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22 INDEPENDENT AUDITORS' REPORT Kost Forer Gabbay & Kasierer 3 Aminadav St. Tel-Aviv 67067, Israel Phone: Fax: INDEPENDENT AUDITORS' REPORT To the shareholders of VISONIC LTD. We have audited the accompanying financial statements of Visonic Ltd. and its subsidiary ("the Group"), which comprise the consolidated balance sheets as of December 31, 2006 and 2005, and the consolidated statements of income, consolidated statements of changes in equity and consolidated statements of cash flows for each of the two years in the period ended December 31, 2006, and a summary of significant accounting policies and other explanatory notes. We did not audit the financial statements of certain subsidiaries, whose assets constitute approximately 25.3% and 24.1% of total consolidated assets as of December 31, 2006 and 2005, respectively, and whose revenues constitute approximately 48.8% and 49.9% of total consociated revenues for the years ended December 2006 and 2005, respectively. The financial statements of those companies were audited by other auditors, whose reports have been furnished to us, and our opinion, insofar as it relates to amounts included for those companies, is based on the reports of the other auditors. MANAGEMENT S RESPONSIBILITY FOR THE FINANCIAL STATEMENT Management is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances. AUDITORS RESPONSIBILITY Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with International Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditors' judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate for the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained, and the reports of the other auditors, are sufficient and appropriate to provide a basis for our audit opinion. OPINION In our opinion, based on our audits and the reports of the other auditors, the consolidated financial statements present fairly, in all material respects, the financial position of the Group as of December 31, 2006 and 2005, and of its financial performance and its cash flows for each of the two years in the period ended December 31, 2006, in accordance with International Financial Reporting Standards. Tel-Aviv, Israel KOST FORER GABBAY & KASIERER 19 March 2007 A Member of Ernst & Young Global 20 VISONIC

23 CONSOLIDATED BALANCE SHEETS ASSETS As of 31 December Note US$ '000 US$ '000 CURRENT ASSETS: Cash and cash equivalents 7,021 7,624 Short-term deposits 3a 8,100 8,000 Available-for-sale financial assets 3b 1, Held-to-maturity investments 7 3,517 1,000 Trade receivable 4 14,336 16,621 Income tax receivable *) 537 1,837 Other accounts receivable 5 *) 1,859 2,288 Inventories 6 9,315 14,425 Total current assets 45,881 51,963 NON-CURRENT ASSETS: Held-to-maturity investments 7 1,024 - Property and equipment, net 8 *) 4,723 5,909 Prepaid expenses Deferred tax assets 17a5 1,293 1,409 Intangible assets, net 9 *) 2,609 3,953 Other investments 10-1,190 Total non-current assets 10,356 13,128 Total assets 56,237 65,091 LIABILITIES AND EQUITY CURRENT LIABILITIES: Credit from banks and current maturities of long-term loans 11 6,452 1,176 Trade payables 12 6,456 10,595 Employees benefits liability 1,955 2,404 Related company Other current liabilities 14 2,338 2,308 Total current liabilities 17,252 16,536 LONG-TERM LIABILITIES: Bank loans 15 3,229 7,000 Employees benefits liability Total long-term liabilities 3,315 7,107 EQUITY: 19 Share capital Share premium 22,740 23,354 Net unrealized gains (loss) reserve 35 (2) Retained earnings 12,874 18,075 Total equity 35,670 41,448 Total liabilities and equity 56,237 65,091 *) Reclassified. The accompanying notes are an integral part of the consolidated financial statements. 19 March 2007 Date of approval of the Yaacov Kotlicki Dr. Avigdor Sacharai Yair Naaman financial statements Chairman of the Board Chief Executive Officer Chief Financial Officer of Directors 2006 ANNUAL REPORT 21

24 CONSOLIDATED STATEMENTS OF INCOME Year ended 31 December Note US$ '000 US$ '000 Except per share data Sale of goods 62,781 65,802 Cost of sales 20a (32,677) (35,691) Gross profit 30,104 30,111 Research and development costs, net 20b (4,665) (5,270) Selling and marketing expenses 20c (14,118) (15,222) General and administrative expenses 20d (3,935) (4,270) Share-based payments expense 19e (156) (150) Total operating expenses (22,874) (24,912) Operating profit 7,230 5,199 Financial income Financial expenses (709) (499) Exchange rate difference, net (406) 592 Other expenses, net 20e (28) (5) Profit before taxes on income 6,656 6,014 Taxes on income 17 (1,620) (813) Net profit 5,036 5,201 Basic earnings per share (in cents) Diluted earnings per share (in cents) The accompanying notes are an integral part of the consolidated financial statements. 22 VISONIC

25 STATEMENTS OF CHANGES IN EQUITY Net Total unrealized recognized Share Share gains (loss) Retained Total income capital premium reserve earnings equity (expenses) US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 US$ 000 As of 1 January , ,838 29,986 Net gains on available-for-sale financial assets Issuance of shares, net *) Exercise of options *) Share based payments expense Net profit ,036 5,036 5,036 As of 31 December , ,874 35,670 5,054 Net loss on available-for-sale financial assets - - (37) - (37) (37) Exercise of options *) Share based payments expense Net profit ,201 5,201 5,201 As of 31 December ,354 (2) 18,075 41,448 5,164 *) Less than $ 1,000. The accompanying notes are an integral part of the consolidated financial statements ANNUAL REPORT 23

