that revenue and expense are recognized throughout the life of the contract, even though the project is not completed and the purchaser does not have possession of the project. Percentage of completion is calculated based on the "Input Method." Project costs include materials purchased to produce the system, related labor and overhead expenses and subcontractor's costs. The percentage to completion is measured by monitoring costs and efforts devoted using records of actual costs incurred to date in the project compared to the total estimated project requirement, which corresponds to the costs related to earned revenues. The amounts of revenues recognized are based on the total fees under the agreements and the percentage to completion achieved. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are first determined, in the amount of the estimated loss on the entire contract. Estimated gross profit or loss from long-term contracts may change due to changes in estimates resulting from differences between actual performance and original forecasts. Such changes in estimated gross profit are recorded in results of operations when they are reasonably determinable by management, on a cumulative catch-up basis. The Company believes that the use of the percentage of completion method is appropriate as the Company has the ability to make reasonably dependable estimates of the extent of progress towards completion, contract revenues and contract costs. In addition, contracts executed include provisions that clearly specify the enforceable rights regarding services to be provided and received by the parties to the contracts, the consideration to be exchanged and the manner and the terms of settlement, including in cases of termination for convenience. In all cases the Company expects to perform its contractual obligations and its customers are expected to satisfy their obligations under the contract. Fees are payable upon completion of agreed upon milestones and subject to customer acceptance. Amounts of revenues recognized in advance of contractual billing are recorded as unbilled accounts receivable. The period between most instances of advanced recognition of revenues and the customers' billing generally ranges between one to six months. F - 17 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES The Company sells security products to customers according to customer orders without installation work. The customers do not have a right to return the products. Revenues from security product sales are recognized in accordance with Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition in Financial Statements," when delivery has occurred, persuasive evidence of an agreement exists, the vendor's fee is fixed or determinable, no further obligation exists and collectability is probable. Services and maintenance are performed under either fixed-price based or time-and-materials based contracts. Under fixed-price contracts, the Company agrees to perform certain work for a fixed price. Under time-and-materials contracts, the Company is 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 services, service contracts and maintenance agreements. n. Accounting for stock-based compensation: The Company accounts for stock-based compensation in accordance with ASC 718 Compensation-Stock Compensation. ASC 718 requires companies to estimate the fair value of equity-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service periods in the Company's consolidated income statement. The Company recognizes compensation expenses for the value of its awards, which have graded vesting, based on the accelerated attribution method over the vesting period, net of estimated forfeitures. Estimated forfeitures are based on actual historical pre-vesting forfeitures. During the years ended December 31, 2009, 2010 and 2011, the Company recognized stock-based compensation expenses related to employee stock options in the amounts of $ 542, $ 833 and $ 344, respectively. In 2009, 2010 and 2011, the Company recognized additional stock-based compensation expenses of $ 156, $ 100 and $ 54, respectively, related to a transaction between two of the Company's related parties, see Note 16d. F - 18 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES The Company estimates the fair value of stock options granted under ASC 718 using the Binomial model. The Binomial model for option pricing requires a number of assumptions, of which the most significant are the suboptimal exercise factor and expected stock price volatility. The suboptimal exercise factor is estimated using historical option exercise information. The suboptimal exercise factor is the ratio by which the stock price must increase over the exercise price before employees are expected to exercise their stock options. Expected volatility is based upon actual historical stock price movements and was calculated as of the grant dates for different periods, since the Binomial model can be used for different expected volatilities for different periods. The risk-free interest rate is based on the yield from U.S. Treasury zero-coupon bonds with an equivalent term to the contractual term of the options. The expected term of options granted is derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding. Estimated forfeitures are based on actual historical pre-vesting forfeitures. The following assumptions were used in the Binomial option pricing model for 2009 (no options were granted in 2010 and 2011). Dividend yield Expected volatility Risk-free interest Contractual term Forfeiture rate Suboptimal exercise multiple o. Research and development costs: 2009 0% 34%-62% 0.27%-3.14% 4-9 years 0% 1.5 Research and development costs incurred in the process of developing product improvements or new products, are charged to expenses as incurred. p. Warranty costs: The Company provides a warranty for up to 26 months at no extra charge. The Company estimates the costs that may be incurred under its warranty and records a liability in the amount of such costs at the time product revenue is recognized in accordance with ASC ASC 450 "Contingencies." Factors that affect the Company's warranty liability include the number of units, historical and anticipated rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. F - 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) The following table provides the detail of the change in the Company's product warranty accrual, which is a component of other accrued liabilities on the consolidated balance sheets for the years ended December 31, 2011 and 2010. MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Warranty provision, beginning of year Charged to costs and expenses relating to new sales Costs of warranties granted Foreign currency translation adjustments Warranty provision, end of year q. Net earnings (loss) per share: December 31, 2011 2010 $ 962 $ 845 (405) (94) $ 1,308 $ 805 628 (522) 51 962 Basic net earnings (loss) per share are computed based on the weighted average number of Ordinary shares outstanding during each year. Diluted net earnings (loss) per share is computed based on the weighted average number of Ordinary shares outstanding during each year, plus dilutive potential Ordinary shares considered outstanding during the year, in accordance with ASC 260 "Earnings Per Share." r. Concentrations of credit risk: Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, marketable securities, short- term and long-term bank deposits, trade receivables, unbilled accounts receivable, long-term trade receivables and long-term loans. Of the Company's cash and cash equivalents and short-term, restricted and long-term bank deposits at December 31, 2011, $ 33,468 is invested in major Israeli and U.S. banks, and approximately $ 6,600 is invested in other banks, mainly with Deutsche Bank, RBC Royal Bank and BBVA Bancomer. Cash and cash equivalents in the United States may be in excess of insured limits and are not insured in other jurisdictions. Generally these deposits may be redeemed upon demand and therefore, bear low