Eviation Aircraft (EVTNF) 20-F 2006 FY Annual report (foreign)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 20-F

(Mark One)

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

OR

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

For the fiscal year ended December 31, 2006

OR

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

OR

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: 0-29884

BVR SYSTEMS (1998) LTD.
(Exact name of Registrant as specified in its charter)

Not Applicable
(Translation of Registrant’s Name into English)

Israel
(Jurisdiction of incorporation or organization)

16 Hamelacha Street, Park Afek, Rosh Ha’ayin 48091, Israel
(Address of principal executive offices)

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

Title of each class	Name of each exchange on which registered
Ordinary shares, par value NIS 1.00 per share	OTC Bulletin Board

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: As of December 31, 2006, the issuer had 116,863,757 ordinary shares outstanding.

Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yeso Nox

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.

Yeso Nox

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 periods that the registrant was required to file such reports), and (2) has been subject to such reporting requirements for the past 90 days.

Yesx Noo

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 Filero Accelerated Filero Non-Accelerated Filerx

        Indicate by check mark which financial statement item the registrant has elected to follow.

Item 17x Item 18o

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).

Yeso Nox

TABLE OF CONTENTS

		Page
INTRODUCTION		ii
PART I		1
Item 1.	Identity of Directors, Senior Management and Advisers	1
Item 2.	Offer Statistics and Expected Timetable	1
Item 3.	Key Information	2
Item 4.	Information on the Company	14
Item 5.	Operating and Financial Review and Prospects	28
Item 6.	Directors, Senior Management and Employees	43
Item 7.	Major Shareholders and Related Party Transactions	54
Item 8.	Financial Information	58
Item 9.	Offer and Listing Details	59
Item 10.	Additional Information	60
Item 11.	Quantitative and Qualitative Disclosures about Market Risk	80
Item 12.	Description of Securities Other than Equity Securities	82
PART II		82
Item 13.	Defaults, Dividend Arrearages and Delinquencies	82
Item 14.	Material Modifications to the Rights of Security Holders and Use of Proceeds	82
Item 15.	Controls and Procedures	82
Item 16.	Reserved	83
Item 16A.	Audit Committee Financial Expert	83
Item 16B.	Code of Ethics	84
Item 16C.	Principal Accountant Fees and Services	84
Item 16D.	Exemptions from the Listing Standards for Audit Committees	85
Item 16E.	Purchases of Equity Securities by the Issuer and Affiliated Purchasers	85
PART III		85
Item 17.	Financial Statements	85
Item 18.	Financial statements	85
Item 19.	Exhibits	86
SIGNATURE		88
INDEX TO FINANCIAL STATEMENTS		F-1

INTRODUCTION

        B.V.R. Systems (1998) Ltd., (“BVR”) an Israeli company, was formed in January 1998 to receive all of the assets and liabilities of the defense-related business of BVR Technologies Ltd. in accordance with the terms of a reorganization plan. The reorganization plan was consummated, and BVR commenced operations as an independent company in October 1998, effective as of January 1, 1998. BVR is controlled by Chun Holdings LP.

        Except for the historical information contained herein, the statements contained in this annual report are forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to our business, financial condition and results of operations. Statements that use the terms “believe”, “anticipate”, “expect”, “plan”, “intend”, “estimate”, “anticipate”, “project” and similar expressions in the affirmative and the negative are intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on current assumptions, expectations, estimates and projections about our business and the markets in which we operate and are subject to risks and uncertainties. Actual events (including our results) could differ materially from those anticipated in these forward-looking statements as a result of various factors, including the risks discussed in “Item 3. Key Information – D. Risk Factors” and elsewhere in this annual report. Except as required by applicable law, including the securities laws of the United States, we do not undertake any obligation nor intend to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

        As used in this annual report, the terms “we”, “us”, “our”, “the Company” and “BVR” mean B.V.R. Systems (1998) Ltd., and our consolidated subsidiary, unless otherwise indicated.

        All references herein to “dollars” or “$” are to United States dollars, and all references to “Shekels” or “NIS” are to New Israeli Shekels.

        References in this annual report to Chun refer to our controlling shareholder, Chun Holdings LP.

        References in this annual report to fiscal 2003 refer to our fiscal year ended December 31, 2003, references to fiscal 2004 refer to our fiscal year ended December 31, 2004, references to fiscal 2005 refer to our fiscal year ended December 31, 2005 and references to fiscal 2006 refer to our fiscal year ended December 31, 2006.

        References in this annual report to the Companies Law refer to the Israel Companies Law, 5759-1999.

        “Ehud™” is a trademark jointly owned by Israel Aircraft Industries and us; and “Atas™” is our wholly-owned trademark. All other trademarks and trade names appearing in this annual report are owned by their respective holders.

ii

PART I

ITEM 1. Identity of Directors, Senior Management and Advisors

        Not applicable.

ITEM 2. Offer Statistics and Expected Timetable

        Not applicable.

1

ITEM 3. Key Information

A. Selected Consolidated Financial Data

        We derived the following selected consolidated financial data presented below for each of the years ended December 31, 2004, 2005 and 2006 from our Consolidated Financial Statements and related notes included in this annual report. The selected consolidated financial data for the years ended December 31, 2003 and 2002 have been derived from consolidated financial statements not included in this annual report. Our Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles in Israel, or Israel GAAP. Israel GAAP, as applicable to our financial statements, differs in certain significant respects from accounting principles generally accepted in the United States, or U.S. GAAP. See Note 21 to the Consolidated Financial Statements included in this annual report for a discussion of certain differences between Israel GAAP and U.S. GAAP.

        You should read the selected consolidated financial data together with the section entitled “Item 5. Operating and Financial Review and Prospects” and our Consolidated Financial Statements included elsewhere in this annual report. Please see Note 2 of our Consolidated Financial Statements for an explanation of the number of shares used in computing per share data.

	Year Ended December 31,
	2002			2003			2004			2005			2006
	(In thousands)
Statement of Operations Data:
Revenues	$	28,290		$	14,467		$	12,684		$	19,196		$	10,103
Cost of revenues:		23,715			13,625		(1)	10,291		(1)	*14,806			7,866
Gross profit		4,575			842			2,393			4,390			2,237
Operating expenses:
Research and development		1,554			693			294			614			615
Selling and marketing		2,363			1,778			1,139			1,356			1,430
General and administrative		4,577			4,016			1,822			2,117			2,155
Total operating expenses		8,494			6,487			3,255			4,087			4,200
Operating profit (loss)		(3,919	)		(5,645	)		(862	)		303			(1,963	)
Financing expenses, net		(855	)		(707	)		(496	)		(187	)		(185	)
Other Income (expenses), net		(140	)		55			192			(2	)		-
Profit (loss) before income taxes		(4,914	)		(6,297	)		(1,166	)		114			(2,148	)
Income tax expense		(878	)		(249	)	(1)	(59	)	(1)	-			(75	)
Net profit (loss)		(5,792	)		(6,546	)		(1,225	)		*114			(2,223	)
Basic and diluted profit (loss) per share		(0.54	)		(0.61	)		(0.01	)		0.00			(0.02	)
Weighted average number of ordinary shares used in   computing basic and diluted profit (loss) per share		10,660			10,661			106,342			95,528			112,361

* Restated pursuant to our compliance with Accounting Standard No. 24, “Share-Based Payments” as further described in this annual report in “Item 5. – Operating and Financial Review and Prospects – Critical Accounting Policies.”

⁽¹⁾ Reclassified

2

	Year Ended December 31,
	2002			2003			2004			2005		2006
	(In thousands)
Reconciliation to U.S. GAAP:
Net profit (loss)	$	(5,792	)	$	(6,546	)	$	(1,225	)	$	*114	$	(2,223	)
Reversal of restatement according to Standard No. 24		-			-			-			*7		-
Allocation of share expense issued to service providers
under the fair value based method		-			-			**(40)			**(14)		-
Compensation expense for all stock-based awards using the modified prospective method		-			-			-			-		(130	)
Profit (loss) under U.S. GAAP		(5,792	)		(6,546	)		(1,265	)		107		(2,353	)
Basic and diluted net profit (loss) per share under U.S. GAAP		(0.54	)		(0.61	)		(0.02	)		0.00		(0.02	)
Weighted average number of ordinary shares outstanding
(in thousands) used in basic profit (loss) per share
calculation according to U.S. GAAP		10,660			10,661			75,962			95,528		112,361
Weighted average number of ordinary shares outstanding   (in thousands) used in diluted profit (loss) per share   calculation according to U.S. GAAP		10,660			10,661			75,962			96,921		112,361

* Restated pursuant to our compliance with Accounting Standard No. 24, “Share-Based Payments” as further described in this annual report in “Item 5. –Operating and Financial Review and Prospects – Critical Accounting Policies.”

** Restated to correct the reconciliation to the U.S. GAAP in 2004 and 2005 in respect to service providers which should have been accounted as employees in fiscal years 2004 and 2005. The Company adopted APB No. 25 in the years 2004 and 2005 and therefore no compensation costs should have been recorded in respect to awards granted to service providers.

	As of December 31,
	2002			2003			2004		2005		2006
	(In thousands)
Consolidated Balance Sheet Data:
Israeli GAAP:
Cash and cash equivalents	$	860		$	1,627		$	2,664	$	3,057	$	3,421
Working capital (deficit)		(5,361	)		(11,593	)		2,749		4,042		3,487
Total assets		26,038			11,403			13,683		10,111		13,293
Short-term bank credit and loans		15,083			10,116			637		637		636
Share capital		2,529			2,529			21,247		21,306		25,861
Shareholders equity (deficit)	$	(3,630	)		(10,176	)		3,609		3,777		5,406
U.S. GAAP:
Total assets		27,647			12,372			14,791		11,244		14,604
Shareholders equity (deficit)	$	(3,608	)	$	(10,176	)	$	3,609	$	3,777	$	5,406

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B. Capitalization and Indebtedness

        Not applicable.

C. Reasons for the Offer and Use of Proceeds

        Not applicable.

D. Risk Factors

        Our business, operating results and financial condition could be seriously harmed due to any of the following risks. If we do not successfully address any of the risks described below, we could experience a material adverse effect on our business, results of operations and financial condition and our share price may decline. We cannot assure you that we will successfully address any of these risks.

Risks Related to our Business

We have reported operating and net losses in the past and may report operating and net losses in the future.

        We commenced operations in 1998. We reported a net loss of $2.2 million for the year ended December 31, 2006, a net profit of $114,000 for the year ended December 31, 2005, a net loss of $1.2 million for the year ended December 31, 2004 and a net loss of $6.5 million for the year ended December 31, 2003. We can offer no assurance that we will achieve profitable operations or that any profitable operations will be sustained. Future profitability will depend on our ability to develop new products, the degree of market acceptance of our existing and new products and the level of competition in the markets in which we operate.

Although we had positive shareholders’ equity and positive working capital since December 31, 2004, we may still need to raise additional funds which may not be available.

        As of December 31, 2006, our shareholders’ equity was $5.4 million, and we had positive working capital amounting to $ 3.5 million. We expect that our existing cash balance, together with our forecasted cash flows from operating activities for fiscal 2007, including orders forecasted in the budget approved by our Board of Directors, will be sufficient for meeting our present working capital and capital expenditure needs. If our operations do not generate cash to the extent currently anticipated or if any of the risk factors discussed in this annual report materialize, we may need to raise additional funds in the future for a number of uses, including:

— implementing further marketing and sales activities;

— hiring additional qualified personnel; and

— expanding research and development programs.

4

        We may not be able to obtain additional funds on acceptable terms or at all. If we cannot raise needed funds on acceptable terms, we may not be able to:

— maintain the level of our current operations;

— develop new products;

— enhance our existing products;

— remain current with evolving defense technologies;

— take advantage of future opportunities; or

— respond to competitive pressures or unanticipated requirements.

Because we receive large product orders from a relatively small number of customers, our sales and operating results are subject to substantial periodic variations. Our revenues and operating results for a specific quarter may not be indicative of our future performance, making it difficult for investors to evaluate our future prospects based on the results of any one quarter.

        Due to the nature of our customers and products, we receive relatively large orders for our products from a relatively small number of customers. Consequently, individual orders from individual customers can represent a substantial portion of our sales in any one period and significant orders by any customer during one period may not be followed by further orders from the same customer in subsequent periods. Our sales and operating results are subject to very substantial periodic variations. Because our quarterly performance is likely to vary significantly, the results of our operations for any quarter are not necessarily indicative of the results that we might achieve for any subsequent period and consequently, quarter-to-quarter comparisons of our operating results may not be meaningful.

We may not be able to convert our entire backlog into revenue.

        We sell the majority of our products through individual purchase orders. Many of our customers have the right to terminate orders by paying the cost of work in process plus a related profit factor. Customers may cancel orders due to the cancellation of a budget or for other reasons. As of December 31, 2006, purchase orders and contractual arrangements reached to approximately $22 million, compared with $12.7 million as of December 31, 2005. If we experience cancellations of pending contracts, terminations or reductions of contracts in progress, we may not be able to convert our entire backlog into revenue. Any reduction in backlog will adversely affect our business, financial condition, results of operations and cash flows.

5

The loss of any of our major customers would result in a loss of a significant amount of our revenues.

        Four of our customers, namely two customers located in Europe, one customer located in Israel and the government of an Asian Pacific country that awarded us several projects, accounted for 63% of our revenues in fiscal 2006. We cannot be certain that these and other customers will maintain the size of their respective purchase orders, or will not reschedule or cancel existing purchase orders. We expect that sales of our products to relatively few customers will account for a significant portion of our net revenues for the foreseeable future. Consequently, the cancellation of an order from any one customer may have a material adverse effect on our business, financial condition, results of operations and cash flows.

Because competition in the market for our products is intense, we may lose market share, and we may be unable to achieve or maintain profitability.

        We compete with numerous other contractors on the basis of product performance, price, reputation, technical and managerial capability, product maintenance cost and responsiveness to customers’ requirements. Our ability to successfully compete for and retain such new projects and customers is highly dependent on technical excellence, management proficiency, strategic alliances, cost-effective performance and the ability to recruit and retain key personnel.

        The continuing consolidation of the global defense industry, which has decreased the number, but increased the relative size and resources of our competitors, has resulted in intensified competition. Some of the competitors which are the top-tier contractors for competing products have substantially greater financial, marketing and other resources than ours. These contractors compete with us in some cases by offering more aggressive pricing and devoting greater resources to product marketing or development than we do. This competition may result in lower prices or reduced demand for our products and a corresponding reduction in our revenues that may impair our ability to achieve and maintain profitability.

We rely on contracts with governments and defense contractors’ entities that entail certain risks, all of which may adversely affect our operations.

        As is the case with many companies that derive a substantial portion of their revenues from government contracts for defense-related products, our business is subject to specific risks, which include changes in governmental appropriations and national defense policies and priorities, a change of government in the customer’s country, as well as political changes or alterations in the government’s policy regarding the issue of export and import permits to various countries and the policies of specific governments to favor local over foreign defense products suppliers. We may be negatively affected by one or more of these factors.

6

        Generally, our contracts with governments may be terminated or suspended by such governments as a result of factors which may not depend on us, including as a result of a decrease in the defense budget, a decline in the military expenditures of governments, the cancellation or a significant cutback of a large project in which we participate or as a result of situations such as a state of war,force majeure or other circumstances seriously disrupting the public safety, peace or good order of the customer’s country. Our contracts with non-governmental military contractors sometimes contain similar provisions. In cases in which we received advanced payments prior to incurring the cost of fulfilling such contracts, we realized a positive project cash flow. Particularly, in the last threeyears, we have received substantial advances under our contracts. In the event of an early termination of a contract, we may be required to return a portion of such advanced payment. Upon such early termination, we would, in most cases, be entitled to reimbursement for our incurred contract costs and to payment of a proportionate share of our fee or profit for the work actually performed. In order to reduce risks of financial exposure resulting from an early termination of a contract, we attempt to stagger funding for projects in accordance with the rate of performance and to ensure ourselves from that risk by providing for positive cash flow in the life cycle of the program. If, however, we are not entitled to all or a portion of such compensation our operations and cash flows would be adversely affected.

Our ability to export our products is subject to approvals by Israeli and United States governmental agencies.

        Our export of military goods and information is subject to approval of SIBAT, the Foreign Defense Assistance and Defense Export Organization of the Israel Ministry of Defense. To date, we have received all required approvals from SIBAT, but there can be no assurance that we will receive such approvals in the future or that the Israeli government will not impose additional requirements on our manufacturing or export activities, which may require us to incur additional substantial expenses or which may otherwise have a material adverse effect on our operations. SIBAT’s policy has generally been to encourage the export of military goods and knowledge; however, SIBAT generally does not permit sales to countries that are in a state of war or hostility with Israel and countries which may otherwise endanger the State of Israel.