26 CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended 31 December Note US$ '000 US$ '000 CASH FLOWS FROM OPERATING ACTIVITIES: Net profit 5,036 5,201 Adjustments to reconcile net profit to net cash provided by operating activities (a) 280 (2,626) Net cash provided by operating activities 5,316 2,575 CASH FLOWS FROM INVESTING ACTIVITIES: Short-term deposits, net (1,100) 100 Purchase of available-for-sale financial assets (1,000) - Proceeds from sale of available-for-sale financial assets 573 1,032 Proceeds from redemption of held-to-maturity investments 500 3,500 Acquisition of intangible assets (1,219) (1,871) Proceeds from sale of property and equipment Purchase of property and equipment (1,927) (2,539) Investment in other investment - (1,190) Net cash used in investing activities (4,162) (933) CASH FLOWS FROM FINANCING ACTIVITIES: Exercise of options Increase (decrease) in balance with related company (754) 2 Receipt of long-term loans from banks 3,000 4,000 Repayment of long-term loans from banks (2,388) - Short-term bank credit, net (77) (5,505) Net cash provided by (used in) financing activities 23 (1,039) Increase in cash and cash equivalents 1, Cash and cash equivalents at the beginning of the year 5,844 7,021 Cash and cash equivalents at the end of the year 7,021 7,624 NON-CASH ACTIVITY: Issuance of shares in exchange for minority interest in VS The accompanying notes are an integral part of the consolidated financial statements. 24 VISONIC

27 NOTES TO CONSOLIDATED STATEMENTS OF CASH FLOWS (a) Adjustments to reconcile net profit to net cash provided by operating activities: Year ended 31 December US$ '000 US$ '000 INCOME AND EXPENSES NOT INVOLVING CASH FLOWS: Depreciation and amortisation 1,642 1,862 Deferred taxes, net 329 (116) Decrease in accrued severance pay liability (281) 21 Loss from sales of available for sale financial assets - 41 Loss (gain) from sale of property and equipment, net 26 (17) Revaluation of bank loan (3) - Interest on held-to-maturity investments 165 (41) Share-based payments expense CHANGES IN WORKING CAPITAL ITEMS: Increase in trade receivables (1,366) (2,285) Decrease (increase) in other accounts receivable 98 (1,729) Increase in inventories (1,470) (5,110) Decrease (increase) in long-term prepaid expenses (707) 40 Increase in trade payables 2,035 4,139 Increase in employee benefits Decrease in other current liabilities (377) (30) (b) Supplemental disclosure of cash flows information: CASH PAID DURING THE YEAR FOR: 280 (2,626) Interest Income taxes 2,458 2,012 CASH RECEIVED DURING THE YEAR FOR: Interest The accompanying notes are an integral part of the consolidated financial statements ANNUAL REPORT 25

28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 GENERAL A. COMPANY DESCRIPTION: The Company was founded in 1973 under the laws of the State of Israel and it is engaged in the design, development, manufacture and marketing of security systems and components for institutional, commercial and residential customers for both personal and property protection. The Company's products are marketed in Europe, the Pacific and North America through its various wholly-owned subsidiaries in each region and in Asia, through its 50 per cent owned jointventure in Hong-Kong. On 15 April 2004, the Company effected an IPO on the London Stock Exchange. In addition, on April 2006 the Company shares were registered for trade also on the Tel-Aviv stock exchange. B. DEFINITIONS: In these financial statements: The Company - Visonic Ltd. Subsidiaries - companies over which the Company exercises control (as defined in IAS 27) and whose accounts are incorporated with those of the Company. Jointly controlled entity - company owned by various entities that have a contractual consent for joint control, and whose accounts are consolidated with those of the Company using the proportionate consolidation method. The jointly controlled entity in these financial statements is: Visonic Deson Limited 50 per cent owned and controlled through Visonic Ltd. ("Visonic Deson") Investees - subsidiaries and jointly controlled entity. Related parties - as defined in IAS 24 "Related Party Disclosures". CPI - Consumer Price Index. C. THE FOLLOWING ACTIVE COMPANIES ARE CONSOLIDATED AND PROPORTIONATE CONSOLIDATED AS OF 31 DECEMBER 2006 AND 2005: Consolidated companies Share (per cent) Visonic Solutions Ltd. ("VS") (1) 100 Visonic Marketing (1988) Ltd. ("VM") (1) 100 Visonetix Ltd. ("Visonetix") (1) (2) 100 Visonic Technologies (1993) Ltd. ("Visonic Technologies") (1) (2) 100 Visonic Inc. (3) (4) 100 Visonic Iberica de Seguridad S.L. ("Visonic Iberica") (4) (5) 100 Visonic Sicherheitstechnik GmbH ("Visonic GmbH") (4) (6) 100 Visonic Sp.Zo.O ("Visonic Sp") (4) (7) 100 Visonic Limited (4) (8) 100 Visonic Security Pty Limited ("Visonic Pty") (4) (9) 100 Visonic Technologies Americas Inc. ("VTA") (3) (11) 100 Visonic Technologies UK Limited ("VT UK") (8) (11) 100 Visonic Technologies Bulgaria Ltd. ("VTB") (10) (11) VISONIC