risk. The short-term and long-term trade receivables of the Company, as well as the unbilled accounts receivable, are primarily derived from sales to large and solid organizations and governmental authorities located mainly in Israel, the United States, Canada, Mexico, and Europe. The Company performs ongoing credit evaluations of its customers and to date has not experienced any material losses. An allowance for doubtful accounts is determined with respect to those amounts that the Company has determined to be doubtful of collection and in accordance with an aging policy. As of December 31, 2011, the Company's allowance for doubtful accounts amounted to $ 1,112. During the years ended December 31, 2009, 2010 and 2011, the Company recorded $ (153), $ 601 and $ 411 of expenses (income) related to doubtful accounts, respectively. In certain circumstances, the Company may require letters of credit, other collateral or additional guarantees. F - 20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES A loan granted to a third party is secured by a personal guarantee of the beneficial owner of the third party; however, management anticipates difficulties in the full repayment of the loan, (see Note 11h). The Company has no significant off-balance sheet concentrations of credit risk, such as foreign exchange contracts or foreign hedging arrangements, s. Income taxes: The Company accounts for income taxes in accordance with ASC 740 "Income Taxes." This ASC prescribes the use of the liability method whereby deferred tax assets and liability account balances are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company provides a valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value. Effective January 1, 2007, the Company adopted an amendment to ASC 740 “Income Taxes”. The amendment clarifies the accounting for uncertainties in income taxes by establishing minimum standards for the recognition and measurement of tax positions taken or expected to be taken in a tax return. Under the requirements of ASC 740, the Company must review all of its tax positions and make a determination as to whether its position is more-likely-than-not to be sustained upon examination by regulatory authorities. If a tax position meets the more-likely-than-not standard, then the related tax benefit is measured based on a cumulative probability analysis of the amount that is more-likely-than-not to be realized upon ultimate settlement or disposition of the underlying issue. In 2009, 2010 and 2011, the Company recorded tax expenses (benefits) of $ (165), $ 88 and $ 113, respectively. t. Severance pay: The Company's liability for its Israeli employees severance pay is calculated pursuant to Israel's Severance Pay Law based on the most recent salary of the employees multiplied by the number of years of employment, as of the balance sheet date (the "Shut Down Method”). Employees are entitled to one month's salary for each year of employment or a portion thereof. The Company's liability for its employees in Israel is fully provided by monthly deposits with insurance policies and by an accrual. The value of these policies is recorded as an asset in the Company's balance sheet. The deposited funds include profits accumulated up to balance sheet date. The deposited funds may be withdrawn only upon the fulfillment of the obligation pursuant to Israel's Severance Pay Law or labor agreements. The value of the deposited funds is based on the cash surrender value of these policies and includes immaterial profits. F - 21 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES On December 31, 2007, the former Chairman of the Company's Board of Directors, (hereinafter - the retired Chairman) retired from his position. Pursuant to his retirement agreement, the retired Chairman is entitled to receive certain perquisites from the Company for the rest of his life. As of December 31, 2011, the actuarial value of these perquisites is estimated at approximately $ 680. This provision was included as part of accrued severance pay. Severance expenses for the years ended December 31, 2009, 2010 and 2011, amounted to approximately $ 1,402, $ 724 and $ 868, respectively. The Company has entered into an agreement with some of the employees implementing Section 14 of the Severance Pay Law and the General Approval of the Labor Minister dated June 30, 1998, issued in accordance with the said Section 14, mandating that upon termination of such employees' employment, all the amounts accrued in their insurance policies shall be released to them. The severance pay liabilities and deposits covered by these plans are not reflected in the balance sheet as the severance pay risks have been irrevocably transferred to the severance funds. u. Fair value of financial instruments: The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: (i) (ii) The carrying amounts of cash and cash equivalents, short-term bank deposits, trade receivables, unbilled accounts receivable, short-term bank credit and trade payables approximate their fair value due to the short-term maturity of such instruments. The carrying amount of the Company's long-term trade receivables and long-term bank deposits approximate their fair value. The fair value was estimated using discounted cash flows analysis, based on the Company's investment rates for similar type of investment arrangements. (iii) The carrying amounts of the Company's long-term debt are estimated by discounting the future cash flows using current interest rates for loans of similar terms and maturities. As of December 31, 2011, there was no material difference in the fair value of the Company's long-term borrowing compared to their carrying amount. F - 22 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) v. Advertising expenses: MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Advertising costs are expensed as incurred. Advertising expenses for the years ended December 31, 2009, 2010 and 2011, were $ 145, $ 137 and $ 164, respectively. w. Fair value measurements: ASC 820 “Fair Value Measurement and Disclosure” 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 - Significant other observable inputs based on market data obtained from sources independent of the reporting entity. Level 3 - Unobservable inputs which are supported by little or no market activity. 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. In 2009 and 2010, the Company did not have any assets or liabilities measured at fair value on a recurring or nonrecurring basis. x. Non-controlling interest: The Company established a Spanish subsidiary in September 2009, which was 76% owned by the Company and 24% owned by a local partner. As of December 31, 2010, the Company changed the engagement terms with the local partner pursuant to a new employment agreement with the Spanish subsidiary. In return for the new arrangement, the local partner gave up his ownership rights and starting December 31, 2010, the Company owns 100% of the Spanish subsidiary. F - 23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) y. Impact of recently issued Accounting Standards still not effective for the Company: MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES 1. 2. 3. In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (ASU 2011-04). This newly issued accounting standard clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This ASU is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011. The adoption of this standard is not expected to have a material impact on the Company financial position or results of operations. In June 2011, the FASB issued ASU No. 2011-05, Topic 220 - Presentation of Comprehensive Income (“ASU 2011-05”), which requires an entity to present total comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements and eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. This guidance is effective for fiscal years and interim periods, beginning after December 15, 2011. The Company's adoption of ASU 2011-05 is not expected to have an impact on the Company financial position or results of operations. In September 2011, the FASB issued ASU No. 2011-08, Topic 350 - Intangibles - Goodwill and Other ("ASU 2011-08"), which amends Topic 350 to allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based the qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This guidance is effective for annual and interim goodwill tests performed for years beginning after December 15, 2011. Early adoption is permitted. The Company's adoption of ASU 2011-08 is not expected to have an impact on its financial statements. F - 24 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.) 