        We purchase from manufacturers in the United States a portion of the commercial computers, a portion of the air combat maneuvering instrumentation pod’s hardware and other “off-the-shelf” products, such as navigation systems, which we incorporate into our products. The export of such components is subject to the approval of the United States Department of Commerce and/or the United States Department of Defense, which often restricts sales to certain countries. Following the events of September 11, 2001, we experienced delays in the receipt of such required approvals. For example, we experienced a delay in the delivery of several components of a system to a customer and incurred additional costs, as a result of the need to modify such components, because of a delay in the receipt of an export approval that has since been obtained. Further, there can be no assurance that we will receive such approvals in the future or that the United States Government will not impose additional requirements on our manufacturing or export activity, which might require us to incur substantial expenses, and/or find and contract with alternative suppliers in countries that do not impose similar export restrictions.

7

International political and economic uncertainty could have an adverse impact on our business and on our operating results.

        In fiscal 2006, 77% of our total revenues came from foreign customers. We estimate that a material portion of our revenues in 2007 will come from foreign customers. The international political and economic uncertainty and the ongoing war on terrorism may adversely impact our ability to maintain the level of our sales to our existing customers located abroad and to develop new business in these and other foreign countries.

We are exposed to general, global economic and market conditions.

        Our business is subject to the effects of general economic conditions globally, and, in particular, conditions in the market for simulation systems for military and civilian applications. Our sales efforts can be adversely affected as a result of unfavorable economic conditions. We may experience material adverse impacts on our business, operating results, and financial condition.

Our contracts have a fixed-price and payment thereunder is subject to timely accomplishment of milestones, which may subject us to unfavorable terms.

        The majority of our contracts are for a fixed-price, meaning they are not subject to adjustment for the costs incurred in the performance of the contract. Consequently, we assume the risk that increased or unexpected costs may reduce our profits or generate a loss. The risk can be particularly significant under a fixed-price contract involving research and development with respect to new technologies.

        The majority of our contracts with our customers provide that after we receive an advance payment at the commencement of a project, additional payments are payable upon progress or achievement of specific milestones. In a majority of the projects, in addition to the bank guarantees that are generally provided by us for the advance payments, we are required to provide performance guarantees in an amount equal to a specific percentage of the contract price.

        Most agreements with our customers impose penalties or reduce the amount payable to us in the event that the completion of a phase of a project is delayed. In addition, we are generally responsible for the delays and defaults of our subcontractors. To mitigate our risk, we attempt to impose liability on our subcontractors on a “back-to-back” basis when such subcontractor is in delay or default which, in turn, could expose us to liability pursuant to the main contract. However, we may not be able to obtain full recovery for such liabilities from such subcontractors.

8

        We may encounter significant reduction in profits or incur losses as a result of one or more of the above unfavorable terms.

We are controlled by Chun Holdings LP which, in the aggregate, beneficially owns approximately 54.03% of our outstanding Ordinary Shares. Therefore, Chun is able to elect the majority of our directors and exercise control over the outcome of matters requiring shareholder’s approval.

        As of March 31, 2007, Chun Holdings L.P., an Israeli limited partnership beneficially owned an aggregate of 58,142,608 of our ordinary shares and an immediately exercisable warrant to purchase an additional 10,864,444 of our ordinary shares (representing, assuming the exercise of such warrant and assuming no other exercise of our warrants and options, approximately 54.03% of our currently outstanding ordinary shares). As a result, Chun controls the outcome of various actions that require our shareholder approval. For example, Chun could elect most of our directors, delay or prevent a transaction in which shareholders might receive a premium over the prevailing market price for their shares and prevent changes in control or management.

Because we operate in international markets, we are subject to additional risks.

        We currently offer our products in a number of countries and a key component of our marketing strategy is to continue to expand in foreign markets. Our business is subject to risks which often characterize international markets, including:

— economic and political instability;

— import or export licensing requirements;

— difficulties in collecting accounts receivable;

— longer payment cycles;

— unexpected changes in regulatory requirements and tariffs;

— fluctuations in exchange rates;

— potentially adverse tax consequences; and

— potentially weak protection of intellectual property rights.

        These risks may impair our ability to generate revenues from our overseas sales efforts, which constitute the majority of our business.

9

Our profitability could suffer if third parties infringe upon our proprietary technology.

        Our profitability could suffer if third parties infringe upon our intellectual property rights or misappropriate our technologies and trademarks for their own businesses. To protect our rights to our intellectual property, we rely on a combination of patent, trademark and copyright laws, trade secret protection, confidentiality agreements and other contractual arrangements with our employees, some of our affiliates, strategic partners and others. We currently own five patents registered in the United States and three additional patents registered in several other countries, along with several registered and pending trademarks, filed in several countries. Several of these patents were also granted or applied for in Israel and/or in several countries in Europe and worldwide. The protective steps we have taken may be inadequate to deter misappropriation of our proprietary information. We may be unable to detect the unauthorized use of, or take appropriate steps to enforce, our intellectual property rights. Effective patent, trademark, copyright and trade secret protection may not be available in every country, especially in Asia Pacific, in which we offer, or intend to offer, our products. Any failure to adequately protect our intellectual property could devalue our proprietary content and impair our ability to compete effectively. Further, defending our intellectual property rights could result in the expenditure of significant financial and managerial resources.

Our products may infringe on the intellectual property rights of others.

        Third parties may assert against us infringement claims or claims that we have violated a patent or infringed a copyright, trademark or other proprietary right belonging to them. Any infringement claim, even if not meritorious, could result in the expenditure of significant financial and managerial resources.

Risks Relating to Our Location in Israel

Conditions in Israel affect our operations and may limit our ability to produce and sell our products.

        We are incorporated under Israeli law and our principal offices, research and development and manufacturing facilities are located in the State of Israel. Political, economic and military conditions in Israel directly affect our operations. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors, and the continued state of hostility, varying in degree and intensity, has led to security and economic problems for Israel. During the summer of 2006, Israel was engaged in an armed conflict with Hezbollah, a Lebanese Islamist Shiite militia group and political party. This conflict involved missile strikes against civilian targets in northern Israel, and negatively affected business conditions in Israel. In addition, Israel and companies doing business with Israel have, in the past, been the subject of an economic boycott. Although Israel has entered into various agreements with Egypt, Jordan and the Palestinian Authority, Israel has been and is subject to civil unrest and terrorist activity, with varying levels of severity, since September 2000. The election in early 2006 of representatives of the Hamas movement to a majority of seats in the Palestinian Legislative Council and the tension among the different Palestinian factions may create additional unrest and uncertainty. Any future armed conflicts or political instability in the region may negatively affect business conditions and adversely affect our results of operations. Parties with whom we do business have sometimes declined to travel to Israel during periods of heightened unrest or tension, forcing us to make alternative arrangements when necessary. In addition, the political and security situation in Israel may result in parties with whom we have agreements involving performance in Israel claiming that they are not obligated to perform their commitments under those agreements pursuant to force majeure provisions in the agreements. To date, we do not believe that the political and security situation has had a material adverse impact on our business but we cannot give any assurance that this will continue to be the case. However, if there were to be emergency conditions, some of our key employees may be called to active duty for extended periods of time and could adversely affect our operations. Any hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could also adversely affect our operations and could make it more difficult for us to raise capital.

10

        Our insurance does not cover losses that may occur as a result of events associated with the security situation in the Middle East. Although the Israeli government currently covers the reinstatement value of direct damages that are caused by terrorist attacks or acts of war, we cannot assure you that this government coverage will be maintained. Any losses or damages incurred by us could have a material adverse effect on our business. Any armed conflicts or political instability in the region would likely negatively affect business conditions and could harm our results of operations.

        Like all male adult citizens and permanent residents of Israel, our directors, officers and employees who are under the age of 45, unless exempt, are obligated to perform up to 36 days of military reserve duty annually. Additionally, all such residents are subject to being called to active duty at any time under emergency circumstances. Some of our officers and employees are currently obligated to perform annual reserve duty. No assessment can be made as to the full impact of such requirements on our workforce or business if conditions in Israel should change, and no prediction can be made as to the effect of any expansion or reduction of such military obligations on us. See “Item 4. Information on the Company – B. Business Overview– Conditions in Israel.”

Our operations may be affected by negative economic conditions in Israel.

        In recent years, Israel has experienced periods of recession in economic activity, resulting in low growth rates and growing unemployment. Our operations could be adversely affected if the economic conditions in Israel deteriorate. In addition, due to significant economic measures proposed by the Israeli government, there have been several general strikes and work stoppages in 2003 and 2004, affecting all banks, airports and ports, and threats of general strikes and work stoppages within key economic sectors of the Israeli economy have arisen during the first four months of 2007. These strikes have had an adverse effect on the Israeli economy and on business, including our ability to deliver products to our customers or to receive raw materials from our suppliers in a timely manner. From time to time, the Israeli trade unions threaten strikes or work-stoppages, which may, if carried out, have a material adverse effect on the Israeli economy and our business.

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If we are considered to be a passive foreign investment company, either presently or in the future, U.S. Holders will be subject to adverse U.S. tax consequences.

        We will be a passive foreign investment company, or PFIC, if 75% or more of our gross income in a taxable year, including our pro rata share of the gross income of any company, U.S. or foreign, in which we are considered to own, directly or indirectly, 25% or more of the shares by value, is passive income. Alternatively, we will be considered to be a PFIC if at least 50% of our assets in a taxable year, averaged over the year and ordinarily determined based on fair market value, including our pro rata share of the assets of any company in which we are considered to own, directly or indirectly, 25% or more of the shares by value, are held for the production of, or produce, passive income. If we were to be a PFIC, and a U.S. Holder does not make an election to treat us as a “qualified electing fund,” or QEF, or a “mark to market” election, “excess distributions” to a U.S. Holder, and any gain recognized by a U.S. Holder on a disposition or our ordinary shares, would be taxed in an unfavorable way. Among other consequences, our dividends would be taxed at the regular rates applicable to ordinary income, rather than the 15% maximum rate applicable to certain dividends received by an individual from a qualified foreign corporation. The tests for determining PFIC status are applied annually and it is difficult to make accurate predictions of future income and assets, which are relevant to the determination of PFIC status. In addition, under the applicable statutory and regulatory provisions, it is unclear whether we would be permitted to use a gross loss from sales (sales less cost of goods sold) to offset our passive income in the calculation of gross income. In light of the uncertainties described above, we have not obtained an opinion of counsel with respect to our PFIC status and no assurance can be given that we will not be a PFIC in any year. If we determine that we have become a PFIC, we will then notify our U.S. Holders and provide them with the information necessary to comply with the QEF rules. If the IRS determines that we are a PFIC for a year with respect to which we have determined that we were not a PFIC, however, it might be too late for a U.S. Holder to make a timely QEF election, unless the U.S. Holder qualifies under the applicable Treasury regulations to make a retroactive (late) election. U.S. Holders who hold ordinary shares during a period when we are a PFIC will be subject to the foregoing rules, even if we cease to be a PFIC in subsequent years, subject to exceptions for U.S. Holders who made a timely QEF or mark-to-market election.

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

        We have received grants and are entitled to tax benefits under Government of Israel programs. In order to maintain our eligibility for these programs and benefits, we must continue to meet specified conditions, including making specified investments in fixed assets and paying royalties with respect to grants received. In addition, some of these programs restrict our ability to manufacture particular products or transfer particular technology outside of Israel. If we fail to comply with these conditions in the future, the benefits received could be cancelled and we could be required to pay increased taxes. The Government of Israel has reduced the benefits available under these programs in recent years, and these programs and tax benefits may be discontinued or curtailed in the future. If the Government of Israel ends these programs and tax benefits, our business, financial condition and results of operations could be affected.

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Because a substantial portion of our revenues is generated in U.S. Dollars and a portion of our expenses is incurred in New Israeli Shekels, our results of operations may be seriously harmed if the rate of inflation in Israel exceeds the rate of devaluation of the New Israeli Shekel against the U.S. Dollar.

        We generate a substantial portion of our revenues in dollars, but we incur a portion of our expenses, principally salaries and related personnel expenses, in New Israeli Shekels, or NIS. As a result, we are exposed to the risk that the rate of inflation in Israel will exceed the rate of devaluation of the NIS in relation to the dollar or that the timing of this devaluation lags behind inflation in Israel. In 2006, the rate of inflation together with the appreciation of the dollar in relation to the NIS, reduced our dollar-linked results of operations. In case the rate of inflation in Israel will exceed the rate of devaluation of the NIS in relation to the dollar or that the timing of this devaluation lags behind inflation in Israel, our dollar-linked results of operations will be adversely affected.

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

        Provisions of Israeli corporate and tax law may have the effect of delaying, preventing or making more difficult a merger with, or other acquisition of, us. This could cause our ordinary shares to trade at prices below the price for which third parties might be willing to pay to gain control of us. Third parties who are otherwise willing to pay a premium over prevailing market prices to gain control of us may be unable or unwilling to do so because of these provisions of Israeli law. See “Management – Approval of Related Party Transactions under Israeli Law” for additional information about some anti-takeover effects of Israeli law.

It may be difficult to enforce a U.S. judgment against us, our officers and directors named in this annual report or to assert United States securities laws’ claims in Israel or serve process on our officers.

        We are incorporated in the State of Israel. All of our executive officers and directors named in this annual report are not residents of the United States, and a substantial portion of our assets and the assets of these persons are located outside the United States. Therefore, it may be difficult to enforce a judgment obtained in the United States based upon the civil liabilities provisions of the United States Federal securities laws against us or any of those persons or to effect service of process upon these persons in the United States. Additionally, it may be difficult to enforce civil liabilities under United States federal securities laws in original actions instituted in Israel.

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

        We are incorporated under Israeli law. The rights and responsibilities of the holders of our Ordinary Shares are governed by our 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 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. See “Item 10. Additional Information – B. Memorandum and Articles of Association.”

ITEM 4. Information on the Company

A. History and Development of the Company

        B.V.R. Systems (1998) Ltd., an Israeli company, was formed in January 1998 to receive all of the assets and liabilities of the defense-related business of BVR Technologies Ltd., or BVR-T, in accordance with the terms of a reorganization plan. The reorganization plan was consummated, and BVR commenced operations as an independent company in October 1998, effective as of January 1, 1998. Our principal executive offices and research and development facilities are located at 16 Hamelacha Street, Afek Industrial Park, Rosh Ha’ayin 48091, Israel, and our telephone number is 972-3-900-8000. Our manufacturing facilities are located in Ashdod, Israel. Our wholly-owned subsidiary, BVR-S Pacific PTE, which is incorporated under the laws of Singapore, is located in Singapore.

        In February 2006, we entered into a non-binding term sheet for the acquisition of all of the shares of the U.S.-based corporation Blue Ridge Simulation, Inc. (BRS). BRS is a privately-held supplier of high-performance radar simulators for the U.S. Department of Defense, commercial and international training applications. In consideration, BVR will pay up to five million dollars in the combined form of BVR’s shares and cash payments. The closing of this transaction is subject to our due diligence review of BRS, the execution of definitive transaction documents and the receipt of customary third-party and regulatory approvals. The Company has decided to halt the application process and the approval of the Committee on Foreign Investment in the United States which is required for the acquisition and the completion of the transaction.

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        In March 2006, H.S.N General Managers Holdings L.P. (or HSN), an Israeli limited partnership led by Mr. Nir Dor invested $3.6 million in our share capital in consideration for the issuance of 20,000,000 ordinary shares, representing approximately 17% of our issued share capital, at a price per share of $0.18. In connection with this investment, HSN was issued three separate warrants for the purchase of 6,000,000 of our ordinary shares per each warrant, with exercise prices of $0.36, $0.54 and $1.00, exercisable for a period of three years, with a mandatory exercise mechanism under certain conditions. As of the date of this annual report, none of these warrants have been exercised. Pursuant to this investment, Mr. Dor was appointed to serve as a member of our board of directors and shall be entitled to continue to serve on the board, either personally or to nominate a representative on his behalf for such time that the Israeli limited partnership holds at least nine percent of our outstanding share capital.

        Our web site iswww.bvrsystems.com. Information on our web site is not incorporated by reference in this annual report.

Capital Expenditures

        Since January 1, 2004, our capital expenditures amounted to approximately $0.9 million. The focus of our capital expenditure program primarily included investment in computers and electronic equipment.

B. Business Overview

BVR is engaged in the military training and simulation industry. According tothe international business consulting firm of Frost & Sullivan, the overall market size of our industry is estimated to be approximately $8 billion per year. The overall market can be divided into the following main segments: live and embedded training; virtual training (simulators); and constructive training. Each of these training methods can be further sub-divided into applications for air, ground and navalsystems.

General

        We are engaged in the development, manufacture, marketing and sale of sophisticated training and simulation systems for military applications. We are currently engaged in the following areas:

— Live and Embedded training systems:

— On-Board, Combat Training Systems such as the "Ehud(TM)"; Air Combat Maneuvering Instrumentation, or ACMI, Naval Combat Instrumentation System, or NCMI; and

— Embedded simulation systems such as Embedded Virtual Avionics or EVA, and In-Flight Electronic Warfare Simulation, or IFEWS.