29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Proportionate consolidation Share (per cent) Visonic Deson Limited ("Visonic Deson") (4) (12) 50 (1) Operates in Israel. (2) Owned through VS. (3) Operates in the United States. (4) Owned through VM. (5) Operates in Spain. (6) Operates in Germany. (7) Operates in Poland. (8) Operates in the United Kingdom. (9) Operates in Australia. (10) Operates in Bulgaria. (11) Owned through Visonic Technologies. (12) Proportionately consolidated - see Note 25. Visonic and its subsidiary VM focus on residential security and provide global technical and marketing support throughout the network of subsidiaries and distributors in over 70 countries. VS focuses on location tracking systems in the institutional and commercial markets through Visonic Technologies. NOTE 2 SIGNIFICANT ACCOUNTING POLICIES AND METHODS OF COMPUTATIONS The significant accounting policies and methods of computations applied in the preparation of the consolidated financial statements, on a consistent basis, are as follows: A. BASIS OF PREPARATION: These financial statements are prepared in accordance with International Financing Reporting Standards ("IFRS") that are effective at December 31, B. FUNCTIONAL CURRENCY AND TRANSLATION: The majority of the Group's sales are made outside of Israel in non Israeli currencies, mainly the US dollar. A substantial portion of the Group's expenses, mainly selling and marketing expenses and service costs is incurred in US dollars. Accordingly, the US dollar is the currency of the primary economic environment of the Company and its subsidiaries, and thus its functional and presentation currency. Transactions in non-us dollar currencies are translated into US dollars at the exchange rate on the transaction date. Monetary assets and liabilities in non-us dollar currencies are translated into US dollars at the exchange rate on balance sheet date. All exchange rate differences are recorded in the statement of income ANNUAL REPORT 27

30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 SIGNIFICANT ACCOUNTING POLICIES (CONT.) Following are data about the representative exchange rate of the U.S. dollar in relation to the New Israeli Shekel ("NIS"), Euro and the GBP: Exchange rate Exchange rate Exchange rate As of of U.S. $ 1 of U.S. $ 1 of U.S. $ 1 NIS Euro GBP December 31, December 31, CHANGE DURING THE YEAR ENDED % % % December 31, 2006 (8.2) (10.6) (12.1) December 31, C. PRINCIPLES OF CONSOLIDATION: Subsidiaries are consolidated from the date on which control is transferred to the Company and cease to be consolidated from the date on which control is transferred out of the Company (See Note 1c). Intercompany balances and transactions including profits from inter-company sales not yet realised outside the group, have been eliminated upon consolidation. Minority interests represent the portion of profit or loss and net assets not held by the Group and are presented separately in the income statement and within equity in the consolidated balance sheet, separately from parent shareholders' equity. Acquisitions of minority interests are accounted for using the parent entity extension method, whereby, the difference between the consideration and the book value of the share of the net assets acquired is recognised as knowhow. D. INTEREST IN JOINT VENTURE: The Group's interest in a joint venture is accounted for by proportionate consolidation, which involves recognising a proportionate share of the joint venture's assets, liabilities, income and expenses with similar items in the consolidated financial statements on a line-by-line basis. E. CASH AND CASH EQUIVALENTS: Cash includes cash on hand and cash in banks. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash with original maturities of three months or less and that are subject to an insignificant risk of change in value. F. TRADE RECEIVABLES: Trade receivables are recognised and carried at original invoice amount less an allowance for any uncollectible amounts. An estimate for doubtful debts is made when collection of the full amount is no longer probable. Bad debts are written-off when identified. G. INVESTMENTS: All investments are initially recognised at fair value plus transaction costs. After initial measurement, available for sale financial assets are measured at fair value with unrealised gains or losses being recognised directly in equity in the net unrealised gains reserve. When the investment is disposed of, the cumulative gain or loss previously recorded in equity is recognised in the income statement. 28 VISONIC

31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Investments which are classified as available-for-sale and marketable bonds are measured at fair value. The fair value of investments that are actively traded in organised financial markets is determined by reference to quoted market bid prices at the close of business on the balance sheet date. For investments where there is no active market, fair value is determined using valuation techniques. Investments with fixed or determinable payments and fixed maturity are classified as held-tomaturity when the Company has the positive intention and ability to hold to maturity. After initial measurement held to maturity investments are measured at amortised cost. This cost is computed as the amount initially recognised minus principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between the initially recognised amount and the maturity amount, less allowance for impairment. This calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums and discounts. Gains and losses are recognised in the income statement when the investments are derecognised or impaired, as well as through the amortisation process. H. INVENTORIES: Inventories are presented at the lower of cost or net realisable value. Cost is determined as follows: Raw materials - at weighted average cost. Work in progress and finished goods - on the basis of weighted average costs of materials and other direct and indirect manufacturing costs, based on normal level of activity. I. PROPERTY AND EQUIPMENT: Property and equipment are stated at cost, net of accumulated depreciation and accumulated impairment. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, at the following annual rates: Per cent Machinery and equipment (mainly 10 per cent) Computers and peripheral equipment (mainly 33 per cent) Office furniture and equipment 6-20 (mainly 7 per cent) Motor vehicles 15 Leasehold improvements - over the shorter of the lease term and the useful life J. INTANGIBLE ASSETS: Intangible assets acquired separately are measured on initial recognition at cost. The cost of intangible assets acquired in a business combination is fair value as at date of acquisition. Following initial recognition, intangible assets are carried at cost less any accumulated amortisation and any accumulated impairment losses. Internally generated intangible assets, excluding capitalised development costs, are not capitalised and expenditure is charged against profits in the year in which the expenditure is incurred. The useful lives of intangible assets are assessed to be finite. Intangible assets with finite lives are amortised over the useful economic life and assessed for impairment whenever there is an indication that the intangible asset may be impaired ANNUAL REPORT 29