4. 5. In December 2011, the FASB issued ASU No. 2011-11, Topic 2010 - Balance Sheet ("ASU 2011-11"), which contains new disclosure requirements regarding the nature of an entity's rights of set off and related arrangements associated with its financial instruments and derivative instruments. Under U.S. GAAP, certain derivative and repurchase agreement arrangements are granted exceptions from the general off-setting model. To facilitate comparison between financial statements prepared under U.S. GAAP and IFRS, the new disclosure requirement will provide financial statement users information regarding both gross and net exposures. This guidance is effective for annual and interim financial statements beginning on or after January 1, 2013. Retrospective application is required. The Company does not set off related arrangements associated with its financial instruments and derivative instruments. Its adoption of ASU 2011-11 is not expected to have an impact on its consolidated results of operations or financial condition. In December 2011, the FASB issued Accounting Standards Update ("ASU") No. 2011-12, Topic 220 - Comprehensive Income ("ASU 2011-12"), which indefinitely deferred certain provisions of ASU 2011-05, including the requirement to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented. This amendment is effective for both annual and interim financial statements beginning after December 15, 2011. The Company's adoption of ASU 2011-12 is not expected to have a material impact on the Company financial position or results of operations. NOTE 3:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES Government authorities Employees Prepaid expenses Advances to suppliers Others F - 25 December 31, 2010 2011 $ $ 1,019 33 747 683 148 $ 2,630 $ 1,053 26 3,711 362 286 5,438 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 4:- INVENTORIES Raw materials Work in progress Finished products NOTE 5:- PROPERTY AND EQUIPMENT a. Composition: Cost: Land and buildings Machinery and equipment Motor vehicles Promotional displays Office furniture and equipment Leasehold improvements Accumulated depreciation: Buildings Machinery and equipment Motor vehicles Promotional displays Office furniture and equipment Leasehold improvements Property and equipment, net MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES December 31, 2010 2011 $ $ 3,146 1,998 5,196 $ 10,340 $ December 31, 2010 2011 $ 7,710 $ 6,759 1,155 2,064 3,242 606 2,021 2,628 5,015 9,664 7,540 6,685 1,373 2,113 3,249 570 21,536 21,530 3,324 6,026 798 1,928 2,536 130 3,606 5,996 773 1,928 2,595 172 14,742 15,070 $ 6,794 $ 6,460 b. c. Depreciation expenses amounted to $ 1,012, $ 970 and $ 1,171 for the years ended December 31, 2009, 2010 and 2011, respectively. For charges, see Note 11g. F - 26 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 6:- OTHER INTANGIBLE ASSETS, NET a. Composition: Cost: Know-how Patents Technology Accumulated amortization: Know-how Patents Technology December 31, 2010 2011 $ 1,138 $ 3,436 12 4,586 1,138 3,226 9 4,373 Other intangibles, net $ 213 $ Amortization expenses related to intangible assets amounted to $ 192, $ 92 and $ 48 for the years ended December 31, 2009, 2010 and 2011, respectively. Estimated amortization of intangible assets for the years ended: b. c. December 31, 2012 2013 2014 2015 2016 and thereafter $ 45 40 32 24 49 $ 190 F - 27 1,056 3,385 12 4,453 1,057 3,196 10 4,263 190 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 7:- GOODWILL Goodwill relates to one reporting unit that resides within the perimeter segment. Changes in the carrying amount of goodwill for the years ended December 31, 2011 and 2010 are as follows: As of January 1, 2010 Foreign currency translation adjustments As of December 31, 2010 Foreign currency translation adjustments As of December 31, 2011 $ 2,053 (27) 2,026 (56) $ 1,970 The Company determined the fair value of the reporting unit using the income approach. The material assumptions used for the income approach for 2011 were 5 years of projected net cash flows, a discount rate of 14.9% and a long-term growth rate of 1.0%. The Company considered historical rates and current market conditions when determining the discount and growth rates to use in its analyses. If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for its goodwill. NOTE 8:- SHORT-TERM BANK CREDIT a. Classified by currency, linkage terms and interest rates: In or linked to NIS In or linked to Euro Interest rate December 31, 2010 2011 2010 2011 % 5.5 - $ 4.69 8.36 9,327 $ - $ 9,327 $ 5,264 93 5,357 Weighted average interest rates at the end of the year 5.5 4.75 F - 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 8:- SHORT-TERM BANK CREDIT (Cont.) b. Credit lines: Short-term bank credit Long-term bank credit Performance guarantees Unutilized credit lines Total authorized credit lines MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES December 31, 2010 2011 $ 9,327 $ 553 7,246 17,126 5,173 5,357 71 8,491 13,919 10,762 $ 22,299 $ 24,681 c. The Company's Canadian subsidiary has undertaken to maintain general covenants and the following financial ratios and terms in respect of its outstanding credit lines: a quick ratio of not less than 1.25:1; a ratio of total liabilities to tangible net worth of not greater than 0.75:1; and tangible net worth of at least $10,000. As of December 31, 2011, the Company's subsidiary was in compliance with the ratios and terms. d. For charges, see Note 11g. NOTE 9:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES Employees and payroll accruals Accrued expenses Deferred revenues Government authorities Income tax payable Others F - 29 December 31, 2010 2011 $ $ 2,648 3,690 390 249 692 289 3,198 7,902 1,447 113 305 173 $ 7,958 $ 13,137 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 10:- LONG-TERM BANK DEBT a. Classified by currency, linkage terms and interest rates: Bank loan Bank loan Less - current maturities Linkage terms U.S. $ NIS Weighted average interest rates at the end of the year b. As of December 31, 2011, the aggregate annual maturities of the long-term loans are as follows: 2012 2013 2014 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Interest rate December 31, 2010 2011 2010 2011 % 0.87 3 $ - 4.26 480 $ 73 553 503 $ 50 $ 1.15 4.26 - 71 71 33 38 $ $ 33 33 5 71 c. As for charges, see Note 11g. NOTE 11:- COMMITMENTS AND CONTINGENT LIABILITIES a. Royalty commitments to the Office of the Chief Scientist of the Israeli Ministry of Industry and Trade ("OCS"): Under the research and development agreements between the Company and the OCS and pursuant to applicable laws, the Company is required to pay royalties at the rate of 3.5% of revenues derived from sales of products developed with funds provided by the OCS and ancillary services, up to an amount equal to 100% of the OCS research and development grants received, linked to the U.S. dollars plus interest on the unpaid amount received based on the 12-month LIBOR rate applicable to U.S. dollar deposits. The obligation to pay these royalties is contingent on actual sales of the products and in the absence of such sales no payment is required. F - 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 11:- COMMITMENTS AND CONTINGENT LIABILITIES (Cont.) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Royalties paid to the OCS amounted to $ 172, $ 0 and $ 68 for the years ended December 31, 2009, 2010 and 2011, respectively. As of December 31, 2011, the Company had remaining contingent obligations to pay royalties in the amount of approximately $ 1,300. Royalty commitments to a third party: b. During 2002, the Company entered into a development agreement for planning, developing and manufacturing a security system with a third party. Under the agreement, the Company agreed to pay the third party royalty fees based on a defined formula. Under this agreement, the Company also committed to purchase a certain volume of products at a minimum amount of approximately $ 300 over 2.5 years after achievement of certain milestones. As of December 31, 2011, royalty commitments under the agreement amounted to $ 55. c. Lease commitments: The Company rents certain of its facilities and some of its motor vehicles under various operating lease agreements, which expire on various dates, the latest of which is in 2024. Future minimum lease payments under non-cancelable operating lease agreements are as follows: 2012 2013 2014 2015 2016 and there after $ 827 616 286 167 952 $ 2,848 Total rent expenses for the years ended December 31, 2009, 2010 and 2011 were approximately $ 806, $ 924 and $ 1,019, respectively. d. Guarantees: As of December 31, 2011, the Company obtained bank performance guarantees and advance payment guarantees and bid bond guarantees from several banks, mainly in Israel, in the aggregate amount of $ 8,491. e. Restricted deposit: In connection with a project in Africa, the Company was required to maintain restricted deposits in order to guarantee the Company performance under that project. The deposits for the project in the amount of $ 4,280, bears an average interest at rate of 1.5% and will be released to the Company after meeting predetermined milestones. F - 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 11:- COMMITMENTS AND CONTINGENT LIABILITIES (Cont.) f. Legal proceedings: MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES In May 2005, the Company entered into an agreement to supply comprehensive security solutions for a sensitive site in Eastern Europe. The Company commenced the project and delivered some of the equipment and other deliverables to the customer in 2005. In April 2006, the customer informed the Company that it was canceling the agreement due to errors in the design documents that the Company submitted. In addition, the customer did not make payments required under the agreement. The Company denied all of the allegations and the case was referred to arbitration. On June 6, 2007, the Court of Arbitration issued its decision in the arbitration and stated that the agreement concluded between the Company and the customer was void due to legal mistakes made by the customer in the tender process. Based on such decision, the Company decided to initiate a new legal action against the customer seeking compensation for the damages incurred. In March 2010, the Court of Arbitration determined that the customer is liable for certain expenses incurred by the Company in connection with the negotiation and execution of the agreement due to the customer's wrongful behaviour during the negotiations. In addition, the Court of Arbitration determined that the customer is liable for damages caused to the Company due to the customer's unjust enrichment resulting from the non-payment for certain deliveries made by the Company. Accordingly, on October 25, 2011 the Company collected an arbitration award of approximately $ 2.5 thousand and recorded income of $ 2.3 thousand from the arbitration, net of legal expenses. The income was recorded in the 2011 Statement of Operations under the captions “other income” A review of public record indicates that the customer filed a claim to vacate the judgment, however, such claim has not yet been served on us. In the Company's view and based on the legal counsel the chances that judgment will be vacated are low. In addition, the Company is subject to legal proceedings arising in the normal course of business. Based on the advice of legal counsel, management believes that these proceedings will not have a material adverse effect on the Company's financial position or results of operations. g. Charges: As collateral for all of the Company liabilities to banks: In January 2010, the Company approved a new credit arrangement and created in favor of the Banks a first degree fixed charge over its unissued share capital and its goodwill and a first degree floating charge over its factory, business, and all of its assets and rights. F - 32 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 11:- COMMITMENTS AND CONTINGENT LIABILITIES (Cont.) h. In October 2006, the Company signed an agreement with a third party who consults, markets and implements projects in the security field. The Company granted a loan to the third party in the amount of $ 600. The Company also provided the third party with additional monthly amounts to fund its activities during the agreement period. The loan and the monthly amounts bear an annual interest rate of 5%. In October 2011 the Company extended the repayment by additional one year. The Company evaluates the anticipated repayment of the loan annually. Due to unanticipated difficulties in the implementation of the projects and based on ASC 310-10- 35-3, "Loan Impairment," management estimated that as of December 31, 2011, the repayment of the loan is not probable, and therefore set a provision for the entire loan amount. The Company recorded expenses of $ 319, $ 206 and $ 0 for the years ended December 31, 2009, 2010 and 2011, respectively, related to such provision. NOTE 12:- SHAREHOLDERS' EQUITY a. Pertinent rights and privileges conferred by Ordinary shares: The Ordinary shares of the Company are listed on the NASDAQ Global Market and were listed on the Tel-Aviv Stock Exchange. The Ordinary shares confer upon their holders the right to receive notice to participate and vote in the general meetings of the Company and the right to receive dividends, if declared. On November 30, 2011, the Company delisted its shares from the Tel Aviv Stock Exchange b. Issued and outstanding share capital: 10,396,548 shares at December 31, 2010 and 15,819,822 shares at December 31, 2011. On August 02, 2011, the Company completed a public offering of $ 16,000 in consideration of the sale of 5,273,274 of the Company's Ordinary shares at a price per share of $ 3.03. On June 17, 2011, the Company completed a private placement of 150,000 of its ordinary shares to Ki Corporation at an initial price per share of $3.04, which was equal to the closing price of its ordinary shares on the NASDAQ Global Market on June 16, 2011. On June 29, 2011,the record date of the rights offering, the price per share paid by Ki Corporation was adjusted to $3.05, which was the closing price of the ordinary shares on the NASDAQ Global Market on the date prior to the record date of the rights offering. F - 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 12:- SHAREHOLDERS' EQUITY (Cont.) c. Stock Option Plan: MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES On October 27, 2003, the Company's Board of Directors approved the 2003 Israeli Share Option Plan ("the 2003 Plan"). Under the 2003 Plan, stock options may be periodically granted to employees, directors, officers and consultants of the Company or its subsidiaries in accordance with the decision of the Board of Directors of the Company (or a committee appointed by it). The Board of Directors also has the authority to determine the vesting schedule and exercise price of options granted under the 2003 Plan. The 2003 Plan is effective for ten years and will terminate in October 2013. Any options that are cancelled or forfeited before expiration become available for future grant. In May 2008, the Board of Directors approved an amendment to the 2003 Plan, which was approved by the shareholders in August 2008, which increased the number of Ordinary shares available for issuance under the 2003 Plan increased by an additional 1,000,000 options and the termination of the 2003 Plan was extended from October 2013 to October 2018. On June 23, 2010, the Company's Annual