— Virtual and Constructive Training systems, such as:

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— Flight simulators for fighter aircraft, helicopters, trainer aircraft, unmanned aerial vehicles;

— Armored & Gunnery Simulators and Infantry Simulators; and

— Naval Tactical Trainers, or NTT, and Action Speed Tactical Trainers, or ASTT

        Our products offer advanced, highly effective and cost-efficient solutions to operational and tactical training needs. Our products are based on a complete training philosophy, which enables our customers to reduce the amount of actual military equipment used in training while enhancing the quality of the training exercises, thereby significantly reducing the risks associated with actual operations and training in a live operational scenario. In addition, our diversified product offerings are aimed to improve the mission preparedness of armed forces by simulating their combat environment with realistic tactical scenarios, thereby allowing networked training between multiple forces to optimize the joint-force operations essential for modern battlespace.

Our Product Offerings

        We continuously design, develop and market new generation technologies for live, embedded, virtual and constructive training. The advances we made in the field reflect our vast experience, unique approach to technological innovation and our drive to singularly fulfill the needs of our global military customers.

Live and Embedded Training

        Our live and embedded training systems are designed to improve real-time management, monitoring, training, safety and debriefing for live training exercises and operations carried out by modern air, naval and ground forces. The on-board training product line includes the following systems:

Ehud™ ACMI

Air Combat Maneuvering Instrumentation

        The Ehud™ air combat maneuvering instrumentation, or ACMI, system is a complete on-board, autonomous training and safety suite. This system is designed to enhance the airborne training of an aircraft crew on a wide variety of missions.

        Ehud™ offers a unique combination of range-less, real-time and post-flight training and debriefing systems together with safety warnings and operational capabilities. The system is effective for air-to-air, air-to-ground and electronics warfare pilot training with an unlimited number of participants due to our patented datalink protocol which dynamically auto-adapts the data exchange rate according to the actual number of participants in the network.

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        The Ehud™ACMI system includes features such as mid-air and ground collision warning systems, which significantly enhance training safety. The Ehud™ ACMI system has been flying operationally since 1994 and has been delivered to many leading air forces around the world.

Naval Combat Instrumentation System

        Our naval combat maneuvering instrumentation, or NCMI, is a full-scale on-board training system. The system enables the conduct of both live field training sessions at sea and constructive war-gaming exercises ashore.

        The basic concept behind our NCMI is the deployment of a distributed embedded simulation system on-board an instrumented ship and a maritime patrol aircraft.

        Our NCMI system supports the debriefing, analysis, and evaluation of naval warfare exercises at all command levels.

        Our NCMI system supports various training levels ranging from operator’s training at console level, through sub-team and team training, and up to full fleet training. Our NCMI system provides training in tactical simulators and enhances the reality of seaborne exercises through the use of computer generated forces integrated with live exercises. Typically, the exercise is coordinated between the participants via a datalink system, which supports the creation of a distributed simulation network.

Embedded Simulation

        We are currently marketing a wide range of embedded simulation solutions. These advanced solutions are an outcome of the synergies gained from the combination of on-board training and simulation technologies. With vast experience in these two fields, we believe that we are well positioned to play a leading role in this evolving market.

Embedded Virtual Avionics Suite, or EVA

        Our Embedded Virtual Avionics Suite, or EVA, is a state-of-the-art embedded simulation suite, installed on basic or advanced trainer aircraft, transforms training aircraft into virtual advanced fighter aircraft. A training aircraft equipped with EVA may offer capabilities such as virtual sensors and weapons, in-flight live or virtual target threats, operational scenarios of gradually increasing complexity, full debriefing capabilities and flight safety features. Our proprietary EVA technology is based on a patent owned by us and registered in numerous countries, including the United States and several European countries.

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        An EVA standard training aircraft is equipped or refitted to replicate the cockpit and avionics instrumentation panel of specifically targeted advanced fighters. The refitted trainers will resemble the behavior, displays and controls of the advanced fighter sensors (such as air-to air radar, air to ground radar and radar warnings receiver, which is part of the electronic warfare suite of most advanced fighters and seekers) and weapon systems. Pilots flying the EVA-fitted trainer benefit from a real-time feel and capabilities of the simulated advanced fighter aircraft. The system offers features such as collision avoidance and hazard warning.

In 2006, we received two orders for the integration of EVA within the avionics suite of two trainer aircrafts.

In addition, in December 2006 we signed a license agreement with a European aircraft manufacturer that entitles BVR to receive royalties for each aircraft which includes embedded simulation sold by this licensee.

In-Flight Electronic Warfare Simulation, or IFEWS

        Our in-flight electronic warfare simulator, or IFEWS™, is a complete, autonomous, on-board threat-environment training and safety suite. The system is an embedded simulator for the training and debriefing of electronic warfare, or EW, scenarios, simulating the real EW systems in an aircraft. IFEWS™ provides a virtual EW range and includes our post-flight debriefing capabilities.

        Our IFEWS™ generates a wide range of on-board simulation of virtual ground and airborne threats. The virtual range, created and managed by the IFEWS™ computer, authentically simulates the characteristics, behavior and interactions of both the threatening weapon systems and the aircraft’s self protection suite. Our system is tightly coupled to the aircraft’s existing EW suite. IFEWS™ simulates all relevant modes of weapon system, including optical tracking modes and other modes not received by the airborne EW suite.

        After landing, our PC-based ground station provides advanced After-Action Review and debriefing with a 3D analysis of crew performance, all weapon engagements, safety events and mission scenarios.

        Based on the legacy of the Ehud™ ACMI systems, IFEWS™ provides multiple features including real-time training, realistic virtual threats, safety elements and debriefing capabilities.

        In the first quarter of 2002, we completed preliminary flight tests with the Israel Air Force, and we conducted further demonstration flight tests with the Israel Air Force during the remainder of 2002.

        In 2005, we received a follow on order from the Israel Air Force for the installation of IFEWS systems on its CH-53 and C-130 Fleets.

        In 2006, we received an order from a European NATO country for the installation of IFEWS on part of its helicopters fleets.

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        For additional information with respect to these purchase orders, see “Item 10. Additional Information – C. Material Contracts.”

Virtual and Constructive Training

        We provide flight, naval and ground forces simulators for various platforms, electronics and weapon systems. Our line of simulators covers a full range of training scale, from basic procedural training to combat mission training and full mission training. Our simulators support the high level architecture world-wide standard for simulators connectivity delivering the capacity to perform sophisticated distributed mission training by communicating and training with other simulators and training devices. Our product offerings include:

— Flight Simulators;

— Ground Forces Simulators;

— Naval Simulators; and

— Weapon and Electronic Systems Simulators

Flight Simulators

        Fighter Aircraft Simulators.We have developed and manufactured fighter aircraft simulators for numerous aircrafts, including the F-16C, F-16D, F-15, F-5, A-4 and Mirage-2000.

        Full Mission Simulators.Our full mission simulators provide training for all aspects of a mission’s flight and procedures, including sophisticated weapon system simulations, sensors and full standard and emergency procedure training. These simulators encompass a high-fidelity cockpit replica and a large variety of visual systems covering a field of view of up to 360°. 

        We use high-end computers and personal computers, or PCs, as image generators to provide the trainee with a high-resolution, fully-textured outside world visual presentation, based on satellite imagery and three dimensional targets and shapes.

        Our full mission simulators provide pilots with complex tactical training, using multiple computer generated forces, such as air, land, or sea participants.

        Trainer Aircraft Simulators.We developed and manufactured trainer aircraft simulators for numerous aircraft, including the PC-7, MB-339 MLU, MB339 C/D and Fouga Magister.

        AMOS – Cadet Screening Simulator.Our AMOS cadet screening and basic flight training simulator has been developed for the Israel Air Force Fouga Magister trainer.

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        Our system provides a methodology for the analysis of cadets’ learning abilities, through screening while training.

Helicopter Full Mission Simulator.

        We developed and manufactured helicopter simulators for helicopters, including the AS-550.

        Our full mission simulators for helicopters are offered for assault and fully armed attack helicopter simulation. The simulators are offered in a number of configurations, from a limited front view outside world imagery to a full dome display. The full dome display configuration includes a full-size cockpit replica for two pilots with a three channel high-resolution full color outside world display. The resulting imagery fidelity level enables the system to perform low flying missions and weapon deployment simulation. The system is capable of simulating typical helicopter flights and attacks, including a full range of malfunctions and emergency procedures. Our simulators also provide for tactical training as the trainee can fly against user pre-programmed computer generated forces.

Unmanned Air Vehicle Mission Simulators

        We developed and manufactured an unmanned air vehicle, or UAV, and tactical mission simulators for tactical UAV, for both the external pilot and the internal mission crew.

        Our UAV mission simulator supports training on near-to-real-life quality imaging systems for the entire crew. Training can be executed both individually and as a team.

Armor and Gunnery Simulation Systems for Ground Forces

        Integrated Tactics and Armor Combat Trainer. Our integrated tactics armor and weapon system vehicle combat trainer, or INTACT system, fulfills the need for effective training, debriefing and evaluation of army units. Our INTACT system was developed by experienced army officers. INTACT is a multi-station armor and weapon vehicle tactical simulator system. Our INTACT system provides training that ranges from individual level to combat team multi-participant tactical exercises.

        Our INTACT system provides training levels from individual precision gunnery to combat team multi-participant exercises and beyond. The training can include unlimited combinations of manned and computer generated forces. The INTACT system fills the need for effective training, debriefing and evaluation of ground forces. Our INTACT system simulates virtual forces and integrates their actions with real forces, adding value to performance and cost-effective training.

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Naval Simulators

        We developed a diversified product line of naval simulators based on dedicated replica workstations and sophisticated visual images provide system training for operators and officers. We specialize in quick responses to requests for unique tailor-made systems from a wide range of naval customers.

Naval Tactical Trainer

        Our naval tactical trainer, or NTT, is a complete tactical training system providing a solution for all shore-based tactical training needs. Our NTT is in operational use by the Israel Navy at its main training base. Our NTT is used for the tactical training of principal war officers and combat information center officers. In several regions of the world, this product is also referred to as the Action Speed Tactical Trainer or ASTT.

        Our weapon and avionic systems simulators provide a unique training device for the training of operators in highly specialized operational tasks. Products delivered to our customers include the LANTIRN simulator used to train pilots to fly with the LANTIRN pod, and our weapon systems trainer used to train the weapon systems officer in the many tasks required to operate and successfully deliver today’s complex weapon to the designated target.

Raw Materials

        The raw materials used for our on-board training systems and our embedded simulation systems include our own software and commercial off-the-shelf, or COTS, hardware that we purchase from various suppliers. This COTS hardware includes computer boards, navigational systems, communication systems and antennae. Due to the competitive nature of the market for these COTS raw materials, the prices for such raw materials are not considered volatile. In some countries, however, such raw materials are controlled items and thus, prior to export, require the issuance of an export license.

        The following table sets forth, for the period indicated, our consolidated revenues by product line expressed as a percentage of total revenues.

	2002			2003			2004			2005			2006
Live and Embedded Training Systems		48	%		46	%		45	%		64	%		56	%
Virtual and constructive Simulators		52	%		54	%		55	%		36	%		44	%
Total		100	%		100	%		100	%		100	%		100	%

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Strategic Relationships

Israel Aircraft Industries Ltd

        From 1992 to 1997, we developed, manufactured and marketed the Ehud™ ACMI systems pursuant to a joint venture agreement entered into in 1992 with MLM Systems Engineering & Integration, or MLM, a division of Israel Aircraft Industries Ltd., or IAI.Pursuant to this agreement, IAI and us agreed to jointly develop, manufacture and market the Ehud™ ACMI systems, with IAI subcontracting some of the manufacturing and integration work with respect to the Ehud™ product. Following the expiration of the term of the agreement, various claims were alleged by both IAI and us regarding the performance of mutual obligations pursuant to the agreement and thereafter. In an ex parte proceeding filed by IAI, the District Court of Tel Aviv issued in February 1999 a temporary injunction preventing us from replacing IAI as our subcontractor in a project for the German Air Force.

        In August 1999, we entered into a cooperation agreement with MLM, which brought an end to these legal proceedings and established terms for cooperation between the two companies with respect to the marketing of the Ehud™ ACMI systems; and in August 2005, we entered into an additional cooperation agreement with MLM to resolve all other outstanding disagreements that had remained prior to the signing of this agreement.

        The cooperation agreement of 2005 relates to cooperation with respect to the worldwide marketing and sale of the Ehud System, R/C and LDN systems, the NCMI System and Electronic Warfare Training Ranges.

        Ehud^TM System.The agreement provides for specific territories in which either we or MLM shall have the exclusive right to act as the leading party and the other party shall not compete with the leading party in such territories. The leading party shall pay royalties to the other party at a rate of 5% of the total consideration it receives for Ehud^TM System projects in such territories. In other territories the parties have agreed to a cooperation arrangement pursuant to which one party shall act as the prime contractor and the other shall act as subcontractor, and each party shall provide its own proposal relating to its part of the project. Any difference in price above the joint proposal shall be equally shared between the parties. The royalties arrangement shall apply in territories not specifically mentioned and agreed upon between the parties.

        R/C and LDN.In the event of agreements in connection with our R/C system or MLM’s LDN system to a specific customer, the relevant party shall pay the other party royalties at the rate of 5% of the total consideration. The parties have agreed not to compete with each other with the R/C system and the LDN system in respect of such customer.

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        NCMI System. We have agreed to provide MLM, within a reasonable time after the execution of the agreement, with our existing NCMI infrastructure as a technological base in order to enable MLM to continue the development of the NCMI system, in consideration for royalties at the rate of 4% of the consideration of any agreement entered into between MLM and a customer in respect of a NCMI system. We have also granted MLM a non transferable license, for the term of the agreement for use of our NCMI infrastructure in certain territories we will provide up to 30% of the scope of work in such projects. In other territories we have agreed on a cooperation arrangement in which the prime contractor shall receive 70% of the consideration and the subcontractor 30% of the consideration and in the event the subcontractor is granted less than 30% it is compensated at a rate of 1% of the total consideration for each 4% of the total consideration not subcontracted to the other party.

        Electronic Warfare Training Range. It was agreed that in agreements for the supply of Electronic Warfare Training Ranges in specific agreed territories MLM shall serve as the prime contractor and shall enter into a subcontracting agreement with us providing us 30% of the scope of work.

        The cooperation agreement is valid for ten years and replaced all prior agreements between the parties relating to its subject matters.

Other Strategic Agreements

        In 2006, we entered into a settlement agreement with a European aircraft company pursuant to claims made by us of potential patent infringements by the aircraft company. Under the settlement agreement, we waived all claims against the aircraft company and granted it a non-exclusive license to certain of our patents in exchange for royalty payments. The aircraft company shall pay us an agreed royalty payment for each aircraft sold which includes embedded simulation by it or any of its affiliates that use any of the licensed patents.

Marketing

        We actively seek to identify and propose solutions for military training and simulation needs of the current and prospective customers. Our research and development activities focus on systems designed to meet specific needs we identified. We market our products, either as a prime contractor or as a subcontractor, to various governments and defense contractors throughout the world directly and through joint ventures, agents or representatives. We have entered into cooperation agreements with a number of defense contractors, which provide for joint participation in pursuit and performance of contracts in certain countries.

        In June 1998, we formed a subsidiary in Singapore, BVR-S Pacific PTE, through which we support our operations in Singapore.

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        The following table sets forth the amount of our revenues, for the periods indicated, by geographic regions:

	Year Ended December 31,
	2002		2003		2004		2005		2006
	(U.S. Dollars in thousands)
Sales
Israel	$	406	$	1,181	$	824	$	1,068	$	2,284
Asia Pacific		19,462		10,391		4,596		6,274		2,120
Europe		7,846		2,041		2,710		8,358		4,557
America		-		854		4,554		3,099		1,142
Africa		576		-		-		397		-
Total	$	28,290	$	14,467	$	12,684	$	19,196	$	10,103

Customers

        Currently, all of the end-user customers of our products are governments or companies that are regulated by government laws and regulations with respect to their military businesses.

        Although the composition of our customers has changed from year to year, and revenues from individual customers are subject to material increases and decreases depending on customer requirements, a customer located in Europe accounted for approximately 18% of our revenues in fiscal 2006, 5% of our revenues in 2005, 8% in 2004 and represented 1% of our backlog as of December 31, 2006. A customer located in Israel accounted for approximately 17% of our revenues in fiscal 2006, 2% of our revenues in 2005, 0% in 2004 and represented 1% of our backlog as of December 31, 2006. Another customer located in Europe accounted for approximately 16% of our revenues in fiscal 2006, 2% of our revenues in 2005, 3% in 2004 and represented 14% of our backlog as of December 31, 2006. One of our customers located in Asia Pacific accounted for approximately 12% of our revenues in fiscal 2006, 15% in fiscal 2005, 27% of our revenues in fiscal 2004, and represented approximately 51% of our backlog as of December 31, 2006. Another customer located in Europe accounted for approximately 0% of our revenues in fiscal 2006, 31% in 2005 and 2% of our revenues in 2004 and represented 0% of our backlog as of December 31, 2006. A customer located in Latin America accounted for approximately 5% of our revenues in fiscal 2006, 11% in 2005 and 34% of our revenues in 2004, and represented approximately 0% of our backlog as of December 31, 2006. Another customer located in Asia Pacific accounted for approximately 2% of our revenues in fiscal 2006, 14% in 2005 and 0% of our revenues in fiscal 2004 and also represented approximately 5% of our backlog as of December 31, 2006. We expect that sales of our products to a small number of customers will continue to account for a substantial percentage of our net revenue in the foreseeable future.