32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 SIGNIFICANT ACCOUNTING POLICIES (CONT.) ERP SOFTWARE: ERP software is amortised using the straight-line method over its useful economic life of 8 years. The amortisation is included in cost of sales. GOODWILL: Goodwill acquired in a business combination is initially measured at cost being the excess of the cost of the business combination over the Group's interest in the net fair value of the identifiable assets, liabilities and contingent liabilities. Following initial recognition, goodwill is measured at cost less any accumulated impairment losses. Goodwill is reviewed for impairment, annually or more frequently if events or changes in circumstances indicate that the carrying value may be impaired. Impairment is determined for goodwill by assessing the recoverable amount of the cashgenerating unit, to which the goodwill relates. Where the recoverable amount of the cashgenerating unit is less than the carrying amount of the cash-generating unit to which goodwill has been allocated, an impairment loss is recognised. Impairment losses relating to Goodwill cannot be reversed in future periods. The Group performs its annual impairment test of goodwill as at 31 December. KNOW-HOW: Know-how acquired separately is measured on initial recognition at cost. The cost of know-how acquired in a business combination is fair value as at the date of acquisition. Know-how is amortised using the straight-line method over its useful economic life of 8 years. The amortisation is included in general and administrative expenses. PRODUCT REGISTRATION COSTS: Product registration costs are expenses which relate to electrical testing and approving of the Company's products standards according to the required standards in the regions which the Company sells to. The product registration costs recognized as assets to the extent that it is expected that such assets will generate future economic benefits. Product registration costs amortised over its useful economic life of the asset. RESEARCH AND DEVELOPMENT COSTS: Expenditures for research are recognized as an expense when incurred. Expenditures on development are charged against income in the period incurred except for product development costs, which comply with all of the following criteria: the product is clearly defined and costs are separately identified and measured reliably; the technical feasibility of the product is demonstrated; the product will be sold or used; the product will generate future economic benefits because a potential market exists for the product; adequate technical, financial and other resources required for completion of the product are available. Capitalization of costs commences when the above criteria are first met. Expenditures recognized as an expense in previous accounting periods are not re-instated. 30 VISONIC

33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The carrying value of development costs is reviewed for impairment annually when the asset is not yet in use, and otherwise when events or changes in circumstances indicate that the carrying value may not be recoverable. Amortisation over the asset begin when development is completed and the asset is available for use. It is amortised over the period of the expected future sales. K. IMPAIRMENT OF ASSETS: All assets are reviewed for impairment at each balance sheet date. Assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Whenever the carrying amount of an asset exceeds its recoverable amount, an impairment loss is recognized in income. The recoverable amount is the higher of an asset's net selling price and value in use. The net selling price is the amount obtainable from the sale of an asset in an arm's length transaction less the costs of disposal while value in use is the present value of estimated future cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life. Recoverable amounts are estimated for individual assets or, if this is not possible, for the cash-generating unit to which the asset belongs. Reversal of impairment losses recognized in prior years is recorded when there is an indication that the impairment losses recognized for the asset no longer exist or have decreased. The reversal is recorded in income. However, the increased carrying amount of an asset due to a reversal of an impairment loss is recognized to the extent it does not exceed the carrying amount that would have been determined (net of amortization or depreciation) had no impairment loss been recognized for that asset in prior years. DEFERRED TAXES: Deferred taxes are calculated using the liability method on temporary differences between the tax base of assets and liabilities and their carrying amounts for financial reporting purposes. A deferred tax asset has been recognised for tax loss carryforwards only to the extent that it is probable that these will be utilised in the foreseeable future. Deferred taxes are not recorded in respect of temporary differences associated with investments in subsidiaries and interests in joint ventures, as the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future. L. REVENUE RECOGNITION: Revenues are recognised when the significant risks and rewards of ownership of the goods have passed to the buyer and the amount of revenues can be measured reliably. M. BORROWING COSTS: Borrowing costs are recognised as an expense when incurred. N. BASIC AND DILUTED EARNINGS PER SHARE: Basic earnings per share are computed using the weighted average number of ordinary shares outstanding during the period. Diluted earnings per share are computed based on the weighted average number of ordinary shares outstanding during each period, adjusted for the effects of dilutive options, outstanding during the period ANNUAL REPORT 31