General Meeting approved the 2010 Israeli Share Option Plan, or the 2010 Plan, which authorizes the grant of options to employees, officers, directors and consultants of our company and subsidiaries. The ordinary shares that remain available for futures option grants under the 2003 Plan as of the date of the adoption of the 2010 Plan and any ordinary shares that become available in the future under the 2003 Plan as a result of expiration, cancellation or relinquishment of any option currently outstanding under the 2003 Plan will be rolled over to the 2010 Plan. Following the adoption of the 2010 Plan, no additional options will be granted under the 2003 Plan. The 2010 Plan has a term of ten years. As of December 31, 2011, 510,575 Ordinary shares were available for future option grants under the 2010 Plan. F - 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 12:- SHAREHOLDERS' EQUITY (Cont.) A summary of employee option activity under the Company's stock option plans as of December 31, 2011 and changes during the year ended December 31, 2011 are as follows: MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Outstanding at January 1, 2011 Granted Exercised Forfeited Outstanding at December 31, 2011 Vested and expected to vest at December 31, 2011 Exercisable at December 31, 2011 Weighted- average exercise price Weighted- average remaining contractual life (in months) Aggregate intrinsic value (in thousands) Number of options 1,168,000 $ (60,000) $ 1,108,000 $ 1,108,000 $ 771,501 $ 5.19 3.53 5.28 5.28 5.42 49.1 - 36.2 36.2 29.5 - 81 81 53 The weighted-average grant-date fair value of options granted during the year ended December 31, 2009 was $ 1.41. No options were granted during 2011. The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company's closing stock price on the last trading day of the fourth quarter of fiscal 2011 and the exercise price, multiplied by the number of in-the-money options). This amount changes, based on the fair market value of the Company's stock. The total intrinsic value of options exercised for the year ended December 31, 2011 was $ 0, as none of the options were exercised in the aforementioned period. As of December 31, 2011, there were approximately $ 143 of total unrecognized compensation costs related to non-vested share-based compensation arrangements granted under the Company's stock option plans and $ 19 related to option granted to related parties (see Note 16d). This cost is expected to be recognized over a period of 1.92 years. F - 35 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data NOTE 12:- SHAREHOLDERS' EQUITY (Cont.) The options outstanding as of December 31, 2011 are follows: Options outstanding as of December 31, 2011 Exercise price Weighted average remaining contractual life (In months) Options exercisable as of December 31, 2011 $ $ $ $ $ $ 100,000 300,000 98,000 250,000 260,000 100,000 1,108,000 8.22 7.59 4.09 4.35 3.53 3.48 7.50 31.67 33.83 40.07 50.09 35.11 36.21 100,000 200,000 49,000 187,501 168,000 67,000 771,501 d. Dividends: Dividends, if any, will be declared and paid in U.S. dollars. Dividends paid to shareholders in Israel will be converted into NIS on the basis of the exchange rate prevailing at the date of payment. The Company has determined that it will not distribute dividends out of tax-exempt profits. NOTE 13:- BASIC AND DILUTED NET EARNINGS PER SHARE Numerator: Income (loss) from continuing operations Income on discontinued operations Income (loss) F - 36 Year ended December 31, 2010 2009 2011 $ $ (5,297) $ 4,216 (6,229) $ - (1,081) $ (6,229) $ 9,844 - 9,844 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 13:- BASIC AND DILUTED NET EARNINGS PER SHARE (Cont.) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Year ended December 31, 2010 2009 2011 Denominator: Denominator for basic net earnings per share weighted-average number of shares outstanding Effect of diluting securities: Employee stock options 10,396,548 10,396,548 12,645,283 2,076 - - Denominator for diluted net earnings per share - adjusted weighted average shares and assumed exercises 10,398,624 10,396,548 12,645,283 Basic earnings (loss) per share from continuing operations Basic net earnings (loss) per share from discontinued operations Basic net earnings (loss) per share Diluted earnings (loss) per share from continuing operations Diluted net earnings (loss) per share from discontinued operations Diluted net earnings (loss) per share $ $ $ $ (0.52) $ 0.41 (0.11) $ (0.52) $ 0.41 (0.11) $ (0.6) $ - (0.6) $ (0.6) $ - (0.6) $ 0.78 - 0.78 0.78 - 0.78 NOTE 14:- TAXES ON INCOME a. Tax benefits in Israel under the Law for the Encouragement of Capital Investments, 1959 ("the Law"): The Company has been granted the status of an "Approved Enterprise" under the Law. Currently, there is expansion program under which the Company is entitled to tax benefits: On August 13, 2002, a program of the Company was granted the status of an "Approved Enterprise". The Company elected to enjoy the "alternative benefits" track - waiver of grants in return for tax exemption - and, accordingly, the Company's income from this program is tax-exempt for a period of two years and is subject to a reduced tax rate of 10%-25% for a period of five to eight years (depending upon the percentage of foreign ownership of the Company). The benefit period for this program began in 2003 and will terminate in 2012. F - 37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 14:- TAXES ON INCOME (Cont.) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES The period of tax benefits detailed above is subject to limits of the earlier of 12 years from the commencement of production or 14 years from receiving the approval ("the years' limitation"). Please note that the years' limitation does not apply to the exemption period. An amendment to the Law, which was published effective as of April 1, 2005 ("the Amendment"), changed certain provisions of the Law. As a result of the Amendment, a company is no longer obliged to implement an Approved Enterprise status in order to receive the tax benefits previously available under the Alternative Benefits provisions, and therefore there is no need to apply to the Investment Center for this purpose (Approved Enterprise status remains mandatory for companies seeking grants). Rather, a company may claim the tax benefits offered by the Investment Law directly in its tax returns, provided that its facilities meet the criteria for tax benefits set out by the Amendment. A company is also entitled to approach the Israeli Tax Authority for a pre-ruling regarding their eligibility for benefits under the Amendment. Tax benefits are available under the Amendment to production facilities (or other eligible facilities), which are generally required to derive more than 25% of their business income from export (referred to as a Beneficiary Enterprise). In order to receive the tax benefits, the Amendment states that a company must make an investment in the Beneficiary Enterprise exceeding a minimum amount specified in the Law. Such investment may be made over a period of no more than three years ending at the end of the year in which a company requested to have the tax benefits apply to the Beneficiary Enterprise ("the Year of Election"). Where a company requests to have the tax benefits apply to an expansion of existing facilities, then only the expansion will be considered a Beneficiary Enterprise and the company's effective tax rate will be the result of a weighted combination of the applicable rates. In such case, the minimum investment required in order to qualify as a Beneficiary Enterprise is required to exceed a certain percentage of the company's production assets before the expansion. The duration of tax benefits is subject to a limitation of the earlier of seven years from the Commencement Year. The Commencement Year is defined as the later of (a) the first tax year in which a company had derived income for tax purposes from the Beneficiary Enterprise or (b) the year in which a company requested to have the tax benefits apply to the Beneficiary Enterprise - Year of Election) or 12 years from the first day of the Year of Election. F - 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 14:- TAXES ON INCOME (Cont.) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES In December 2010, the "Knesset" (Israeli Parliament) passed the Law for Economic Policy for 2011 and 2012 (Amended Legislation), 2011, which prescribes, among others, amendments in the Law for the Encouragement of Capital Investments, 1959 ("The Law"). The amendment became effective as of January 1, 2011. According to the amendment, the benefit tracks in the Law were modified and a flat tax rate applies to the Company's entire preferred income. The Company will be able to opt to apply (the waiver is non-recourse) the amendment and from then on it will be subject to the amended tax rates that are: 2011 and 2012 - 15% (in development area A - 10%, 2013 and 2014 - 12.5% (in development area A - 7%) and in 2015 and thereafter - 12% (in development area A - 6%). b. On March 3, 2007, the Company received a pre-ruling from the Israeli Tax Authority for its request for a Beneficiary Enterprise, regarding eligibility for benefits under the Amendment. The Company's income from this program is tax-exempt for a period of two years and is subject to a reduced tax rate of 10%-25% for a period of five to eight years (depending upon the percentage of foreign ownership of the Company). The Company has not yet obtained any tax benefits from this program. Income from sources other than an "Approved Enterprise" during the benefit period was subject to tax at regular rate of 25% in 2010 (see e. below). By virtue of the Law, the Company is entitled to claim accelerated depreciation on equipment used by the "Approved Enterprise" during five tax years. Since the Company is operating under approval for an Approved Enterprise and since part of its taxable income is not entitled to tax benefits under the Law and is taxed at regular rates (25% in 2010), its effective tax rate is the result of a weighted combination of the various applicable rates and tax-exemptions. The computation is made for income derived from each program on the basis of formulas determined in the law and in the approvals. The tax-exempt income attributable to the "Approved Enterprises" can be distributed to shareholders without subjecting the Company to taxes only upon the complete liquidation of the Company. If the retained tax-exempt income is distributed in a manner other than in the complete liquidation of the Company, it would be taxed at the corporate tax rate applicable to such profits as if the Company had not chosen the alternative tax benefits (currently - 15%). The Company's Board of Directors has decided that its policy is not to declare dividends out of such tax-exempt income. Accordingly, no deferred income taxes have been provided on income attributable to the Company's "Approved Enterprises" and "Beneficiary Enterprise," as such retained earnings are essentially permanent in duration. F - 39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 14:- TAXES ON INCOME (Cont.) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES c. Measurement of taxable income under the Income Tax (Inflationary Adjustments) Law, 1985: Under the Income Tax (Inflationary Adjustments) Law, 1985, results for tax purposes are measured in real terms, in accordance with the changes in the Israeli Consumer Price Index ("Israeli CPI"). Accordingly, until 2002, results for tax purposes were measured in terms of earnings in NIS after certain adjustments for increases in the Israeli CPI. Commencing in taxable year 2003 through 2006, the Company elected to measure its taxable income and file its tax returns under the Israeli Income Tax Regulations (Principles Regarding the Management of Books of Account of Foreign Invested Companies and Certain Partnerships and the Determination of Their Taxable Income), 1986. Changes in the tax laws applicable to the Company: In February 2008, the "Knesset" (Israeli Parliament) passed an amendment to the Income Tax (Inflationary Adjustments) Law, 1985, which limits the scope of the law with effect from 2008 and thereafter. From 2008, the results for tax purposes will be measured in nominal values, excluding certain adjustments for changes in the Israeli CPI carried out in the period up to December 31, 2007. The amended law includes, among other things, the elimination of the inflationary additions and deductions and the additional deduction for depreciation with effect from 2008. d. Tax benefits (in Israel) under the Law for the Encouragement of Industry (Taxes), 1969: The Company is an "industrial company" as defined by this law and, as such, is entitled to certain tax benefits including accelerated depreciation, deduction of the purchase price of patents and know-how and deduction of public offering expenses. e. Tax rates: 1. Tax rates applicable to the income of the Company: Taxable income of the Company is subject to tax at the rate of 26% in 2009, 25% in 2010 and 24% in 2011. On December 5, 2011, the Israeli Parliament (the Knesset) passed the Law for Tax Burden Reform (Legislative Amendments), 2011 ("the Law") which, among others, canceled the scheduled progressive reduction in the corporate tax rate effective from 2012. The Law also increased the corporate tax rate to 25% in 2012. In view of said increase in the corporate tax rate to 25% in 2012, the real capital gains tax rate and the real betterment tax rate were also increased accordingly. F - 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 14:- TAXES ON INCOME (Cont.) MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES 2. The tax rates of the Company's subsidiaries range between 16%-40%. In December 2007, the tax rate in Germany was reduced to 30% from 38%. The tax reduction is effective beginning January 1, 2008. Deferred taxes have been adjusted accordingly. f. Income taxes on non-Israeli subsidiaries: Non-Israeli subsidiaries are taxed according to the tax laws in their respective country of domicile. Israeli income taxes and foreign withholding taxes were not provided for undistributed earnings of the Company's foreign subsidiaries. The Company's board of directors has determined that the Company will not distribute any amounts of its undistributed earnings as dividends. The Company intends to reinvest these earnings indefinitely in its foreign subsidiaries. Accordingly, no deferred income taxes have been provided. If these earnings were distributed to Israel in the form of dividends or otherwise, the Company would be subject to additional Israeli income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes. g. Israeli Transfer Pricing Regulations: On November 29, 2006, Income Tax Regulations (Determination of Market Terms), 2006, promulgated under Section 85A of the Tax Ordinance, came into effect ("TP Regulations"). Section 85A of the Tax Ordinance and the TP Regulations generally requires that all cross-border transactions carried out between related parties be conducted on an arm's length principle basis and be taxed accordingly. The TP Regulations did not have a material effect on the Company. F - 41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 14:- TAXES ON INCOME (Cont.) h. Reconciliation between the theoretical tax expense, assuming all income is taxed at the Israeli statutory rate, and the actual tax expense, is as follows: Income (loss) from continued operations before taxes as reported in the statements of operations $ (4,433) $ (5,627) $ 10,567 Year ended December 31, 2010 2009 2011 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Tax rate Theoretical tax benefit Increase (decrease) in taxes: Non-deductible items Temporary differences on current year losses for which valuation allowance was provided Realization of carry forward tax losses for which valuation allowance was provided Deferred taxes on carry forward losses recognized in prior years against which valuation allowance was provided this year Reduction and tax rate differences in subsidiaries