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General Financial Considerations for Projects

        A significant majority of our contracts are fixed-price contracts, as opposed to cost-plus-type contracts. Under fixed-price contracts, the price is generally not subject to adjustment for costs actually incurred in the performance of such contract. Under such fixed-price contracts, we assume the risk that increased or unexpected costs may reduce our profits or generate a loss.

        There are various types of financing terms applicable to defense contracts. In most cases, after we receive advance payment at the commencement of a project, we receive progress or milestone payments according to a percentage of cost incurred in performance or achievement of a specific milestone. In these projects we are required to provide a bank guarantee in an amount equal to the payments. In a majority of projects, we are required to provide performance guarantees in an amount equal to a specific percentage of the contract price. A portion of our agreements with customers contains clauses that impose penalties or reduce the amount payable to us in the event that the completion of a phase of work is delayed. We are generally responsible for the delays and defaults of our subcontractors. Accordingly, we attempt to impose liability on our subcontractors on a “back-to-back” basis when delay or default under a contract could expose us to liability.

        Our contracts with governments generally may be terminated or suspended as a result of factors which may not depend on us, such as a state of war, force majeure or other circumstances seriously disrupting the public safety, peace or good order of the customer’s country. Our contracts with non-governmental military contractors sometimes contain similar provisions. In cases in which we receive advanced payments prior to incurring the cost of fulfilling the contract, we realize a positive project cash flow. In the last three years, we received substantial advances from our customers under a portion of our contracts. In the event that a contract under which an advance or progress payment has been paid is cancelled, we may be required to return a portion of such payments to the customer. In general, in order to reduce risks of financial exposure resulting from an early termination of a contract, we attempt to expend funds for projects in accordance with the rate of performance. Upon such termination, we would, in most cases, be entitled to reimbursement for incurred contract costs and to payment of a proportionate share of our fee or profit for the portion of such contract that was actually performed. If, however, we are not entitled to all or a portion of such compensation, our operations would be adversely effected. In certain cases, when possible, we insure ourselves against such risks.

Manufacturing and Suppliers

        We develop the majority of the software and hardware for our products at research and development facilities in two locations in Israel. We manufacture cockpit replicas, turret replicas and other hardware components and perform hardware integration, systems assembly, and quality assurance testing at our manufacturing facilities in Ashdod, Israel. We purchase components for the systems manufactured, including commercial computers, integrated circuits, circuit boards, sheet metal fabricated into subassemblies and cabinets, power supplies, television monitors and floppy disc drives. Many of the purchased components are manufactured based on our designs and specifications. Most materials and purchased components are generally available from a number of different sources.

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Competition

        We operate in a competitive environment with respect to most of our products. The defense industry has been characterized in recent years by a consolidation of companies, which has decreased the number, but increased the relative size and resources of competitors. Competition is based on price, product performance, reputation, reliability, maintenance costs and responsiveness to customer requirements, including the ability to respond to changing technology. Some of the companies with which we compete, such as divisions of Thales, Lockheed-Martin, L-3 Communications, Cubic, IAI (in some countries), Elbit Systems and CAE, have substantially greater financial, marketing and other resources than ours and have the ability to develop and market products competitive with ours. We believe that our products favorably compete with those of our competitors based on their technological capabilities, price/performance ratio, proven track record and common technological platform. We also believe that our competitive advantage is in our relatively small size that enables us to be more flexible and responsive to customer requirements than our larger competitors. In addition, we assume that we typically have lower overhead costs than our larger competitors.

Research and Development

        The majority of our research and development activity is performed as an inherent part of our various projects. In addition, we believe that continued and timely development of new products and enhancements to existing products is necessary to compete effectively. Accordingly, through our ongoing and extensive research, development and engineering activities, we devote a portion of our resources to: (i) sustaining and upgrading our existing products by improving serviceability and adding new capabilities and features, (ii) decreasing the cost of owning and operating such products, (iii) maintaining close relationships with our customers to identify their product needs, (iv) developing new products with improved capabilities to address such needs and other military training, debriefing and communications needs identified by us, (v) adapting our products to new evolving technologies that can lower the costs of our products; and (vi) tailoring our products to meet the specific needs of our customers.

        Our internally financed expenditures for all research and development programs during fiscal 2006, 2005 and 2004 totaled approximately $0.6 million, $0.6 million and $0.3 million, respectively, and represented 6%, 3% and 2% of our revenue, respectively. Royalty-bearing grants received in the past from the Office of the Israeli Chief Scientist, or OCS, for research and development were offset against our research and development costs. In fiscal 2006, 2005 and 2004, we did not receive any grants from the OCS. We expect that we will continue to commit resources to research and development in the future

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Intellectual Property

        In order to protect our proprietary rights and technology used in our products, we rely primarily upon a combination of patents, trademarks and copyrights as well as on unpatented proprietary know-how, trade secrets, and various confidentiality and other agreements with employees, consultants and others, to protect our trade secrets and know-how. These methods, however, may not afford complete protection and we cannot be sure that others will not independently develop products including our trade secrets and know-how or obtain access thereto.

        BVR has five United States patents relating to the collision warning and the data link features incorporated in our Ehud™ systems, the animation technology incorporated in our simulators and our airborne avionics simulator technology. Several of these patents were also granted or applied for in Israel and/or in specific countries in the European Community and worldwide.

        Our trademark “Atas,” was registered in Israel, Europe and Turkey. Our trademark “Ehud™,” jointly-owned with IAI, was recently registered in several Asian–Pacific countries, and we have applied for its registration in Israel, the European Community and several other foreign countries.

        As part of our cooperation agreement with IAI, IAI and us have each granted the other party a license to use all patents and other intellectual property rights owned by the other party relating to the Ehud™ ACMI system, as is required to enable such party to exercise its rights under the cooperation agreement. We further agreed to jointly own with IAI the trade name “Ehud.” See “Item 4 – Information on the Company – B. Business Overview – Strategic Relationship.”

C. Organizational Structure

        We are controlled by Chun Holdings L.P., which, assuming the exercise of its warrants to purchase 10,864,444 ordinary shares and assuming no other exercise of our convertible securities, beneficially owns 54.03% of our currently outstanding ordinary shares.

        We hold 100% of the issued and outstanding share capital of BVR-S Pacific PTE, which is incorporated under the laws of Singapore.

D. Property, Plant and Equipment

        Our executive offices and research and development facilities are located in Rosh Ha’ayin, Israel. At this location, in 2006, we leased approximately 2,539 square meters of office space at a monthly rent of approximately $23,000. This lease will expire on September 14, 2009. See also Note 16B to our Consolidated Financial Statements.

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        We lease approximately 875 square meters of manufacturing facilities in Ashdod, Israel for a monthly rent of approximately $11,000. This lease will expire on October 31, 2007.

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

ITEM 5. Operating and Financial Review and Prospects

        The following discussion of our financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and the related notes 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. Key Information– D. Risk Factors.”

General

        We are engaged in the development, manufacture and marketing of sophisticated training and computer-based simulation systems for military applications.

        Most of our revenues are generated in U.S. Dollars, and a significant proportion of our expenses is incurred in U.S. Dollars, or is linked to the U.S. Dollar. Consequently, we use the U.S. Dollar as our functional currency. Transactions and balances originally denominated in U.S. Dollars are presented in the financial statements in their original amounts, and non-dollar transactions and balances have been translated into U.S. Dollars using the exchange rates in effect on the date of a transaction or balance. Our Consolidated Financial Statements have been prepared in accordance with Israel GAAP. Israel GAAP, as applicable to our financial statements, differs in certain significant respects from U.S. GAAP. See Note 21 to our Consolidated Financial Statements.

        We derive a substantial portion of our revenues from government contracts, the majority of which are fixed-price, as opposed to cost-plus type contracts. Under fixed-price contracts, the price is generally not subject to adjustment for costs actually incurred in the performance of the contract.

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        In most of our projects, we receive advance payment at the commencement of the project and progress or milestone payments according to our performance or achievement of specific milestones. In these cases, the advance payments that we receive prior to incurring the cost of fulfilling the contract create a positive project cash flow. In the last three years, we have received substantial advances from our customers under a portion of our contracts. Our contracts generally may be terminated or suspended as a result of factors which may not depend on us, such as a state of war,force majeure, or other circumstances seriously disrupting the public safety, peace or good order of the customer’s country. In the event that a contract under which an advance or progress payment has been paid is canceled, we may be required to return such payments or portion of them to the customer.

        We generally attempt to extend funds for projects in accordance with the rate of performance in order to reduce risks of financial exposure resulting from an early termination of a contract. Upon such termination, we would, in most cases, be entitled to reimbursement for our incurred contract costs and to payment of a proportionate share of our fee or profit for the work actually performed.

        Revenues related to work in progress under long-term contracts are recognized according to the percentage-of-completion method. The percentage of completion method is computed-based on the project’s total execution costs which reflect the progress of its completion, and which include: salaries, material costs and subcontractor charges. Revenues ascribed to each period are the amounts of gross profits earned on such contracts during such period plus the costs incurred during such period, excluding cost of materials that have not yet been used and costs incurred for subcontracted work that is still to be performed).

        With respect to the sale of products acquired from third parties as shelf products and where the cost of adaptation thereof for a customer’s specific needs is not material, the related revenue is recognized after completion and delivery. Provision 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. Royalty revenues are generally recorded on a cash basis.

Critical Accounting Policies

        The preparation of our financial statements, in conformity with Israeli 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 amount of revenues and expenses during the reporting period. These are our management’s best estimates based on experience and historical data. Actual results could differ from those estimates.

        Certain specific accounting policies we utilize require higher degrees of judgment than others in their application. These include going concern, revenue recognition on long-term contract work and income taxes. In addition, Note 2 to our Consolidated Financial Statements includes a further discussion of our significant accounting policies.

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Stock-Based compensation

        As of January 1, 2006, our financial statements comply with Accounting Standard No. 24, “Share-Based Payments” which requires our share-based payment transactions, including transactions with employees or other parties that are to be settled by equity instruments, cash or other assets, to be recognized in our financial statements. Standard No. 24 requires the restatement of comparative data relating to periods after March 15, 2005. As of December 31, 2005, the charge for equity-settled share-based payments in the consolidated income statement is approximately $7,000.

Going Concern

        The application of the going concern basis of accounting involves a range of subjective judgments, principally in relation to the sufficiency of our resources to allow us to continue to operate in the ordinary course and thereby realize our assets and discharge our liabilities in the normal course of business for a period of 12 months following the approval date of the consolidated financial statements. These resources are derived from working capital, cash flow, volume of orders obtained, backlog of orders, existing cash balances together with meeting forecasted cash flows from operating activities, as well as obtaining orders forecasted in the budget.

Revenue Recognition

        We account for our revenues on fixed price long-term contract work on the percentage of completion method. This method of accounting requires us to calculate project profit to be recognized in each reporting period for each project based upon our predictions of future outcomes which include estimates of the total cost to complete (such as assumptions relative to future labor performance and costs, materials costs and subcontractor charges) and estimates of project schedule and completion date.

        At the onset of each contract, we prepare a detailed analysis of our estimated cost to complete the project. Our project personnel evaluate the estimated costs at the project level. Significant projects are reviewed in detail by senior management on a quarterly basis.

        Our estimates of revenues and expenses on long-term contracts could change periodically in the normal course of business. Such changes would be reflected in results of operations as a change in accounting estimate in the period the revisions are determined. For all the contracts, provisions for estimated losses on uncompleted individual contracts are made in the period in which such losses are first determined, in the amount of the estimated loss on the entire contract.

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Income Taxes

        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 requires us to estimate our actual current tax exposure and make an assessment of 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, to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent that we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations. Significant management judgment is required in determining our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have a valuation allowance of $12 million as of December 31, 2006, which is equal to the value of the deferred tax asset consisting primarily of our net operating loss carry forwards. This indicates our management’s current assessment that because we are yet to generate taxable income, we cannot determine whether it is likely that we will be able to use this asset in the future. In the event that we generate taxable income in a particular jurisdiction in which we operate and in which we have net operating loss carry-forwards, we may be required to adjust our valuation allowance.

A. Results of Operations

        The table below sets forth, for the periods indicated, financial data, expressed as a percentage of total revenues that we believe to be significant in analyzing our results of operations. The data is as follows:

	For Years Ended December 31,
	2002			2003			2004			2005			2006
Revenues		100	%		100	%		100	%		100	%		100	%
Cost of revenues		84	%		94	%		81	%		77	%		78	%
Gross profit (loss)		16	%		6	%		19	%		23	%		22	%
Research and development		5	%		5	%		2	%		3	%		6	%
Selling, general and administrative   expenses		25	%		40	%		23	%		18	%		35	%
Operating profit (loss)		(14	)%		(39	)%		(6	)%		2	%		(19	)%
Financing expenses, net		3	%		5	%		4	%		1	%		2	%
Other income (expenses), net		-			-			2	%		-			-
Profit (loss) before income taxes		(17	)%		(43	)%		(10	)%		1	%		(21	)%
Income tax (expenses) benefits		(3	)%		(2	)%		-			-			(1	)%
Net Profit (loss)		(20	)%		(45	)%		(10	)%		1	%		(22	)%

Our order backlog as of December 31, 2006 was $22 million.

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Subsequent Events

— There are no substantial events subsequent to December 31, 2006.

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

Revenues.

        Revenues in fiscal 2006 were $10.1 million, a decrease of 47% compared to revenues of $19.2 million in fiscal 2005. The decrease was primarily attributed to the completion of several significant projects in 2005, particularly to the progress achieved during 2005 in one significant project in Europe, which contributed $6.0 million to the revenues of fiscal 2005. In addition, according to the agreement signed with IAI on August 2005, we have received royalties from IAI amounting to $1.7 million during 2005. Revenues from sales of our live and embedded training systems products in fiscal 2006 accounted for 56%, compared to 64% of our revenues in fiscal 2005. Revenues derived from our virtual and constructive simulator products accounted for 44% of our revenues in fiscal 2006, compared to 36% of our revenues in fiscal 2005. The geographical breakdown of our revenues in fiscal 2006 was as follows: approximately 45% of our revenues were in Europe, 23% in Israel, 21% in Far East and 11% in America. In fiscal 2005, approximately 43% of our revenues were in Europe, 33% in Far East, 16% in America, 6% in Israel and 2% in Africa. The fluctuations in the proportion of our revenues attributed to geographic areas are the result of the completion of several contracts, which we had with various countries. Our agreements are multi-year contracts, and we generally recognize revenues on the percentage of completion method, recognizing expenses when incurred.

        In fiscal 2005, income from royalties and commissions was $1.7 million pursuant to the cooperation agreement with MLM signed in August 2005 which resolved past disagreements. During 2006, we recognized income from royalties in the amount of $276,000.

Gross Profit (Loss).

        Gross profit in fiscal 2006 was approximately $2.2 million, a decrease of $2.2 million from a gross profit of $4.4 million in fiscal 2005. The decrease in gross profit was primarily due to royalties revenues from IAI amounting to $1.7 million in 2005, together with a $0.8 million decrease in cost of revenue in 2005 as result of a reversal of certain previously accrued liabilities that are no longer payable as a result of the new agreement signed with IAI in 2005. Royalties from IAI in 2006 were $0.3 million. In addition, the decrease in revenues in 2006 in comparison to revenues in 2005 contributed to the decrease in gross profit. As a percentage of revenues, gross margin did not change significantly from an overall gross margin of 23% in fiscal 2005, to an overall gross margin of 22% in fiscal 2006. The gross margin from projects improved in 2006 due to higher gross margins in projects received during the end of 2005 and during 2006. The increase in gross margin in 2006 was offset by increased costs in one of our projects for the completion of the project. Our gross margin is influenced by various factors, such as the type and size of a project, and the portion of projects performed by subcontractors.

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Research and Development Costs.

        Gross research and development expenditures consist primarily of salaries, subcontractors and other personnel related expenses related to design, development and enhancement of our products and, to a lesser extent, depreciation and other expenditures. Gross research and development expenses in fiscal 2006 were $0.6 million, the same as in fiscal 2005. Gross research and development expenses were primarily attributed to continuing the development of the EVA and its derivatives.

Selling and Marketing Expenses.

        Selling and marketing expenditures consist primarily of costs relating to payroll expenses, sales commissions, subcontractors and consultants, travel expenses, demonstrations, exhibitions and participation in trade shows. Selling and marketing expenditures in fiscal 2006 were $1.4 million, an increase of $0.1 million, or 5%, from $1.3 million in fiscal 2005. The increase in selling and marketing expenses was primarily attributed to the fact that we participated in 2006 in several exhibitions, including the Asian Aerospace Show, the Farnbourough Airshow and IITSEC, and from increasing our marketing activities for our EVA and IFEWS products.

General and Administrative Expenses.

        General and administrative expenses consist primarily of salaries and related costs of welfare and administration, finance and general management personnel, professional fees, office, vehicle and rental expenses. General and administrative expenses in fiscal 2006 were $2.2 million, an increase of $38,000, or 2%, from $2.1 million in fiscal 2005. The small increase in general and administrative expenses was primarily attributed to an increase in legal fees, professional fees and travel costs relating to our inquiries into a potential acquisition of a company. This increase was almost offset by a decrease in other professional fees, including market analysis of the training military market and management skills improvement, which took place in 2005.