34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 SIGNIFICANT ACCOUNTING POLICIES (CONT.) O. GOVERNMENT GRANTS: Royalty-bearing grants from the Government of Israel (through the Chief Scientist) for funding approved research and development projects are recognised at the time the Group is entitled to such grants, on the basis of the costs incurred and included as a deduction of research and development costs. The liability for these grants with a corresponding charge to the statement of income may need to be recorded in the future to the extent of the Group s estimate of sales from products developed of these projects. P. ACCRUED SEVERANCE PAY LIABILITY: The Company operates a defined benefit plan for severance pay pursuant to the Israeli Severance Pay Law. Under the law, Israeli resident employees are entitled to receive severance pay upon involuntary termination of employment, or upon retirement, which is calculated based on the most recent monthly salary at the time of termination, multiplied by the number of years of employment. The Company funds its liability for severance pay by monthly payments to pension funds and insurance companies ("plan assets"). The cost of providing severance pay is determined using the projected unit credit actuarial value method. Actuarial gains and losses are recognized immediately in the period in which they occur. The severance pay liability recognized in the balance sheet represents the present value of the defined benefit obligation reduced by the fair value of plan assets. If such calculation is negative, the asset is measured at the lower of this calculation or the aggregate of past service cost, plus the present value of available refunds and reductions in future contributions to the plan. Pursuant to Section 14 of the Severance Pay Law, which covers most of the Group's employees, monthly deposits with insurance companies release the Group from any future severance obligations in respect of those employees (defined contribution). Deposits under Section 14 are recorded as an expense in the Company's statement of income. Q. ACCOUNTING FOR LEASES: Operating lease - leases of assets under which substantially all risks and rewards of ownership are effectively retained by the lessor are classified as operating leases. The Group as lessee - lease payments under an operating lease are recognized as an expense on a straight-line basis over the lease term. R. SHARE-BASED PAYMENT TRANSACTIONS: Employees (including senior executives) of the Group receive remuneration in the form of sharebased payment transactions, whereby employees render services as consideration for equity instruments ( equity settled transactions'). Employees working in the business development group are granted share appreciation rights, which can only be settled in cash ( cash-settled transactions'). In situations where some or all of the goods or services received by the entity as consideration for equity instruments cannot be specifically identified, they are measured as the difference between the fair value of the share-based payment and the fair value of any identifiable goods or services received at the grant date. For cash-settled transactions, the liability is measured at each reporting date until settlement. The cost of equity-settled transactions with employees, for awards granted after 7 November 2002, is measured by reference to the fair value at the date on which they are granted. The fair 32 VISONIC

35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS value is determined by an external valuer using an appropriate pricing model, further details of which are given in Note 19d. The cost of equity-settled transactions is recognised, together with a corresponding increase in equity, over the period in which the performance and/or service conditions are fulfilled, ending on the date on which the relevant employees become fully entitled to the award ( the vesting date'). The cumulative expense recognised for equity-settled transactions at each reporting date until the vesting date reflects the extent to which the vesting period has expired and the Group's best estimate of the number of equity instruments that will ultimately vest. The income statement charge or credit for a period represents the movement in cumulative expense recognised as at the beginning and end of that period. No expense is recognised for awards that do not ultimately vest, except for awards where vesting is conditional upon a market condition, which are treated as vesting irrespective of whether or not the market condition is satisfied, provided that all other performance conditions are satisfied. Where the terms of an equity-settled award are modified, the minimum expense recognised is the expense if the terms had not been modified. An additional expense is recognised for any modification, which increases the total fair value of the share based payment arrangement, or is otherwise beneficial to the employee as measured at the date of modification. S. IFRS AND IFRIC INTERPRETATIONS NOT YET EFFECTIVE: The Group has not early adopted IFRSs and IFRIC Interpretations that have been issued but are not effective as of December 31, Management expects that adoption of those pronouncements will not have a material impact on the financial position and profit of the Group in the period of initial application. T. FUTURE CHANGES IN ACCOUNTING POLICIES: 1. IFRS 7, "Financial Instruments: Disclosures" IFRS 7, effective for financial years beginning on or after January 1, 2007, requires new disclosures to be presented in next year's financial statements on a comparative basis that will enable users to evaluate the significance of the Group's financial instruments and the nature and extent of risks arising from those financial instruments. 2. IFRS 8, "Operating Segments" IFRS 8, effective for financial years beginning on or after January 1, 2009, replaces IAS 14, "Segment Reporting", and adopts a management approach to segment reporting. The information reported would be that which management uses internally for evaluating the performance of operating segments and allocating resources to those segments. This information may be different from that reported in the balance sheet and income statement, and entities will need to provide explanations and reconciliations of the differences. U. SIGNIFICANT ACCOUNTING JUDGMENTS, ESTIMATES AND ASSUMPTIONS: Estimates and assumptions: The key assumptions concerning the future and other key sources of estimation uncertainty at the balance sheet date, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed below. Impairment of Goodwill: The Group determines whether goodwill is impaired at least on an annual basis. This requires an estimation of the 'value in use' of the cash-generating units to which the goodwill is allocated. Estimating a value in use amount requires management to make an estimate of the expected future cash flows from the cash-generating unit and also to choose a suitable discount rate in order to calculate the present value of those cash flows. V. RECLASSIFICATION: Certain amounts from prior years referring to property and equipment have been reclassified to confirm to current period presentation ANNUAL REPORT 33