Taxes in respect of prior years Tax withheld against which valuation allowance was provided this year Other 26% 25% 24% $ (1,153) $ (1,407) $ 467 925 (129) *) 677 (20) (70) - 167 335 1,909 (383) - 107 103 - (62) 2,536 126 112 (2,932) - 189 150 228 314 723 Taxes on income in the statements of operations $ 864 $ 602 $ *) The Company recorded a valuation allowance in 2009 in the amount of $ 677 relating to deferred tax on losses created in prior years by its subsidiary in Canada due to the uncertainty of their future realization. F - 42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 14:- TAXES ON INCOME (Cont.) i. Taxes on income (tax benefit) included in the statements of operations: Current: Domestic Foreign Deferred: Domestic Foreign Taxes in respect of prior years: Domestic Foreign Total taxes on income j. Deferred income taxes: MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Year ended December 31, 2010 2009 2011 $ $ - 141 $ - 667 - 793 (16) (54) - (168) 107 (4) $ 864 $ 602 $ 228 413 - (68) 96 54 723 Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets are as follows: Deferred tax assets: Operating loss carry forwards Reserves and tax allowances Total deferred taxes before valuation allowance Valuation allowance Net deferred tax assets Deferred tax liabilities Intangible assets Net deferred tax assets (liabilities) Domestic Foreign F - 43 December 31, 2010 2011 $ $ $ $ 8,048 $ 3,685 11,733 (11,259) 474 190 284 $ - $ 284 284 $ 6,674 3,803 10,477 (9,969) 508 205 303 - 303 303 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 14:- TAXES ON INCOME (Cont.) k. The domestic and foreign components of income (loss) before taxes are as follows: Domestic Foreign l. Net operating carry forward tax losses: MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Year ended December 31, 2010 2009 2011 $ $ (4,330) $ (103) (7,874) $ 2,247 8,876 1,691 (4,433) $ (5,627) $ 10,567 The Company has estimated total available carry forward tax losses of $ 12,947 to offset against future taxable income. As of December 31, 2011, the Company recorded a full valuation allowance on these carry forward tax losses due to the uncertainty of their future realization. There is no time limitation for the realization of such tax losses. The Company's subsidiaries have estimated total available carry forward tax losses of $ 9,011, which may be used to offset against future taxable income, for periods ranging between 2 to 20 years. As of December 31, 2011, the Company recorded a full valuation allowance for its subsidiaries' carry forward 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. m. In July 2011, the Company finalized with the Israeli Tax Authority the tax assessment with respect to the years 2005-2006. F - 44 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 14:- TAXES ON INCOME (Cont.) n. Uncertain tax provisions: As of December 31, 2010 and 2011 balances in respect to ASC 740 Income Taxes amounted to $ 243 and $ 332, respectively. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: Balance at the beginning of the year Additions based on tax positions taken during a prior period Reduction related to tax positions taken during a prior period Reductions related to settlement of tax matters Foreign currency translation adjustments December 31, 2010 2011 $ 140 $ 189 (100) 14 Balance at the end of the year $ 243 $ NOTE 15:- DISCONTINUED OPERATIONS 243 115 (2) (24) 332 In September 2009, the Company resolved to discontinue the operation of the European subsidiary. The subsidiary was sold in December 2009 in consideration of Euro 2,900 (approximately $ 4,200). In addition, the remaining escrow amount of approximately Euros 620 was released back to the Company. Accordingly, the operating results and the cash flows of the European subsidiary , as well as the capital gain of approximately $ 4,300 resulting from the sale, were classified as discontinued operations, in accordance with ASC 205-20 "Discontinued Operations." The operating results of the European subsidiary during 2009 were immaterial. As of December 31, 2010 and 2011, there are no balance sheet items related to the operations of the European subsidiary. F - 45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 16:- BALANCES AND TRANSACTIONS WITH RELATED PARTIES a. Transactions with related parties: Sales to a related party Loan from a related party Interest expenses MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Year ended December 31, 2010 2011 2009 $ $ $ - - - $ $ $ 107 9,703 195 $ $ $ 222 - 378 b. c. d. e. In October 2010, the Company entered into agreement with its principal shareholder to install a perimeter security system project at one of his premises in Europe. The work started in December 2010 and was finalized during the first half of 2011. On September 8, 2010, Ki Corporation provided the Company with a $ 10,000 bridge loan. The loan has born interest of LIBOR + 4%. The interest was paid together with, and in the same manner as, the principal, at the end of the term of the loan. The Company undertook to repay the bridge loan within five business days after the successful completion of the rights offering. The loan was recorded at fair value in the amount of $ 9,703 using an effective interest rate of 6.7%. The difference between the consideration received and the fair value of the loan was recorded in the statement of changes in shareholders' equity. During 2011, the Company used part of the proceeds from its rights offering for the repayment of the bridge loan, In May 2008, one of the Company's major shareholders granted to the executive chairman of the Board of Directions the right to purchase 100,000 shares, subject to the same terms and conditions that apply to the exercise of the options the executive chairman received from the Company pursuant to his employment agreement. The employment agreement was approved in the Company's annual shareholders' meeting on August 20, 2008 and consequently, the chairman of the Board of Directors has the right to purchase the shares in three equal installments commencing on August 20, 2010 at a price of $ 7.59 per share. The right to purchase each installment expires after three years. The Company recorded $ 14 in deferred stock compensation expense with respect to this in 2011. On December 31, 2007, the Company's Chairman retired from his position. Pursuant to his retirement agreement as amended, the retired Chairman undertook not to compete with the Company for a period of three years following his retirement. In consideration, the Company agreed to pay the retired Chairman a onetime payment of $ 360 payable within three months. In addition, the Chairman is entitled to receive certain perquisites from the Company for the rest of his life. The liability as of December 31, 2011 and the special post-benefit expense related to the retirement agreement amounted to $ 680. F - 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 17:- SEGMENT INFORMATION MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES The Company adopted ASC 280, "Segment Reporting." The Company operates in two major reportable segments, which represent the Company's operating segments as follows: 1. 