Operating Profit (Loss).

        As a result of the foregoing, we had an operating loss of $(2.0) million in fiscal 2006, compared to an operating profit of $0.3 million in fiscal 2005. As a percentage of revenues, operating profit decreased from an operating profit of 2% in fiscal 2005, to an operating loss of (19%) in fiscal 2006.

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Financial Expenses, Net.

        Financial expenses, net consist primarily of interest paid on loans and bank charges, net of income from interest earned on short-term deposits and interest on non-current receivables, gains or losses from derivatives instruments and gains or losses arising from foreign exchange erosion of monetary balances. Financial expenses, net in fiscal 2006 were approximately $0.19 million, similar to fiscal 2005. The changes in financial expenses, net were primarily attributed to a decrease in interest on loans received from banks due to reduced amounts of loans because of the repayment of loans during fiscal 2005 and fiscal 2006. The changes were also attributed to an increase in interest income received from cash deposits due to higher amounts deposited during the year, a decrease in bank charges relating to guarantees due to a decreased commission rate on guarantees amount, offset by losses from derivative instruments and foreign exchange losses.

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

Revenues.

        Revenues in fiscal 2005 were $19.2 million, an increase of 51% compared to revenues of $12.7 million in fiscal 2004. The increase was primarily attributed to the completion of several significant projects in 2005, particularly to the progress achieved during 2005 in one significant project in Europe which contributed $ 6.0 million to the revenues of fiscal 2005. In addition, according to the agreement signed with IAI on August 2005, we have received royalties from IAI amounting to $ 1.7 million. Revenues from sales of our live and embedded training systems products in fiscal 2005 accounted for 64% compared to 55% of our revenues in fiscal 2004. Revenues derived from our virtual and constructive simulator products accounted for 36% of our revenues in fiscal 2005 compared to 45% of our revenues in fiscal 2004. The geographical breakdown of our revenues in fiscal 2005 was as follows: approximately 43% of our revenues were in Europe, 33% in Asia Pacific, 16% in America and Latin America, 6% in Israel and 2% in Africa. In fiscal 2004, approximately 36% of our revenues were in Asia Pacific, 21% in Europe, 36% in Latin America and 7% in Israel. The fluctuations in the proportion of our revenues attributed to geographic areas are the result of the completion of several contracts which we had with various countries. Our agreements are multi-year contracts, and we generally recognize revenues on the percentage of completion method, recognizing expenses when incurred.

        In fiscal 2005, income from royalties and commissions was $1.7 million pursuant to the Cooperation agreement with MLM signed in August 2005.During 2004, there were certain disagreements between the company and MLM and as a result no income from royalties and commissions were recognize .

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Gross Profit (Loss).

        Gross profit in fiscal 2005 was approximately $4.4 million, an increase of $2.0 million from a gross profit of $2.4 million in fiscal 2004. As a percentage of revenues, gross profit increased from a gross profit of 19% in fiscal 2004, to a gross profit of 23% in fiscal 2005. The increase in gross profit was primarily due to the increase in royalties revenues from IAI amounting to $1.7 million, together with $0.8 million decrease in cost of revenue as result of a reversal of certain previously accrued liabilities that are no longer payable as a result of the new agreement signed with IAI in 2005. The increase in gross margin was partially offset by a lower gross margin in one significant project in Europe with a lower profitability, which contributed $6.0 million to the revenues of fiscal 2005.

Research and Development Costs.

        Gross research and development expenditures consist primarily of salaries, subcontractors and other personnel-related expenses related to design, development and enhancement of our products and, to a lesser extent, depreciation and other expenditures. Gross research and development expenses in fiscal 2005 were $0.6 million, an increase of $0.3 million or 109% from $0.3 million in fiscal 2004. The increase in gross research and development expenses was primarily attributed to the development of the EVA.

Selling and Marketing Expenses.

        Selling and marketing expenditures consist primarily of costs relating to payroll expenses, sales commissions, subcontractors and consultants, travel expenses, demonstrations, exhibitions and participation in trade shows. Selling and marketing expenditures in fiscal 2005 were $1.3 million, an increase of $0.2 million, or 19%, from $1.1 million in fiscal 2004. The increase in selling and marketing expenses was primarily attributed to the fact that we participated in 2005 in several exhibitions including the Paris Air Show and Indian Air Show and from increasing our marketing activities for our Eva and IFEWS products.

General and Administrative Expenses.

        General and administrative expenses consist primarily of salaries and related costs of welfare and administration, finance and general management personnel, professional fees, office, vehicle and rental expenses. General and administrative expenses in fiscal 2005 were $2.1 million, an increase of $0.3 million, or 16%, from $1.8 million in fiscal 2004. The increase in general and administrative expenses was primarily attributed to bonuses to employees paid only in fiscal 2005, increases in professional fees includes market analysis of the training military market and management skills improvement and increase in travel costs for business development. As a percentage of revenues, general and administrative expenses in fiscal 2005 were approximately 11% compared to 14% in fiscal 2004.

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Operating Profit (Loss).

        As a result of the foregoing, we had an operating profit of $0.3 million in fiscal 2005 compared to an operating loss of $(0.9) million in fiscal 2004. As a percentage of revenues, operating profit increased from an operating loss of (6%) in fiscal 2004, to an operating profit of 2% in fiscal 2005.

Financial Expenses, Net.

        Financial expenses, net consist primarily of interest paid on loans and bank charges, net of income from interest earned on short-term deposits and interest on non-current receivables, gains or losses from derivatives instruments and gains or losses arising from foreign exchange erosion of monetary balances. Financial expenses, net in fiscal 2005 were approximately $0.19 million, a decrease of approximately $0.3 million from approximately $0.5 million in fiscal 2004. The decrease was primarily attributed to a decrease in interest on loans received from banks due to reduced amounts of loans because of the repayment of loans during fiscal 2004 and fiscal 2005 and the conversion of loans to shares during 2004. The decrease was also attributed to an increase in interest income received from cash deposits due to higher amounts deposited during the year, a decrease in bank charges relating to guarantees due to a decrease in the guarantee amount, gains from derivative instruments and foreign exchange gains.

Other Income (Expenses), Net.

        We incurred other expenses of approximately $2,000 in fiscal 2005, compared to approximately $192 thousand net other income in fiscal 2004. The net income in 2004 was primarily attributed to gain on the forgiveness of a long–term loan from a former related party in the amount of $177, 000.

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

        The dollar cost of our operations is influenced by the extent to which inflation in Israel is or is not offset, or is offset on a lagging basis, by the devaluation of the NIS in relation to the dollar. When the rate of inflation in Israel exceeds the rate of devaluation of the NIS against the dollar, companies experience increases in the dollar cost of their operations in Israel. Unless offset by a devaluation of the NIS, inflation in Israel will have a negative effect on our profitability, as we receive payment in dollars or dollar-linked NIS for all of our sales, while we incur a portion of our expenses in NIS.

        The following table presents information about the rate of inflation in Israel, the rate of devaluation of the NIS against the dollar, and the rate of inflation in Israel adjusted for the devaluation:

Year ended December 31	Israeli inflation % rate			Devaluation of the NIS rate %			Israeli inflation adjusted for devaluation %
2002		6.5			7.3			(0.8	)
2003		(1.9	)		(7.6	)		5.7
2004		1.2			(1.6	)		2.8
2005		2.4			6.8			(4.4	)
2006		(0.1	)		(8.2	)		(8.3	)

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        A devaluation of the NIS in relation to the dollar has the effect of reducing the dollar amount of any of our expenses or liabilities payable in NIS, unless those expenses or payables are linked to the dollar. This devaluation also has the effect of decreasing the dollar value of any asset that consists of NIS or receivables payable in NIS, unless the receivables are linked to the dollar. Conversely, any increase in the value of the NIS in relation to the dollar has the effect of increasing the dollar value of any unlinked NIS assets and the dollar amounts of any unlinked NIS liabilities and expenses.

        Because exchange rates between the NIS and the dollar fluctuate continuously, with a historically declining trend in the value of the NIS, exchange rate fluctuations, particularly larger periodic devaluations, will have an impact on our profitability and period-to-period comparisons of our results.

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

        We entered into currency future contracts and put and call option contracts to reduce our exposure to fluctuations of specific currencies against the dollar, resulting primarily from firm commitments in such currencies.

        As of December 31, 2006, we had an obligation to sell $200,000 for a total amount of NIS 846,000.

        The fair value of this derivative financial instrument was immaterial.

Political and Economic Conditions.

Political Conditions.

        Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors, and the continued state of hostility, varying in degree and intensity, has led to security and economic problems for Israel. During the summer of 2006, Israel was engaged in an armed conflict with Hezbollah, a Lebanese Islamist Shiite militia group and political party. This conflict involved missile strikes against civilian targets in northern Israel, and negatively affected business conditions in Israel. In addition, Israel and companies doing business with Israel have, in the past, been the subject of an economic boycott. Although Israel has entered into various agreements with Egypt, Jordan and the Palestinian Authority, Israel has been and is subject to civil unrest and terrorist activity, with varying levels of severity, since September 2000. The election in early 2006 of representatives of the Hamas movement to a majority of seats in the Palestinian Legislative Council and the tension among the different Palestinian factions may create additional unrest and uncertainty. Any future armed conflicts or political instability in the region may negatively affect business conditions and adversely affect our results of operations. We could be adversely affected by hostilities involving Israel, the interruption or curtailment of trade between Israel and its trading partners, or a continuous downturn in the economic or financial condition of Israel. In addition, several countries continue to restrict business with Israel and with companies having operations in Israel. We could be negatively affected by further adverse developments in the peace process, including the recent violence, or by restrictive laws or practices directed towards Israel or Israeli exporters.

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        Like all male adult citizens and permanent residents of Israel, our directors, officers and employees who are under the age of 45, unless exempt, are obligated to perform up to 36 days of military reserve duty annually. Additionally, all such residents are subject to being called to active duty at any time under emergency circumstances. The majority of our officers and employees are currently obligated to perform annual reserve duty. No assessment can be made as to the full impact of such requirements on our workforce or business if conditions in Israel should change, and no prediction can be made as to the effect of any expansion or reduction of such military obligations on us. See “Item 4. Information on the Company – B. Business Overview – Conditions in Israel.”

Economic Conditions

        Israel’s economy has been subject to numerous destabilizing factors, including a period of rampant inflation in the early to mid-1980s, low foreign exchange reserves, fluctuations in world commodity prices, military conflicts and civil unrest. The Israeli government has intervened in various sectors of the economy by utilizing fiscal and monetary policies, import duties, foreign currency restrictions and controls of wages, prices and foreign currency exchange rates. The Israeli Government has periodically changed its policies in all these areas.

Effective Corporate Tax Rate

        Israeli companies are subject to corporate tax on their income, at a rate which will be gradually reduced from the rate of 31% in 2006, to 29% in 2007, 27% in 2008, 26% in 2009 and 25% in 2010 and thereafter.

        However, our old manufacturing facilities in Jerusalem and our facilities in Rosh Ha’ayin have been granted “Approved Enterprise” status under the Law for the Encouragement of Capital Investments, 1959, as amended, known as the Investment Law. Consequently, these facilities are eligible, subject to compliance with specified requirements, for tax exemption for a period of two years and reduced tax rate of 25% for an additional period of five years on our increased income, if any, commencing on the day we derive taxable income from our facilities in Rosh Ha’ayin. We may utilize such tax benefits until 2016. The tax benefits under the Investment Law are not available with respect to income derived from products manufactured outside of Israel. We expect to derive a substantial portion of our income from our Approved Enterprise facility.

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B. Liquidity and Capital Resources

        Historically we have met our financial requirements primarily through the private sale of equity securities, customer payments and advances and the utilization of bank credit lines. In addition, we raised capital through equity financings in 2004 and in 2006. As of December 31, 2006, we had cash and cash equivalents of approximately $3.4 million and a positive working capital of approximately $3.4 million.

        On April 20, 2004, we reached an agreement with a former related party for the repayment of $204,000 out of an outstanding loan amounting to $381,000 resulting in the forgiveness of a debt amounting to $177,000.

        Pursuant to these transactions, the banks agreed to postpone repayment of $1.5 million in short-term credit, such that $0.5 million is repayable in each of the years 2005, 2006 and 2007. The first payment was paid in January 2005, the second payment was paid in January 2006 and the third payment is scheduled to be made in January 2007.

        There are no restrictions as to our use of the credit lines with our banks. The banks may terminate our credit lines at any time, and the banks may demand repayment in full of any indebtedness then outstanding.

        In addition, we have obtained bank guarantees to secure our performance of certain obligations, including under our leases and contracts with customers. Of these guarantees, which amounted to an aggregate of $12.1 million on December 31, 2006, guarantees in an aggregate of $11.5 million are to be released by our obtaining specific performance milestones, which are scheduled to be completed through October 2012.

        In connection with our guarantees, loans and credit lines from banks, we have placed equally ranking, first priority fixed and floating liens on all of our assets.

        Our operating cash flow is influenced by cash provided from our customers as an advance and by cash used in the performance of ongoing projects. Operating activities for the year 2006, 2005 and 2004, provided (or used) cash of approximately ($2.4) million, $1.0 million and ($1.9) million, respectively. For fiscal 2006, cash derived from changes in assets and liabilities of ($0.8) million primarily consisted of an increase in trade receivables of ($2.9) million. Additionally, there was an increase in excess of advances from customers over amounts recognized as revenues of $2.1 million.

        For fiscal 2005, cash provided from changes in assets and liabilities of $0.5 million primarily consisted of a decrease in trade receivables of $2.4 million. Additionally, there was a decrease in excess of advances from customers over amounts recognized as revenues of $(2.4) million, a decrease in inventory of $1.2 million, a decrease in trade payables of ($0.6) million and a decrease in other payables and accrued expenses of $0.2 million.

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        For fiscal 2004, changes in operating assets and liabilities of $0.9 million primarily consisted of a decrease in trade payables of $1.1 million. Additionally, there was a decrease in trade receivables of $0.2 million, a decrease in other receivables and prepaid expenses of $0.4 million, a decrease in inventory of $0.2 million and a decrease in other payables and accrued expenses of $0.3 million.

        Investing activities for fiscal 2006, fiscal 2005 and fiscal 2004 used cash of approximately ($0.2) million, ($0.1) million and ($2.7) million, respectively. Cash flows used in investing activities in fiscal 2006 consisted primarily of a purchase of fixed assets in the amount of $0.3 million and a decrease in restricted bank deposits of $0.3 million and an increase in other assets in the amount of $0.3 million. The decrease in restricted bank deposits was due to a decrease in advanced payments and performance guarantees. .

        Cash flows used in investing activities in fiscal 2005 consisted primarily of a purchase of fixed assets in the amount of $0.3 million and a decrease in restricted bank deposits of $0.2 million. The decrease in restricted bank deposits was due to a decrease in advanced payments and performance guarantees.

        Cash flows used in investing activities in fiscal 2004 consisted primarily of an increase in restricted bank deposits of $2.6 million and purchase of fixed assets in the amount of $0.1 million. The increase in restricted bank deposits was due to an increase in advance payment and performance guarantees.

        Financing activities for fiscal 2006, fiscal 2005 and fiscal 2004 provided (or used) cash of approximately 3.1 million, ($0.5) million and $5.7 million, respectively.

        Cash flows used in financing activities in fiscal 2006 consisted primarily of share and warrant issuances in the amount of $3.6 million and the net repayment of long-term loans from banks of $0.5 million.

        Cash flows used in financing activities in fiscal 2005 consisted primarily of the net repayment of long-term loans from banks of $0.5 million.

        Cash flows provided by financing activities in fiscal 2004 consisted primarily of the issuance of ordinary shares and options in consideration for $9.7 million, the exercise of $3.1 million in stock options and the net repayments of $6.6 million, $0.4 million and $0.2 million, respectively, with respect to a short-term bank credit, a short-term loan from Chun and long-term loans from former shareholders.

        Our current assets exceed our current liabilities. We believe that the existing cash balances together with meeting forecasted cash flows from operating activities for fiscal 2007, as well as obtaining orders forecasted in the budget approved by the Board of Directors will be sufficient to meet our present working capital and capital expenditure needs.

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C. Research and Development, Patents and Licenses

        See "Item 4 - Information on the Company - B. Business Overview - Research and Development; Intellectual Property."

D. Trend Information

Periodic Variations in Operating Results

        Due to the nature of our customers and products, our sales are often made pursuant to a relatively small number of customers and large orders. Consequently, an individual project from an individual customer can represent a substantial portion of our revenues in any one period. In addition, a significant project for any customer during one period may not be followed by further projects for the same customer in subsequent periods. Our sales and operating results may, therefore, vary substantially from period to period. In 2003, we experienced a significant increase in orders from Latin American countries. This would appear to be the result of our having invested substantial amounts of our time and resources from 2001, in developing a market that we believe to have significant commercial potential. In 2004, we successfully entered into a significant contract with a Portuguese entity pursuant to diligent marketing efforts. In 2005, we successfully entered into a significant contract with an Israeli company regarding a purchase order made by the Israel Air Force. In 2006, we successfully entered into five significant contracts with two major European companies and three foreign customers.