36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 3 SHORT-TERM INVESTMENTS As of 31 December US$ '000 US$ '000 (a) Short-term deposits 8,100 8,000 The deposits bear interest at annual rates ranging between 5.30 per cent to 5.46 per cent. (b) Available-for-sale financial assets: Bonds - listed 1, As of 31 December 2006, the bonds are traded in Israel. As of 31 December 2005, the bonds were traded in Israel and USA. NOTE 4 TRADE RECEIVABLES As of 31 December US$ '000 US$ '000 Trade receivables 14,279 16,469 Checks receivable ,729 16,857 Allowance for doubtful accounts (393) (236) 14,336 16,621 NOTE 5 OTHER ACCOUNTS RECEIVABLE As of 31 December US$ '000 US$ '000 Government authorities Prepaid expenses (1) Income receivable Employees Advances to suppliers Other (1) Including $ 104,000 (2005: $ 115,000) from related company. NOTE 6 INVENTORIES 1,859 2,288 As of 31 December US$ '000 US$ '000 Raw materials 5,627 8,164 Work in progress 1,504 2,910 Finished goods 2,184 3,351 9,315 14, VISONIC

37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 7 HELD-TO-MATURITY INVESTMENTS As of 31 December US$ '000 US$ '000 CURRENT ASSETS: Held-to-maturity investments 3,517 1,000 (1) NON-CURRENT ASSETS: Held-to-maturity investments 1,024 - (1) Marketable bonds which will mature through April The market value of these bonds at 31 December 2006 amounted to $ 1,000,120 (2005: 989,000). NOTE 8 PROPERTY AND EQUIPMENT Computers Office Machinery and furniture and peripheral and Motor Leasehold equipment equipment equipment vehicles improvements Total US$ '000 US$ '000 US$ '000 US$ '000 US$ '000 US$ '000 COST: Balance as of 1 Jan ,637 4,236 2, ,477 17,093 Additions during the year 1,417 *) ,930 Disposals during the year - (237) (151) (20) (1) (409) Balance as of 31 Dec ,054 *) 4,405 2, ,486 18,614 Additions during the year 2, ,539 Disposals during the year (47) (35) (49) (77) - (208) Balance as of 31 Dec ,034 4,728 2, ,609 20,945 ACCUMULATED DEPRECIATION: Balance as of 1 Jan ,788 3,425 1, ,844 Depreciation during the year ,416 Disposals during the year - (219) (133) (16) (1) (369) Balance as of 31 Dec ,406 3,642 1, ,041 13,891 Depreciation during the year ,335 Disposals during the year (47) (32) (42) (69) - (190) Balance as of 31 Dec ,956 4,013 1, ,163 15,036 Depreciated cost as of 31 December , ,909 Depreciated cost as of 31 December ,648 *) *) 4,723 *) Reclassified ANNUAL REPORT 35

38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9 INTANGIBLE ASSETS Product registration Dev. ERP Know-how costs Goodwill (1) costs Software Total US$ '000 US$ '000 US$ '000 US$ '000 US$ '000 US$ '000 Balance as of 1 Jan net of accumulated amortisation 1, ,384 Additions - internal development *) 842 1,219 Know-how arising on acquisition of a minority interest in subsidiary (Note 19(b)) Amortisation charge for the year (211) (15) (226) Balance as of 31 Dec net of accumulated amortisation 1, *) 842 2,609 Additions - internal development ,190 1,856 Acquisition of know-how Acquisition charge for the year (224) (55) - - (248) (527) Balance as of 31 Dec net of accumulated amortisation ,784 3,953 (1) Goodwill derives from the acquisition of Visonic Sp, a Polish company, in April 2002 by VM. *) The Group reclasified an amount of $ 842 thousand that was recorded as property and equipment. NOTE 10 OTHER INVESTMENT On 26 February 2006, the Company closed an agreement with TMT Telemedicine - web Medical Center LLC ("TMT") and its controlling shareholders (as defined in the agreement) to invest $ 920,000 through issuance of shares in TMT which reflects holdings of per cent on a fully diluted basis of the outstanding capital stock of TMT. According to the Company management estimation the book value of the investment in TMT reflects its Fair Market Value. In August 2006, the Company lent to TMT the amount of 110,000 ($ 140,000) and an additional amount of $ 130,000. TMT shall not make any payment to the Company of any principal, interest or any other amount in respect to the loan. TMT was founded in 2003 in Lyon, France. TMT develops service solutions for home care based on telemedicine technologies. NOTE 11 CREDIT FROM BANKS AND CURRENT MATURITIES OF LONG-TERM LOANS Weighted average interest rate As of 31 December Per cent US$ '000 US$ '000 Credit from banks in NIS Current maturities of long-term bank loans in U.S.$ , Short-term bank loan in NIS ,452 1, VISONIC