2. Perimeter security systems - The Company's line of perimeter security systems consists of the following: Microprocessor-based central control units, taut wire perimeter intrusion detection systems, INNO fences, vibration detection systems, field disturbance sensors, and other. Security turnkey projects - The Company executes turnkey projects based on the Company's security management system and acts as an integrator. F - 47 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 17:- SEGMENT INFORMATION (Cont.) a. The following data present the revenues, expenditures, assets and other operating data of the Company's operating segments: Perimeter Projects 2009 Eliminations Total Perimeter Year ended December 31, 2010 Eliminations Projects Total Perimeter Projects 2011 Eliminations Total Revenues $ 39,102 $ 15,416 $ - $ 54,518 $ 33,248 $ 17,249 $ (798) $ 49,699 $ 30,012 $ 59,707 $ (1,128) $ 88,591 Depreciation and amortization Other income $ $ 886 $ 318 $ - $ - $ - - $ $ 1,204 $ 665 $ 397 $ - $ - $ - $ - - $ $ 1,062 $ 722 $ 497 $ - $ - $ 2,304 $ - - $ $ 1,219 2,304 Operating income (loss), before financial expenses and taxes on income Financial expenses (income), net Taxes on income (tax benefit) Income (loss) from discontinued operations, net Net income (loss) $ (1,053) $ (1,812) $ - $ (2,865) $ (1,641) $ (2,716) $ (303) $ (4,660) $ 2,665 $ 7,528 $ (382) $ 1,568 864 4,216 $ (1,081) 967 602 - 9,811 (756) 723 - $ (6,229) $ 9,844 Perimeter 2010 Projects Total Perimeter 2011 Projects Total Total long-lived assets $ 5,765 $ 3,268 $ 9,033 $ 5,117 $ 3,503 $ 8,620 F - 48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 17:- SEGMENT INFORMATION (Cont.) b. Major customer data (percentage of total revenues): Customer A Customer B Customer C (see note 1d) ∗) Less than 10%. c. Geographical information: MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Year ended December 31, 2010 2009 2011 19.6% *) - 13.4% 11.4% - *) 10.7% 34.8% The following is a summary of revenues within geographic areas based on end customer's location and long-lived assets: 1. Revenues: Israel Europe North America South and Latin America Africa Others 2. Long-lived assets: Israel Europe USA Canada Others F - 49 Year ended December 31, 2010 2009 2011 $ $ 12,968 10,808 13,763 3,986 3,747 9,246 $ 9,838 9,787 15,393 9,958 1,108 3,615 10,091 10,913 13,373 12,145 35,499 6,570 $ 54,518 $ 49,699 $ 88,591 December 31, 2010 2011 $ $ 4,065 1,082 39 3,620 227 $ 9,033 $ 3,810 1,091 41 3,410 268 8,620 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. dollars in thousands (except share and per share data) NOTE 18:- SELECTED STATEMENTS OF INCOME DATA Financial expenses: Financial expenses: Interest on long-term debt Interest on short-term bank credit Interest on a related party loan Foreign exchange losses, net Financial income: Interest on short-term and long-term bank deposits. Marketable securities gain Foreign exchange gains, net F - 50 MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES Year ended December 31, 2010 2011 2009 $ (93) $ (879) - (1,138) (11) $ (744) (195) (199) (6) (773) (378) - (2,110) (1,149) (1,157) 484 58 - 542 182 - - 182 $ (1,568) $ (967) $ 519 - 1,394 1,913 756 SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS (U.S. dollars in thousands) Balance at beginning of period Provision for doubtful accounts Offsets against receivables balances for which allowance was provided in previous years Translation adjustments Balance at end of period 919 $ 411 $ (144) $ (74) $ 1,112 911 $ 601 $ (610) $ 17 $ 1,506 $ (153) $ - $ 2 $ 919 911 $ $ $ Year ended December 31, 2011: Allowance for doubtful debts Year ended December 31, 2010: Allowance for doubtful debts Year ended December 31, 2009: Allowance for doubtful debts (1) ________________ (1) 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. In connection with the acquisition, the buyer assumed $444,000 of doubtful accounts of the subsidiary. - 84 - The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this amendment to annual SIGNATURE report on its behalf. Date: April 4, 2012 MAGAL SECURITY SYSTEMS LTD. /s/ Eitan Livneh By: Name: Eitan Livneh Title: President and Chief Executive Officer - 85 - SUBSIDIARIES OF MAGAL SECURITY SYSTEMS LTD. Below is a listing of Magal Security Systems Ltd.’s wholly-owned active subsidiaries: Country/State of Incorporation/Organization Exhibit 8.1 United States (Delaware) Netherlands Romania Cyprus Colombia United States (Delaware) Mexico United Kingdom Canada Spain Netherlands Germany Switzerland Israel Subsidiary Name KOBB Inc. Magal B.V. Magal Sisteme S.R.L. Pranco Limited Senstar Andina S.A.S Senstar Inc. Senstar Stellar LA Senstar Limited Senstar Corp. Magal S3 España, S.L. Fidifull Finance B.V. Senstar GmbH JEE Investment A.G. E.S.E. Ltd. CERTIFICATION OF CHIEF EXECUTIVE OFFICER Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended Exhibit 12.1 I, Eitan Livneh, certify that: 1. I have reviewed this annual report on Form 20-F of Magal Security Systems Ltd.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report; 4. The company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15 (e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the company and have: (a) (b) (c) (d) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting; 5. The company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the company’s auditors and the audit committee of the company’s board of directors (or persons performing the equivalent function): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company’s ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the company’s internal control over financial reporting. Date: April 4, 2012 /s/ Eitan Livneh * Eitan Livneh President and Chief Executive Officer * The originally executed copy of this Certification will be maintained at the Company’s offices and will be made available for inspection upon request. CERTIFICATION OF CHIEF FINANCIAL OFFICER Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended Exhibit 12.2 I, Ilan Ovadia, certify that: 1. I have reviewed this annual report on Form 20-F of Magal Security Systems Ltd.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report; 4. The company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15 (e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the company and have: (a) (b) (c) (d) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting; 5. The company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the company’s auditors and the audit committee of the company’s board of directors (or persons performing the equivalent function): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company’s ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the company’s internal control over financial reporting. Date: April 4, 2012 /s/ Ilan Ovadia * Ilan Ovadia Senior Vice President – Finance, Chief Financial Officer and Secretary * The originally executed copy of this Certification will be maintained at the Company’s offices and will be made available for inspection upon request. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 13.1 In connection with the Annual Report of Magal Security Systems Ltd. (the “Company”) on Form 20-F for the period ending December 31, 2011 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Eitan Livneh, Chairman of the Board of Directors of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Eitan Livneh * Eitan Livneh President and Chief Executive Officer Date: April 4, 2012 * The originally executed copy of this Certification will be maintained at the Company’s offices and will be made available for inspection upon request. This certification accompanies this Annual Report on Form 20-F pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 13.2 In connection with the Annual Report of Magal Security Systems Ltd. (the “Company”) on Form 20-F for the period ending December 31, 2011 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Ilan Ovadia, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Ilan Ovadia* Ilan Ovadia Senior Vice President – Finance, Chief Financial Officer and Secretary Date: April 4, 2012 * The originally executed copy of this Certification will be maintained at the Company’s offices and will be made available for inspection upon request. This certification accompanies this Annual Report on Form 20-F pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Exhibit 15.1 We consent to the incorporation by reference in the Registration Statements on Form S-8 (File Nos. 333-127340 and 333-164696) of our report dated April 4, 2012 with respect to the consolidated financial statements and schedule of Magal Security Systems Ltd. included in this Annual Report on Form 20-F for the year ended December 31, 2011 filed with the Securities and Exchange Commission. Tel-Aviv, Israel April 4, 2012 /s/ Kost Forer Gabbay & Kasierer KOST FORER GABBAY & KASIERER A Member of Ernst & Young Global 

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