Delay in the Receipt of Required Export Approvals

        We purchase from manufacturers in the United States a portion of the commercial computers, a portion of the air combat maneuvering instrumentation pod’s hardware and other “off-the-shelf” products, such as navigation systems, which we incorporate into our products. The export of such components is subject to the approval of the United States Department of Commerce and/or the United States Department of Defense, which often restricts sales to certain countries. Since the events of September 11, 2001, the United States has imposed a longer bureaucratic process on the provision of approvals and has attached more stringent conditions; consequently, we have experienced delays in the receipt of such required approvals.

E. Off-Balance Sheet Arrangements

        We do not have any off-balance sheet arrangements.

F. Tabular Disclosure of Contractual Obligations

        Our significant financial and contractual obligations as of December 31, 2006, and the periods in which such obligations are due are as follows:

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Payments and Amount of Commitment
Expiration Per Period
(U.S. Dollars in Thousands)

Contractual Obligations(1)	Total Amounts Committed		Less than 1 Year		1-3 Years		3-5 Years		More than 5 Years
Borrowed Lines of credit		636		636		-		-		-
Guarantees:
Performance guarantees		6,087		5,159		336		-		592
Advance payment guarantees		5,423		1,998		465		2,960		-
Other bank guarantees		602		602		-		-		-
Total Guarantees		12,112		7,759		801		2,960		592
Operating lease commitments		876		406		470		-		-
Total commercial commitments		13,624		8,801		1,271		2,960		592

(1) Excludes liability for employee severance benefits, net in the amount of $166,000 and long term payable in respect of income taxes of $154,000.

G. Safe Harbor

        Not applicable.

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ITEM 6. Directors, Senior Management and Employees

A. Directors and Senior Management

        The following table lists the name, age and position held by each of our executive officers and directors, as of March 31, 2007:

Name	Age		Position
Aviv Tzidon		51	Director and Chairman of the Board of Directors
Avi Leumi		43	Director
Uri Manor		64	Director
Avraham Gilat		60	Director
Rimon Ben-Shaoul		62	Director
Gadi Aviram		52	Director
Orit Stav		36	Director*
Amnon Harari		56	Director*
Ken Lalo		49	Director
Nir Dor		43	Director
Ilan Gillies		38	Chief Executive Officer
Reuven Shahar		48	Vice President of Finance and Chief Financial Officer
Dekel Tzidon		47	Vice President of Development and Chief Technological Officer
Gilad Yavets		37	Vice President of Marketing

*External Director

        Aviv Tzidon has been a Director and the Chairman of our Board of Directors since November 24, 2003. Mr. Tzidon was the co-founder of BVR Technologies Ltd. (or BVR-T) and served as its Chief Technology Officer and a director since it commenced operations in 1987. From October 1998, upon the spin-off of BVR Systems (1998) Ltd. from BVR-T, and until April 2000, Mr. Tzidon served as Chairman of the Board of Directors and Chief Executive Officer of BVR-T. For three years, Mr. Tzidon worked as an independent consultant for Israel Aircraft Industries. Mr. Tzidon served as a combat pilot with the Israel Air Force, including reserve service, for approximately 20 years.

        Avi Leumi has been a Director since March 1, 2004. Mr. Leumi has served as CEO, Co-Founder and Chairman of the Board of Directors of Aeronautics Defense Systems Ltd. since November 1997. From 1992 to 1997, Mr. Leumi served as CEO of Leumi Chemicals Ltd., a family owned business. Mr. Leumi is a graduate of the Israel Naval Academy.

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        Uri Manor has been a director since March 1, 2004. Mr. Manor has served as Managing Director of Datus Ltd., a consulting company specializing in the marketing of defense systems since January 1, 1996 and Managing Director of Loven Hachatzav Ltd., a holding company specializing in high tech and defense companies since 2001. Mr. Manor is also a member of the board of directors of Soltam Systems, Fibrotex International and Aeronautics Defense Systems Ltd.. Moreover, Mr. Manor represents Hindustan Aeronautics Limited in Israel. From 1969 to 1996, Mr. Manor held various management positions in Israel Aircraft Industries Ltd. including Deputy General Manager, MBT Division. Mr. Manor holds a B.Sc. and an M.Sc. in Aeronautical Engineering from the Technion, the Israel Institute of Technology.

        Avraham Gilat has been a director since June 28, 2005. Mr. Gilat serves as the Chairman of Soltam Systems Ltd. and the Soltam Group, one of Israel’s prominent defense companies and as a Director General of Mikal Ltd., a holdings company for a wide range of commercial activities. Prior to this Mr. Gilat served in various positions in Israel Military Industries Ltd. Mr. Gilat holds an M.B.A. from New York University and a B.A. in Economics from Tel-Aviv University.

        Rimon Ben-Shaoul has been a director since March 1, 2004. Since 2004, Mr. Ben-Shaoul has served as President and Chief Executive Officer of Polar Communications Ltd., an investment company investing in the technology and telecommunications sectors, and as chairman or a member of the Board of Directors of various private and publicly traded companies within the Polar group. Since February 2001, Mr. Ben-Shaoul has also served as Co-Chairman, President and Chief Executive officer of Koonras Technologies Ltd., an investment company controlled by Polar Investments Ltd. From June 1997 to February 2001, Mr. Ben-Shaoul served as President and Chief Executive Officer of Clal Industries and Investments Ltd., one of Israel’s largest holdings companies in the industrial and high-tech sectors, and as a member of the Board of Directors of Clal (Israel) Ltd. and various subsidiaries thereof. From 1985 to June 1997, Mr. Ben-Shaoul served as President and Chief Executive Officer of Clal Insurance Company Ltd., was a member of its board of directors and served as Chairman or as a member of the board of directors of various subsidiaries of Clal Insurance Company Ltd. Mr. Ben-Shaoul holds an M.B.A. and a B.A. in Economics from Tel-Aviv University.

        Gadi Aviram has been a director since March 1, 2004. Mr. Aviram is the founder and Chief Executive Officer of Metro Motor Marketing Ltd., local importer and representative of Kawasaki Heavy Industries. From 2000 to 2002, Mr. Aviram served as director of Safecom Car Communication Ltd. and from 1999 to 2000, Mr. Aviram served as director of Pointer (Eden Telecom Group) Ltd.

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        Orit Stav has been one of our external directors since March 1, 2004. Ms. Stav is an Investment Associate at Siemens Venture Capital. Prior to joining Siemens VC, Ms. Stav was a partner in Platinum Neurone Ventures (PNV), an Israeli Venture Capital Fund and has more than six years of experience in the venture capital market and the technology industry in Israel. She led investments from seed stage to exit and worked with leading international VCs. She gained experience with varied technology companies throughout the Siemens investment spectrum. Ms. Stav holds a B.A. in Economics and Management from Tel Aviv University and an M.B.A. from Hertfordshire University, UK.

        Amnon Harari has been one of our external directors since July 2002. Mr. Harari currently serves as the Vice President of sales and service for EMEA in Lumenis Ltd. From March 2002 until August 2004, Mr. Harari served as the Chief Executive Officer of Advanced Heating Technologies Ltd. From May 2000 to March2002, Mr. Harari served as Chief Executive Officer of Partner Future Communication Ltd. From April1999 to April2000, Mr. Harari served as General Manager of Alcatel Israel. From April1997 to April1999, Mr. Harari served as Corporate Vice-President and General Manager of the Public Switching Division of Tadiran Telecommunication Ltd that was later acquired by Alcatel to become Alcatel Israel. From 1992 to 1996, Mr. Harari served as the head of the Israel Air Force Material Directorate. From February1997 to February 2002, Mr. Harari served as an External Director of Elbit Systems Ltd. Mr. Harari is a Brigadier-General in the Israel Air Force. Mr. Harari holds a B.Sc. in Physics from the Tel Aviv University.

        Ken Lalo has been a director since February 20, 2006. Since 2004, Mr. Lalo has served as Executive Vice President of Polar Communications Ltd., an investment company controlled by Polar Investments Ltd. and is a member of the Boards of Directors of various affiliates of Polar, including publicly traded and private companies. Between 2001 and 2004, Mr. Lalo served as Vice President and General Counsel of other entities within the Polar Investments group. From 1993 to 2001, Mr. Lalo served as Vice President and General Counsel of Clal Industries and Investments Ltd. and was a member of the Boards of Directors of various affiliates of Clal, including publicly traded and private companies. From 1986 – 1992, Mr. Lalo worked as an attorney in Maryland, USA. Mr. Lalo holds an M.B.A. from Northwestern University / Tel- Aviv University, an M.C.L. from George Washington University and an LL.B. from Tel-Aviv University.

        Nir Dorhas been a director since March 21, 2006. Mr. Dor currently serves as the chairman of the board of directors of Cargal Carton Industries Ltd., Vice Chairman of the board of directors of Global Factoring Ltd. and serves on the board of directors of The Danone Spring of Eden BV. Mr. Dor served as the chief executive officer of Eden Springs Ltd. between 1999 and 2004. Mr. Dor is a certified public accountant and holds a B.A. in business management and finance from the College of Management of Tel-Aviv.

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        Ilan Gillies has been our Chief Executive Officer since his appointment on November 26, 2003. Mr. Gillies has been employed by the BVR Group since 1995 and served as Managing Director of BVR S Pacific from November1998 to September 2003. Mr. Gillies has served as a combat pilot with the Israel Air Force since 1989.

        Reuven Shaharhas been our Chief Financial Officer and Vice President of Finance since his appointment on July 1, 2000. From 1995 through June 2000, he was Treasurer and Director of Finance of Elisra Electronic Systems Ltd. From 1990 to 1995, Mr. Shahar was the head of the economic staff in the defense division of Elisra. He previously held various positions at Elisra as of 1984. Mr. Shahar holds a B.A. in business management from the Hebrew University of Jerusalem and an M.B.A. from Recanati Graduate School of Business Administration in Tel Aviv University.

        Dekel Tzidon has been our Chief Technology Officer and Vice President of Research & Development since January 1, 2004. From 1995 to 1997, Mr. Tzidon was employed by RTSET as an R&D engineer and IP manager. In 1997, Mr. Tzidon joined BVR as a senior systems engineer, IP manager and head of the technology group. In 2001, Mr. Tzidon served as a senior systems engineer in Comview. Since 2002, Mr. Tzidon has been employed as an IP consultant for a number of hi-tech companies including BVR. Mr. Tzidon has a B.Sc. in computer engineering. Mr. Tzidon is the brother of Mr. Aviv Tzidon, the Chairman of our Board of Directors.

        Gilad Yavetshas been our Vice President of Marketing since March 3, 2004. Mr. Yavets joined BVR in 1997 and has served in different positions in the company, including Contracts Director, Director of Business Development and Acting Vice President of Marketing. Mr. Yavets holds an LL.B. from the Faculty of Law of the Hebrew University of Jerusalem and an Executive M.B.A. from the Recanti Graduate School of Business Administration in Tel-Aviv University.

Expiration of Term of Office

        No term of our external directors has expired, in accordance with the provisions of the Israel Companies Law – 1999, as amended from time to time (the Companies Law). On June 28, 2005, our shareholders extended Mr. Harari’s appointment to continue to serve as an external director for an additional three-year term.

B. Compensation

        The aggregate remuneration we paid for the year ended December 31, 2006 to all executive officers as a group (4 persons) was approximately $546,000 in salaries, fees, commissions and bonuses. This amount includes approximately $67,000 set aside to provide for pension, retirement or similar benefits provided to our directors and executive officers.

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        Members of our board of directors, other than our external directors, do not receive cash compensation for their service on the board of directors or any committee of the board of directors. However, all of our directors are reimbursed for their expenses for each board of directors meeting attended. Our external directors received an aggregate of approximately $11,900 for the year ended December 31, 2006.

        At the meeting of our shareholders held on March 1, 2004, a special majority of our shareholders who voted at that meeting, approved the grant of an option to purchase 72,000 of our Ordinary Shares to each of our nine directors serving on our Board of Directors at the time, with the exception of Aviv Tzidon, the Chairman of our Board of Directors. The options vested with the following Directors upon their completion of one full year of service on our board following the March 1, 2004 shareholders meeting: Yaron Sheinman (formerly, a member of our board of directors), Avi Leumi, Uri Manor, Eric Chan, Gadi Aviram, Rimon Ben-Shaoul, Orit Stav and Amnon Harari and are exercisable at a price of $0.18 per share for a period of three years.

        At the meeting of our shareholders held on March 1, 2004, a majority of our shareholders who voted at that meeting also approved the grant of an option to purchase 9,000,000 of our Ordinary Shares to Mr. Aviv Tzidon. One fifth of the options will vest upon the completion of each full year of service on our board, which commenced on November 24, 2003, for a period of five years and will be exercisable at a price of $0.18 per share for a period of three years.

        Taking into account the option grants described in the preceding two paragraphs above, as of March 31, 2007, options to purchase 11,226,000 Ordinary Shares granted to our directors and executive officers under our option plans were outstanding. The exercise price of these options was $0.18 per share. Of these options, options to purchase 7,086,000 Ordinary Shares are currently exercisable or will become exercisable within 60 days of such date.

C. Board Practices

        Our articles of association provide for a board of directors of not less than two and no more than fifteen members. Each director is elected to serve until the next annual general meeting of shareholders and until his or her successor has been elected. Officers serve at the discretion of the board of directors. The Israeli Companies Law, which entered into effect on February 1, 2000 and was amended most recently in March 2005 requires that, at least one external director have financial and accounting expertise and the other external directors are to possess professional qualifications as promulgated by regulations to the Companies Law; these regulations provide that financial and accounting expertise require such external director to possess a high level of understanding in business matters, such that he or she can read and understand financial statements in depth and be able to raise issues with respect to the manner in which the financial data is presented therein. The company’s board of directors is to determine such candidate’s qualifications based on his or her education, experience and skills regarding financial and control matters in companies of similar size and in a similar industry and knowledge of preparation and approval of financial statements under the Companies Law and Israeli securities laws.

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        Our articles of association provide that any director may, by written notice, appoint another person to serve as a substitute director and may cancel such appointment. According to the Companies Law, a person may not serve as a substitute director for more than one director and a director may not serve as a substitute director. Any substitute director will have all of the rights and obligations of the director appointing him or her, except the power to appoint a substitute, unless the instrument appointing him provides otherwise, and the right to remuneration. Appointment of a substitute director for a member of a committee of the board of directors is only permitted if the substitute is a member of the board of directors and does not regularly serve as a member of such committee. If the committee member being substituted is an external director, such substitute may only be another external director possessing the same expertise as the external director being substituted and may not be a regular member of such committee. Unless the time period or scope of any appointment is limited by the appointing director, the appointment is effective for all purposes, but will expire upon the expiration of the appointing director’s term. To our knowledge, no director currently has appointed any other person as a substitute director.

External Directors

        Under the Companies Law, companies incorporated under the laws of Israel whose shares have been offered to the public in or outside of Israel are required to appoint no less than two external directors. The 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 any entity under the person’s control, has, as of the date of the person’s appointment to serve as external director, or had, during the two years preceding that date, any affiliation with the company, any entity controlling the company or any entity controlled by the company or by this controlling entity. The term affiliation includes:

— an employment relationship;

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

— control; and

— service as an office holder.

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        No person can serve as an external director if the person’s position or other business creates, or may create, conflict of interests with the person’s responsibilities as an external director. A person shall be qualified to serve as an external director only if he or she possesses accounting and financial expertise or professional qualifications. At least one external director must posses accounting and financial expertise and the other external directors are to possess professional qualifications as promulgated by regulations to the Companies Law; these regulations provide that financial and accounting expertise require such external director to possess a high level of understanding in business matters, such that he or she can read and understand financial statements in depth and be able to raise issues with respect to the manner in which the financial data is presented therein. The company’s board of directors is to determine such candidate’s qualifications based on his or her education, experience and skills regarding financial and control matters in companies of similar size and in a similar industry and knowledge of preparation and approval of financial statements under the Companies Law and Israeli securities laws. These requirements do not apply to external directors appointed before the recent amendment to the Companies Law but will apply to their reappointment for an additional term. Until the lapse of two years from termination of office, a company may not engage an external director to serve as an office holder and cannot employ or receive services from that person, either directly or indirectly, including through a corporation controlled by that person. External directors are to be elected by a majority vote at a shareholders’ meeting, provided that either:

— the total number of votes for the appointment of the external directors shall include the votes of at least one third of the shares represented at the meeting in person or by proxy, which are not held by controlling shareholders of the company; or

— the total number of votes against the appointment of the external directors, among the non-controlling shareholders of the company, shall not exceed 1% of the aggregate voting rights in the company.

        When counting the votes of the non-controlling shareholders, abstentions are not to be included in such calculations.

        An external director is entitled to compensation as provided in regulations promulgated under the Companies Law and is otherwise prohibited from receiving any compensation, directly or indirectly, in connection with services provided as an external director. We compensate our two external directors in accordance with regulations promulgated under the Companies Law.