39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 12 TRADE PAYABLES As of 31 December US$ '000 US$ '000 Open accounts 6,436 10,571 Checks payable NOTE 13 PREPAID EXPENSES 6,456 10,595 The balance represents prepaid expenses paid to S.M.D., a company under the control of the Company's controlling shareholders for rental payments of the manufacturing facility the Company is leasing (See Note 18b). NOTE 14 OTHER CURRENT LIABILITIES As of 31 December US$ '000 US$ '000 Accrued expenses 2,041 2,211 Customer advances Related party Other ,338 2,308 NOTE 15 BANK LOANS A. COMPOSITION: Weighted average interest rate As of 31 December Per cent US$ '000 US$ '000 Denominated in dollar ,458 7,229 Less - current maturities 6, B. AS FOR CHARGES, SEE NOTE 18C. 3,229 7, ANNUAL REPORT 37

40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 16 EMPLOYEE BENEFITS LIABILITY A. THE AMOUNT INCLUDED IN THE BALANCE SHEET ARISING FROM OBLIGATIONS IN RESPECT OF THE DEFINED BENEFIT PLAN FOR SEVERANCE PAY IS COMPRISED AS FOLLOWS: As of 31 December US$ '000 US$ '000 Net liability as of January Expense recognized in the statement of income Contributions paid (697) (583) Benefits not paid from assets (53) (41) Net liability as of December B. AMOUNTS RECOGNIZED IN THE STATEMENT OF INCOME IN RESPECT OF THE DEFINED BENEFIT PLAN ARE AS FOLLOWS: Year ended 31 December US$ '000 US$ '000 Current service cost Interest cost Expected return on plan assets (108) (80) Total expense included in statement of income C. THE ACTUARIAL ASSUMPTIONS USED ARE AS FOLLOWS: As of 31 December Discount rate 6.4% 5.7% Future salary increases 5.5% 5.5% Earnings rate on assets 5.9% 2.2% NOTE 17 TAXES ON INCOME A. ISRAELI INCOME TAXES: 1. Tax benefits under the Law for the Encouragement of Capital Investments, 1959 ("the Law"): A) THE COMPANY: Four expansion programs of the Company have been granted "Approved Enterprise" status, under the Law. For these expansion programs, the Company has elected alternative benefits, waiving grants in return for tax exemptions. Pursuant thereto, the income of the Company derived from the following "Approved Enterprise" expansion programs is tax-exempt for the periods stated below and will be eligible for reduced tax rates thereafter, as described below. 1. The Company received special approval regarding four of the expansion programs described henceforth. The special approval determines a specific ratio in respect of allocating the income deriving from the Approved Enterprise between income deriving from the plant in the centre of Israel (Development Region C) and income deriving from the plant in Kiryat Gat (Development Region A). The Company's management estimates that most of the income deriving from those programs will be attributed to the plant in Development Region A. 2. The first program that commenced in 1999 and is to expire in 2007 was an expansion of S.M.D. 38 VISONIC

41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Income deriving from the first program and attributed to the plant in Development Region A will be tax-exempt for the six-year period ending 31 December Income deriving from the first program and attributed to the plant in Development Region C is not entitled to benefits and is liable to tax at the regular rate. See Note 17e. 3. Income deriving from the second program, which commenced in 2002 and is to expire in 2011, entitles the Company to a tax exemption for the 10-year period ending 31 December 2011 in respect of income attributed to the plant in Development Region A. Income attributed to the plant in Development Region C is liable to tax at the regular rate. See Note 17e. 4. Income deriving from the third program, which commenced in 2002 and is to expire in 2011, entitles the Company to a tax exemption for the 10-year period ending 31 December 2011 in respect of income attributed to the plant in Development Region A. Income attributed to the plant in Development Region C is liable to tax at the regular rate. See Note 17e. 5. In February 2004, the Company received approval for an additional expansion. The Centre of Investment approved an investment plan in property and equipment to be carried out until 15 February 2007, in the amount of $ 4,605,000. The entitlement to the above benefits is conditional upon the fulfilment of the conditions stipulated by the above law, regulations published thereunder and the letter of approval for the investments in the Approved Enterprises. In the event of failure to comply with these conditions, the benefits may be cancelled and the Company may be required to refund the amount of the benefits, in whole or in part, including interest. Management of the Company believes that the Company has complied with all the conditions described above. Any income derived from sources other than Approved Enterprise is subject to the regular corporate tax rate. See Note 17e. In the event of distributions of dividends out of income deriving from an Approved Enterprise, which is entitled to tax exemptions, the distributing company shall be liable to pay tax at the rate of 25 per cent on the distributed earnings. Dividend distributions derived from an approved enterprise are subject to 15 per cent withholding tax. The Company may distribute dividends from earnings that do not derive from tax exempt income by virtue of the Approved Enterprise status. In December 2006, the Company was granted "Approved Enterprise which is characterized by high technological turnover" status, under the Law. According to the approval, the Company may depreciate every year 10% of the turnover base that is used for allocation among the plans, subject to meeting the procedure conditions for turnover erosion. The benefits from this status will apply for the expansion programs described in paragraphs 4 and 5 above. The management of the Company believes that the Company has complied with all the conditions described above ANNUAL REPORT 39

42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 17 TAXES ON INCOME (CONT.) B) VISONIC TECHNOLOGIES: Visonic Technologies' production facilities in Development Area C have been granted the status of an Approved Enterprise under the above Law. Pursuant to the provisions of the Law, Visonic Technologies' undistributed income will be tax-exempt for a period of two years commencing with the year it first realises taxable income. In the remaining five years of benefits, Visonic Technologies will be subject to corporate tax at a reduced rate of 25 per cent. The period of tax benefits, described above, is subject to limits of the earlier of 12 years from the commencement of production, or 14 years from the approval date, whichever is earlier. If a dividend is distributed out of such tax-exempt profits deriving from the Approved Enterprise, Visonic Technologies will be liable to corporate tax at the rate of 25 per cent. Dividend distributions derived from an approved enterprise are subject to 15 per cent withholding tax. Any income derived from sources other than Approved Enterprise is subject to the regular corporate tax rate. See Note 17e. The entitlement to the abovementioned benefits is conditional upon Visonic Technologies fulfilling the terms stipulated by the Law, regulations published thereunder and letters of approval for the specific investments in the Approved Enterprises. In the event of failure to comply with these conditions, the benefits may be cancelled and the Visonic Technologies may be required to refund the amount of the benefits, in whole or in part, including interest. The management of Visonic Technologies believes that Visonic Technologies has complied with all the conditions stipulated above. 2. The provisions of the Income Tax (Inflationary Adjustments) Law, 1985 apply to the Company and certain of its Israeli investees. According to the law, the results for tax purposes are measured based on changes in the Israeli CPI. 3. Tax benefits under the Law for the Encouragement of Industry (Taxes), 1969: The Company and certain investees are "industrial companies", as defined by this law and, as such, are entitled to certain tax benefits, mainly accelerated depreciation of machinery and equipment, as prescribed by regulations published under the Income Tax Inflationary Adjustments Law, 1985, and the right to claim public issuance expenses and amortisation of patents and other intangible property rights as a deduction for tax purposes. Under the Income Tax (Inflationary Adjustments) Law, 1985, the Company's results for tax purposes are measured in accordance with the changes in the Israeli CPI. The following are the changes in the CPI: Year ended 31 December CPI 2.4% (0.1)% 4. Subsidiaries which were incorporated outside Israel are taxed according to their countries of residence. 40 VISONIC

43 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The principal tax rates applicable to the subsidiaries whose place of incorporation is outside Israel are: U.S. - 39% Federal tax + 10% State tax United Kingdom - 30% Australia - 30% Spain - 35% Poland - 19% Germany - 38% Bulgaria - 15% Hong Kong % 5. Deferred taxes: The deferred tax assets reported in the balance sheet are based on the following temporary differences. The deferred taxes were determined using tax rates in Israel and abroad ranging between 14 per cent to 32 per cent. Significant components of the Company's deferred tax assets are as follows: Accrued vacation Allowance Property Accrued and Tax loss for and severance recreation carry- doubtful Issuance equipment Inventories pay pay forward accounts expenses Total US$ '000 US$ '000 US$ '000 US$ '000 US$ '000 US$ '000 US$ '000 US$ '000 Balance as of 1 Jan ,622 Amounts charged to statement of income (153) 104 (89) 37 - (30) (198) (329) Balance as of 31 Dec (99) ,293 Amounts charged to statement of income (96) (33) 53 (8) (134) 116 Balance as of 31 Dec (3) , ANNUAL REPORT 41

44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 17 TAXES ON INCOME (CONT.) B. THEORETICAL TAX: Year ended 31 December US$ '000 US$ '000 Profit before taxes on income, as reported 6,656 6,014 Provision at statutory rate per cent, per cent 2,263 1,864 Effect of benefits to approved enterprises (1,150) (1,663) Adjustment of the tax rates in the computation of deferred taxes (22) (24) Non-deductible expenses Increase in losses for which deferred taxes were not provided Difference between measurement basis, net (U.S.$ - CPI) *) 485 (859) Prior years tax Other (106) 352 1, *) The amount represents the difference resulting from the basis of measurement for income tax purposes in Israel calculated based on the New Israeli shekel linked to the Israeli Consumer Price Index) and the measurement currency of the Company (the U.S. dollars) for changes in the CPI, see Note 17(3). Per cent Effective tax rate C. TAXES ON INCOME CONSIST OF THE FOLLOWING: Year ended 31 December US$ '000 US$ '000 Current 1, Deferred 329 (116) Prior years taxes , D. LOSS CARRYFORWARDS: Certain subsidiaries have tax loss carryforwards in the amount of $ 15,720,000 (2005: 14,592,000) in respect of which deferred taxes in the amount of $ 3,769,000 (2005: 3,014,000) were not provided. E. In June 2004, an amendment to the Income Tax Ordinance (No. 140 and Temporary Provision), 2004 was passed by the "Knesset" (Israeli parliament) and on July 25, 2005, another law was passed, the amendment to the Income Tax Ordinance (No. 147) 2005, according to which the corporate tax rate is to be progressively reduced to the following tax rates: per cent, per cent, per cent, per cent, per cent, 2010 and thereafter - 25 per cent. 42 VISONIC