        The initial term of an external director is three years and may be extended for an additional three years. Each committee of a company’s board of directors, which exercises board powers, is required to include at least one external director. However, the audit committee should include all the external directors.

        Pursuant to the decisions of the Special General Meetings dated July 9, 2002 and March 1, 2004, respectively, Amnon Harari and Orit Stav were each appointed as external directors of the Company for a three-year term. On June 28, 2005, our shareholders extended Mr. Harari’s appointment to continue to serve as an external director for an additional three-year term.

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Exculpation, Insurance and Indemnification of Directors and Officers

        Under the Companies Law, an Israeli company may not exempt an office holder from liability with respect to a breach of his duty of loyalty, but may exempt in advance an office holder from his liability to the company, in whole or in part, with respect to a breach of his duty of care, provided, that the company is so permitted under its articles of association. The breach of such duty is governed by Israeli contract laws.

Office Holder Insurance

        Our articles of association provide that, subject to the provisions of the law, we may enter into a contract for the insurance of the liability of any of our office holders with respect to:

— a breach of his duty of care to us or to another person;

— a breach of his duty of loyalty to us, provided that the office holder acted in good faith and had reasonable cause to assume that his act would not prejudice our interests; or

— a financial liability imposed upon him in favor of another person concerning an act performed by him in his capacity as an office holder.

Indemnification of Office Holders

        Our articles of association provide that we may indemnify an office holder against:

— a financial liability imposed on him in favor of another person by any judgment, including a settlement or an arbitrator’s award approved by a court concerning an act performed in his capacity as an office holder; and

— reasonable litigation expenses, including attorneys’ fees, expended by the office holder or charged to him by a court, in proceedings we institute against him or instituted on our behalf or by another person, or in a criminal charge from which he was acquitted, or a criminal charge in which he was convicted for a criminal offense that does not require proof of intent, in each case relating to an act performed in his capacity as an office holder.

        Under the Companies Law, these provisions are subject to shareholder approval.

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Limitations on Insurance and Indemnification

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

— a breach by the office holder of his duty of loyalty unless the office holder acted in good faith and had a reasonable basis to believe that the act would not prejudice the company;

— a breach by the office holder of his duty of care if the breach was done intentionally or recklessly;

— any act or omission done with the intent to derive an illegal personal benefit; or

— any fine levied against the office holder.

        In addition, under the Companies Law, indemnification of, and procurement of insurance coverage for, our office holders must be approved by our Audit Committee and our Board of Directors and, in specified circumstances, by our shareholders.

        We have obtained directors and officers liability insurance.

Audit Committee

        Under the Companies Law, the board of directors of any public company, as defined by the Companies Law, must appoint an audit committee comprised of at least three directors, including all of the external directors, but excluding the chairman of the board of directors, the general manager, the chief executive officer and a controlling shareholder or its relative and any director employed by the company or who provides services to the company on a regular basis. Ken Lalo (appointed following the resignation of Yaron Sheinman), Amnon Harari and Orit Stav currently serve as members of our Audit Committee. Orit Stav is the financial expert of the Committee.

        The role of the audit committee is to examine flaws in the company’s business management, in consultation with its internal auditor and independent accountants, and suggest appropriate courses of action.

        In addition, the approval of the audit committee is required to effect specified actions and transactions with office holders and interested parties. An interested party is defined in the Companies Law as a 5% or greater shareholder, any person or entity who has the right to designate one or more directors or the general manager of the company or any person who serves as a director or as a general manager. An audit committee may not approve an action or a transaction with an interested party or with an office holder unless at the time of approval the two external directors are serving as members of the audit committee and at least one external director was present at the meeting in which such approval was granted.

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Management Employment Agreements

        We have entered into employment or consulting agreements with each of our executive officers. These agreements contain various provisions, including provisions relating to assignment of intellectual property rights to us and confidentiality and are in effect until terminated by either party upon advance notice or otherwise in accordance with the terms of the particular agreement. All of these agreements also contain non-competition provisions. Under the Companies Law, in a public company, as defined in the Companies Law, the chief executive officer may not serve as the company’s chairman of the board. However, the shareholders of the company may approve the service of the chairman of the board also as the chief executive officer, for periods of up to three years each, provided, that at least two-thirds of the votes of non-controlling shareholders present and voting at the meeting vote affirmatively.

Employee Share Option Plans

        We have two employee share option plans. Options granted under our option plans generally vest over a period of two to five years. Options granted under each plan expire five or eight years from the date of grant. Our share option plans are administered by our Board of Directors. All of our employees are eligible to participate in our option plans. Our board of directors has complete discretion to make all decisions relating to the interpretation and operation of our option plans, including the discretion to determine which eligible individuals are to receive an award, and to determine the type, number, vesting requirements and other features and conditions of each award.

        On January 4, 2004, our board of directors adopted a new share option plan under which options for the purchase of 5,000,000 Ordinary Shares of the Company may be granted to our employees and consultants. In 2006, our Board of Directors approved an increase to the total option program to 5,200,000 Ordinary Shares. Under this plan, as of March 31, 2007, 4,960,000 options were granted to employees and consultants of the Company, at an exercise price of $0.145 – $0.65 each. These options will vest over five years with one-fifth vesting each year, and each increment expiring three years after vesting. Moreover, as of March 31, 2007, an additional 240,000 Ordinary Shares of the Company were reserved for issuance pursuant to options issuable under this share option plan.

        As of March 31, 2007, we had outstanding options for the purchase of an aggregate of 4,966,000 Ordinary Shares of the Company.

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Employees

        The following table sets forth for the last three fiscal years, the number of our employees engaged in the specified activities:

	Year ended December 31,
Activity	2006		2005		2004
Production & Research and Development		66		53		49
Marketing and Sales		4		3		3
Administration and Management		10		10		11
Total		80		66		63

        As of, March 31, 2007, we employed approximately 68 employees in research and development operations and productions, both internally financed and pursuant to contracts with our customers performed an integral role in our various projects

        Our employees are required to sign a nondisclosure agreement covering all of our proprietary information which they might possess or to which they might have access. We believe that we have satisfactory labor relations with our employees and have never experienced a work stoppage.

        We are subject to labor laws and regulations in Israel. We and our Israeli employees are also subject to certain provisions of the general collective bargaining agreements between the Histadrut, the General Federation of Labor in Israel, and the Coordination Bureau of Economic Organizations, including the Industrialists Association, by order of the Israel Ministry of Labor and Welfare. None of our employees are represented by a labor union and we have not experienced any work stoppages. We generally provide our employees with benefits and working conditions beyond the required minimums. In addition to salary and other benefits, certain of our marketing and sales personnel are paid commissions based on our performance in certain territories worldwide.

        We are subject, like all other Israeli employers, to Israeli labor laws and regulations. The laws principally concern matters like paid annual vacation, paid sick days and other conditions of employment. In addition, Israeli law generally requires severance pay, which may be funded by managers’ insurance described below (or by other funds), upon the retirement or death of an employee or termination of employment, subject to the provisions of the law. Provisions for severance pay amount to approximately 8.33% of wages. Furthermore, Israeli employees and employers are required to pay predetermined sums to the National Insurance Institute, which is similar to the United States Social Security Administration. These amounts also include payments by the employee for national health insurance. The total payments to the National Insurance Institute are equal to approximately 16.25% of the wages (up to a specified amount), of which the employee contributes approximately 66% and the employer contributes approximately 34%.

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        We follow a practice, although not legally required, to contribute funds on behalf of all of our employees to a fund known as “managers’ insurance”. This fund provides a combination of savings plan, insurance and severance pay benefits to the employee, giving the employee a lump-sum payment upon retirement and securing the severance pay, if legally entitled, upon termination of employment. We decide whether each employee is entitled to participate in the plan, and each employee who agrees to participate contributes an amount equal to 5% of his or her basic salary and the employer contributes approximately 14% of the salary.

D. Share Ownership

        As of March 31, 2007, Aviv Tzidon beneficially owned an option to purchase 5,400,000 Ordinary Shares, (for further information, see item 6B) exercisable at a price of $0.18 per share for three years. Assuming the exercise of such options and no other exercise of our convertible securities, Mr. Tzidon will hold 4.42% of our then outstanding Ordinary Shares. In addition, Mr. Tzidon holds 33.3% of Chun LP, which beneficially owned, as of March 31,2007, 58,142,608 Ordinary shares and a four-year option to purchase 10,864,444 Ordinary Shares, vesting immediately and exercisable at a price of $0.18 per share. Assuming the exercise of such options and no other exercise of our convertible securities, Chun will hold 54.03% of our then outstanding Ordinary Shares.

        Other than Mr. Aviv Tzidon, none of our directors and officers beneficially owned more than 1% of our outstanding equity securities.

ITEM 7. Major Shareholders and Related Party Transactions

A. Major Shareholders

        The following table sets forth certain information regarding the beneficial ownership of our Ordinary Shares as of, March 31, 2007, by each person or entity known to own beneficially more than 5% of our outstanding Ordinary Shares based on information provided to us by the holders or disclosed in public filings with the Securities and Exchange Commission.

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Name	Number of Ordinary Shares Beneficially Owned(1)			Percentage of Outstanding Ordinary Shares(2)
CHUN Holdings Limited Partnership(3)		69,007,052	(6)		54.03	%
c/o Yigal Arnon & Co.
1 Azrieli Center Tel-Aviv 67021 Israel
H.S.N General Managers Holdings LP		38,000,000	(4)		28.18	%
7 Berkowitz St.
Tel Aviv Israel
Polar Investments House		8,411,167	(5)		7.148	%
Platinum House
21 Ha'arbah St.
Tel Aviv 64731 Israel
Bank Leumi Le-Israel B.M.		6,111,111			5.23	%
24-32 Yehuda Halevi St.
Tel Aviv 63432 Israel

(1) Except as otherwise noted and pursuant to applicable community property laws, each person named in the table has sole voting and investment power with respect to all ordinary shares listed as owned by such person. Shares beneficially owned include shares that may be acquired pursuant to options that are exercisable within 60 days of March 31, 2007.

(2) Ordinary shares deemed beneficially owned by virtue of the right of any person or group to acquire these ordinary shares within 60 days of March 31, 2007 are treated as outstanding only for the purposes of determining the percent owned by such person or group. The percentage of outstanding ordinary shares is based on 116,863,757 Ordinary Shares outstanding as of March 31, 2007.

(3) Based on information reported by Chun LP in its Schedule 13D, the general partner of Chun LP is Chun Holdings Ltd., a private Israeli company jointly held by Aviv Tzidon (33.3%), Aeronautics Defense System Ltd. (33.3%) and Prescient System & Technologies Pte. Ltd. (33.3%).

(4) Includes three separate warrants for the purchase of 6,000,000 ordinary shares per each warrant, with exercise prices of $0.36, $0.54 and $1.00, exercisable for a period of three years, with a mandatory exercise mechanism under certain conditions.

(5) Includes 3,181,807 Ordinary Shares held by Koonras Technologies Ltd., a wholly-owned subsidiary of Polar Investments Ltd. It also includes a four-year warrant to purchase 2,158,960 (including 911,678 warrants held by Koonras) of our Ordinary Shares at a price of $0.18 share, exercisable immediately.

(6) Includes a four-year warrant to purchase 10,864,444 of our Ordinary Shares at a price of $0.18 share, exercisable immediately.

As of March 31, 2007, there were a total of five holders of record of our ordinary shares with addresses in the United States. Such United States holders were, as of such date, the holders of record of 13,256,359 ordinary shares representing approximately 11.34% of our outstanding share capital.

B. Related Party Transactions

Agreement with Consult Wise Pte Ltd.

        On January 1, 2004, we entered into an agreement with Consult Wise Pte Ltd., a Singaporean company. Maayan Tzidon, the brother of Aviv Tzidon, the Chairman of our Board of Directors, holds 50% of the issued and outstanding shares of Consult Wise. Pursuant to this agreement, we agreed to pay Consult Wise $3,000 per month for the provision of its marketing services of our products and services in Korea and Singapore, for a period of three years commencing January 1, 2004. In lieu of cash, we agreed to pay the monthly fee in our Ordinary Shares based on a per share price of $0.18. In order to facilitate the payment of shares, a trustee was issued 600,000 of our Ordinary Shares and was instructed to release 16,667 of our Ordinary Shares to Consult Wise each month during the term of the agreement.

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On January 1, 2007, following the expiration of the above agreement, we entered into a new agreement with Consult Wise Pte Ltd. Pursuant to this agreement, we agreed to pay Consult Wise $3,500 per month for the provision of its marketing services and $3,500 per month for supporting our operating programs in Singapore, for a period of two years commencing January 1, 2007; furthermore, Consult Wise is entitled to commissions on purchase orders issued by customers introduced to us pursuant to its marketing services. For further information see:

— “Sale of Shares and Issue of Warrants to Investors” below.

— Note 16 and note 20 to the Consolidated Financial Statements included in this annual report.

— Agreement with Affiliate of Dekel Tzidon

— On March 1, 2004, the Company entered into a consulting agreement with Eyepoint Ltd., an Israeli company wholly owned by Mr. Dekel Tzidon, brother of Mr. Aviv Tzidon, the Chairman of our Board of Directors. Pursuant to this consulting agreement, Mr. Tzidon continues to serve as the Company’s Vice President of Research & Development and Chief Technological Officer. The terms of this agreement were approved by the Company’s Audit Committee in July 2004.

Sale of Shares to Principal Shareholders

Sale of Shares to and Issue of Warrants to H.S.N General Managers Holdings L.P.

        In March 2006, H.S.N General Managers Holdings L.P. (or HSN), an Israeli limited partnership led by Mr. Nir Dor invested $3.6 million in our share capital in consideration for the issuance of 20,000,000 Ordinary Shares, representing approximately 17% of our issued share capital, at a price per share of $0.18. In connection with this investment, HSN was issued three separate warrants for the purchase of 6,000,000 of our Ordinary Shares per each warrant, with exercise prices of $0.36, $0.54 and $1.00, exercisable for a period of three years, with a mandatory exercise mechanism under certain conditions. As of March 2006, Mr. Dor serves as a member of our board of directors.

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Sale of Shares to and Issue of Warrants to Chun

        On November 21, 2003, Chun Holdings Ltd., or Chun, issued a tender offer to purchase all of our outstanding shares for a purchase price of $0.18 per share. Pursuant to the tender offer, which expired on December 30, 2003, some of our shareholders, including Clal Industries Ltd. and our former controlling shareholder Elisra Electronics Systems Ltd., or Elisra, tendered an aggregate of 7,142,608 of their shares, constituting 67% of our issued and outstanding share capital. Upon the request of Chun, all of the tendered shares were registered in the name of its affiliate Chun Holdings L.P., or Chun LP which became our controlling shareholder. As of, March 31, 2007 Chun was holding an aggregate of 49.75% of our outstanding shares and 54.03 % including options that are exercisable within 60 days of March 31, 2007.

        Following the expiration of the tender offer, Elisra no longer held any of our share capital.

        On March 3, 2004, Chun entered into an agreement to purchase 33,333,333 of our Ordinary Shares at a price per share of $0.18 for an aggregate purchase price of $6,000,000. This transaction was approved by our Audit Committee, Board of Directors and by a special majority of our shareholders who did not have a personal interest in the transaction and who voted at our Shareholders Meeting held on March 1, 2004.

        Chun also agreed on such date to provide our company with a credit line in the amount of $3.2 million. In consideration for this credit line our Audit Committee and our Board of Directors agreed, subject to shareholder approval, to grant Chun a four-year warrant to purchase an additional 40,000,000 of our Ordinary Shares for an exercise price of $0.18 per share. A special majority of our shareholders who did not have a personal interest in the transaction and who voted at our shareholders meeting held on March 1, 2004, approved the grant of the warrant. Chun, however, waived its right to receive warrants for the purchase of 10,000,000 of our Ordinary Shares and agreed that such warrants be granted to other investors as disclosed below. During the third quarter of 2004, the $3.2 million credit line was replaced by an additional investment in the same amount made by Chun in our share capital.

Options issued to the Chairman of the Board of Directors

        On January 1, 2004, Aviv Tzidon received an option to purchase 9,000,000 of our Ordinary Shares issued for services rendered as Chairman of our Board of Directors. One fifth of the options will vest upon completion of each full year of service on our Board of Directors, which commenced on November 24, 2003. Each option is exercisable for three years following vesting and is exercisable at a price per share of $0.18. This transaction was approved by our Audit Committee, our Board of Directors and a special majority of our shareholders who did not have a personal interest in the transaction and who voted at our shareholders meeting held on March 1, 2004.

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Sale of Shares and Issuance of Warrants to Investors

        On March 3, 2004, a group of investors entered into an investment agreement to purchase 22,428,225 of our Ordinary Shares at a price per share of $0.18 for an aggregate purchase price of $4,037,080. Two of the investors, Polar Communications Ltd. and Koonras Technologies Ltd., who were also existing security holders of the Company prior to the March 2004 investment, were issued additional shares in consideration for their agreement to convert an aggregate debt owed to them of $100,000 into 555,556 of our Ordinary Shares at a price per share of $0.18. Pursuant to this investment agreement, the investors were also issued four-year warrants to purchase an aggregate of 10,000,000 of our Ordinary Shares with an exercise price of $0.18 per share; Chun LP was initially granted these warrants, but subsequently waived its rights to receive such warrants in favor of the investors, pro rata to their investments. This transaction was approved by our Audit Committee, our Board of Directors and a special majority of our shareholders who did not have a personal interest in the transaction and who voted at our Shareholders Meeting held on March 1, 2004.

Convertible Loan Agreements

        On March 3, 2004, three of our banks, namely Bank Leumi Le-Israel B.M., Bank Hapoalim B.M. and the Industrial Development Bank Ltd., agreed to convert existing loans in the amount of $1.1 million, $700,000 and $200,000, respectively, into 6,111,111; 3,888,889; and 1,111,111 of our Ordinary Shares, respectively.

Employment Agreements

        We have entered into employment agreements with each of our executive officers. See “Item 6 – Directors, Senior Management and Employees – C. Board Practices–Management Employment Agreements.”

C. Interests of Experts and Counsel

        Not applicable.

ITEM 8. Financial Information

A. Consolidated Statements and Other Financial Information

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

Legal Proceedings

        We are not a party to any material legal proceedings.

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B. Significant Changes

        There have been no material changes in our financial position since December 31, 2006; see Item 4 – Information on the Company – A. History and Development of the Company.

ITEM 9. The Offer and Listing

A. Offer and Listing Details

        Our Ordinary Shares have traded on the Over The Counter Bulletin Board under the symbol BVRSF.OB since February 2003 and previously traded on the Nasdaq Small Cap Market from March 2001. From October 1998 until March 2001 our shares were traded on the Nasdaq National Market.

        The following table sets forth, for the periods indicated, the range of high and low sales prices of our Ordinary Shares:

	High		Low
2002
Year ending December 31, 2002	$	3.00	$	0.50
2003
Year ending December 31, 2003	$	1.10	$	0.75
2004
Year ending December 31, 2004	$	1.10	$	0.40
2005
First Quarter	$	0.72	$	0.20
Second Quarter	$	0.21	$	0.16
Third Quarter	$	0.22	$	0.14
Fourth Quarter	$	0.22	$	0.16
2006
First Quarter	$	0.28	$	0.16
Second Quarter	$	0.27	$	0.22
Third Quarter	$	0.24	$	0.18
Fourth Quarter	$	0.22	$	0.15
October	$	0.22	$	0.17
November	$	0.21	$	0.15
December	$	0.21	$	0.17
2007
January	$	0.23	$	0.19
February	$	0.24	$	0.21
March	$	0.23	$	0.21

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B. Plan of Distribution

        Not applicable.

C. Markets

        Our Ordinary Shares traded on the Nasdaq Capital Market until February 13, 2003. Our Ordinary Shares were delisted from the Nasdaq Capital Market after we failed to comply with its required listing standards. Since February 14, 2003, our Ordinary Shares have been traded on the Over-the-Counter Bulletin Board under the symbol “BVRSF.OB”.

D. Selling Shareholders

        Not applicable.

E. Dilution

        Not applicable.

F. Expenses of the Issue

        Not applicable.

ITEM 10. Additional Information

A. Share Capital

        Not applicable.

B. Memorandum and Articles of Association

Objects and Purposes

        We were first registered under Israeli law on January 6, 1998. Our registration number with the Israel Registrar of Companies is 52-004362-1. Our objectives and purposes include the development, design, manufacture and marketing of advanced training systems for military objectives and a wide variety of other business purposes.

Transactions Requiring Special Approval

        An “office holder” is defined in the Companies Law as a director, general manager, chief business manager, deputy general manager, vice general manager and any person assuming the responsibilities of any of the foregoing positions without regard to such person’s title and any other manager who is directly subject to the general manager.

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        The Companies Law imposes a duty of care and a duty of loyalty on all office holders of a company. The duty of care requires an office holder to act with the level of care which a reasonable office holder in the same position would have acted under the same circumstances. The breach of such duty is governed by Israeli contract laws. The duty of care includes a duty to use reasonable means to obtain:

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

— all other important information pertaining to the previous actions.

        The duty of loyalty requires an office holder to act in good faith for the interests of the company and includes a duty to:

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

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

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

— disclose to the company any information or documents relating to a company’s affairs which the office holder has received due to his position as an office holder.

        Each person listed in the table under “Item 6 – Directors, Senior Management and Employees – A. Directors and Senior Management” is an office holder.

        The Companies Law requires that an office holder disclose to the company any personal interest that he or she may have, and all related material information known to him or her, in connection with any existing or proposed transaction by the company. The disclosure is required to be made promptly and in any event, no later than the board of directors meeting in which the transaction is first discussed. A personal interest of an office holder includes an interest of a company in which the office holder is, directly or indirectly, 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. If the transaction is an extraordinary transaction, the office holder must also disclose any personal interest held by his or her relative.

        Under the Companies Law, an extraordinary transaction is a transaction:

— not in the ordinary course of business;

— not on market terms; or

— likely to have a material impact on the company's profitability, assets or liabilities.

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        Under the Companies Law, once an office holder complies with the above disclosure requirement, the board of directors may approve the transaction, unless the company’s articles of association provide otherwise. A transaction that is adverse to the company’s interest may not be approved. If the transaction is an extraordinary transaction, then it also must be approved by the audit committee, before the board approval, and under certain circumstances, by the shareholders of the company. A director who has a personal interest in a matter which is considered at a meeting of the board of directors or the audit committee may not be present at this meeting or vote on this matter. If a majority of the directors has a personal interest in a transaction, these directors are permitted to be present and vote, but shareholder approval is also required.

        Under the Companies Law, the disclosure requirements which apply to an office holder also apply to a controlling shareholder of a public company. A controlling shareholder includes a shareholder that holds 25% or more of the voting rights in a public company if no other shareholder owns more than 50% of the voting rights in the company. Extraordinary transactions of a public company with a controlling shareholder or in which a controlling shareholder has a personal interest, and the terms of compensation of a controlling shareholder who is an office holder, require the approval of the audit committee, the board of directors and the shareholders of the company. The shareholder approval must satisfy either of the following criteria:

— the majority of the votes for the approval includes the votes of at least one-third of the total votes of shareholders who are present at the meeting and who have no personal interest in the transaction; the votes of abstaining shareholders shall not be included in the number of the said total votes; or

— the total number of votes against the approval, among the shareholders who are present at the meeting and who have no personal interest in the transaction shall not exceed 1% of the aggregate voting rights in the company.

        For information concerning the direct and indirect personal interests of certain of our office holders and principal shareholders in certain transactions with us, see “Item 7 – Major Shareholders and Related Party Transactions – B. Related Party Transactions.”

Directors’ Compensation

        Under the Companies Law, all arrangements as to compensation of office holders who are not directors require approval of the board of directors. Arrangements as to compensation of directors also require audit committee approval, before board approval, and shareholder approval. Nevertheless, pursuant to our articles of association, our directors who are not our employees or professional services providers shall not be paid any remuneration for their services unless it was approved by the general meeting of our shareholders.

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Directors Borrowing Powers

        Our board of directors may from time to time, in its discretion, cause the Company to borrow or secure the payment of any sum or sums of money for the purposes of the Company. Such borrowing powers may be exercised by a majority of the board in accordance with our articles of association.

Rights attached to our Shares

        Dividend Rights. Our articles of association provide that our shareholders at a general meeting and upon the recommendation of our board of directors may from time to time, declare such dividend as may appear to be justified but not in excess of our board of directors recommendation. Subject to the rights of the holders of shares with preferential or other special rights that may be authorized in the future, holders of Ordinary Shares are entitled to receive dividends according to their rights and interest in our profits.

        Voting Rights. Holders of Ordinary Shares have one vote for each ordinary share held on all matters submitted to a vote of shareholders. These 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. The Ordinary Shares do not have cumulative voting rights in the election of directors. As a result, holders of Ordinary Shares that represent more than 50% of the voting power have the power to elect all the directors to the exclusion of the remaining shareholders.

        Liquidation Rights. In the event of our liquidation, after satisfaction of liabilities to creditors, our assets will be distributed to the holders of Ordinary Shares in proportion to their respective holdings. This liquidation right may be affected by the grant of preferential dividends or distribution rights to the holders of a class of shares with preferential rights that may be authorized in the future.

        Redemption Provisions. We may, subject to applicable law, issue redeemable preference shares and redeem the same.

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

        Preemptive, First Refusal and Co-Sale Rights. All outstanding Ordinary Shares are validly issued, fully paid and non-assessable and do not have preemptive rights, rights of first refusal or co-sale rights.

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        Transfer of Shares. Fully paid Ordinary Shares are issued in registered form and may be transferred pursuant to our articles of association, unless such transfer is restricted or prohibited by another instrument and subject to applicable securities laws.

Modification of Rights

        Unless otherwise provided by our articles of association, rights attached to any class may be modified or abrogated by a resolution adopted in a general meeting approved by a majority of 75% of the voting power represented at the meeting in person or by proxy and voting thereon, subject to the sanction of a resolution passed by majority of the holders of 75% a majority of the shares of such class present and voting as a separate general meeting of the holders of such class.

Shareholders’ Meetings and Resolutions

        The quorum required for an ordinary meeting of shareholders consists of at least two shareholders present in person or by proxy, who hold or represent between them at least 33-1/3% of the outstanding voting shares, unless otherwise required by applicable rules. A meeting adjourned for lack of a quorum generally is adjourned to the same day in the following week at the same time and place or any time and place as the chairman of the board may designate. At such reconvened meeting the required quorum consists of any two shareholders present in person or by proxy.

        Under the Companies Law, each shareholder of record will be provided at least 21 calendar days’ prior notice of any general shareholders meeting.

        Under the Companies Law and our articles of association, all resolutions of our shareholders require a simple majority of the shares present, in person or by proxy, and voting on the matter, subject to certain exceptions provided for under the Companies Law, which require a majority of at least 75% of the shares present. However, the Companies Law requires that any amendment to the articles of association of a company incorporated prior to February 1, 2000, shall be approved by holders of at least 75% of the voting rights represented at the meeting, in person or by proxy, and voting thereon, unless the articles are amended to the effect of requiring a different majority.

        Under the Companies Law, each and every shareholder has a duty to act in good faith in exercising his rights and fulfilling his obligations towards us and other shareholders, such as in voting in the general meeting of shareholders on the following matters:

— any amendment to the articles of association;

— an increase of our authorized share capital;

— a merger; or

— approval of certain actions and transactions that require shareholder approval.

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

        Our annual general meetings are held once in every calendar year at such time (within a period of not more than fifteen months after the last preceding annual general meeting) and at such place determined by our board. All general meetings other than annual general meetings shall be called extraordinary general meetings. Our board may, whenever it thinks fit, convene an extraordinary general meeting at such time and place as it determines, and shall be obligated to do so upon a requisition in writing in accordance with the Companies Law.

Limitation on Owning Securities

        The ownership of our Ordinary Shares by nonresidents of Israel is not restricted in any way by our memorandum of association and articles of association or the laws of the State of Israel, except for citizens of countries, which are in a state of war with Israel, who may not be recognized as owners of our Ordinary Shares.

Mergers and Acquisitions under Israeli Law

        The Companies Law includes provisions that allow a merger transaction and requires that each company that is a party to a merger have the transaction approved by its board of directors and a vote of at least 75% of its shares, at a shareholders’ meeting called on at least 21 days’ prior notice. For purposes of the shareholders vote, unless a court rules otherwise, the merger will not be deemed approved if a majority of the shares held by parties other than the other party to the merger, or by any person who holds 25% or more of the shares of the other party, or the right to appoint 25% or more of the directors of the other party, vote against the merger. Upon the request of a creditor of either party of the proposed merger, the court may delay or prevent the merger if it concludes that there exists a reasonable concern that as a result of the merger, the surviving company will be unable to satisfy the obligations of any of the parties to the merger. In addition, a merger may not be completed unless at least 50 days have passed from the time that a proposal for the approval of the merger has been filed with the Israel Registrar of Companies and 30 days have passed from the time that the approval of the merging parties’ shareholders has been received.

        The Companies Law also provides that an acquisition of shares of a public company must be made by means of a tender offer if as a result of the acquisition the purchaser would become a 25% shareholder of the company and there is no existing 25% or greater shareholder in the company. If there is no existing 45% or greater shareholder in the company, the Companies Law provides that an acquisition of shares of a public company must be made by means of a tender offer if as a result of the acquisition the purchaser would become a 45% shareholder of the company. Regulations adopted under the Companies Law provide that these tender offer requirements do not apply to companies whose shares are listed for trading outside of Israel if, according to the laws of the country in which the shares have been offered to the public or in which the shares are listed for trading on an exchange, including the rules and regulations of such exchange, there is either a restriction upon any acquisition of control to any extent, or the acquisition of control to any extent requires the purchaser to make a tender offer to the public.

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        If following any acquisition of shares, the acquirer will hold 90% or more of the company’s shares or of a class of shares, the acquisition may not be made other than through a tender offer to acquire all of the shares of such class. If the shareholders who declined the tender offer hold 5% or less of the company’s outstanding share capital or class of shares, all the shares that the acquirer offered to purchase will be transferred to it. However, the tendered shareholders may seek to alter the consideration by court order.

C. Material Contracts

        In September 2001, we entered into an agreement with Aermacchi S.p.A., a leading manufacturer and producer of modern military training aircraft in Europe, for the supply of a MB339 training aircraft full mission simulator and three years of logistical support. The contract price is $7.1 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely achievement of specific milestones during the lifetime of the project. We completed this project during the second quarter of 2003 and enter into the logistical support period. As of March 31, 2006, we received $0.1 million under this contract.

        In April 2003, we entered into a contract with the air force of a Latin American country for the development and supply of an F-16 training facility. The contract price is approximately $5.0 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely achievement of specific milestones during the lifetime of the project. We completed this project during the third quarter of 2005.

        In October 2003, we entered into a contract with the armed forces of a Latin American country for the development and supply of a tank training center. The contract price is approximately $2.7 million, which, as in substantially all of our contracts, is payable in accordance with and subject to timely achievement of specific milestones during the lifetime of the project. We completed this project during the fourth quarter of 2005.

        In November 2003, we entered into a contract, together with a European company, with the navy of a European country for the development and supply of a naval tactical trainer. The contract price is approximately $1.5 million (a significant portion of which will be payable to us), which, as in substantially all of our contracts, is payable in accordance with and subject to timely achievement of specific milestones during the lifetime of the project. We completed this project during the first quarter of 2005.

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        In December 2003, we entered into a leasing contract with the Israel Air Force for the use and maintenance of an ACMI system. The contract price is approximately $0.7 million, and is payable on a monthly basis. We completed this contract during the third quarter of 2005.

        In July 2004, we entered into a follow on contract with a customer in Asia for the provision of integrated logistic support services for a period of three years for a training system that was previously provided by us. The contract price is approximately $1.6 million. We expect to complete this project during the first quarter of 2007. As of March 31, 2007, we received $1.4 million under this contract.

        In August 2004, we entered into a contract with a NATO Member for the provision of EHUD™ Air Combat Maneuvering Instrumentation (ACMI) systems. The contract price is approximately $6.0 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely achievement of specific milestones during the lifetime of the project. We completed this project during the fourth quarter of 2005.

        In October 2004, we entered into a contract with Boeing for the integration of EHUD™ ACMI systems on Boeing’s new F-15K aircraft, to be supplied to the Republic of Korea Air Force. The contract price is approximately $1.5 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely achievement of specific milestones during the lifetime of the project. We completed this project during the fourth quarter of 2006.

        In November 2004, we entered into a contract with Systex Corporation, a leading Asian system integration company for the supply of an infantry multi-weapon firing simulation system. The contract price is approximately $2.6 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely achievement of specific milestones during the lifetime of the project. We expect to complete this project during the fourth quarter of 2007. As of March 31, 2007, we received $1.1 million under this contract.

        In January 2005, we entered into an additional contract with Systex Corporation for the supply of a tank simulation system. The contract price is approximately $1.4 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely achievement of specific milestones during the lifetime of the project. We completed this project during the fourth quarter of 2006.

        In September 2005, we entered into a contract with Elbit Systems for the supply of work-share in a new F-16I simulator for the Israel Air Force. The contract price is approximately $2.2 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely achievement of specific milestones during the lifetime of the project. We expect to complete this project during the first quarter of 2008. As of March 31, 2007, we received $2.0 million under this contract.

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        In January 2006, we entered into an agreement with Aermacchi S.p.A., a leading manufacturer and producer of modern military training aircraft in Europe, for the upgrade of two MB339a training aircraft simulators. The contract price is approximately $4.5 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely achievement of specific milestones during the lifetime of the project. We expect to complete this project during the third quarter of 2007. As of March 31, 2007, we received $2.2 million under this contract.

        In March 2006, we entered into a contract with an international customer for the provision of an F-16 MLU Improved Unit Line Trainer.  The contract price is $2.7 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely milestones during the lifetime of the project.  We expect to complete this project during the first quarter of 2008. As of March 31, 2007, we received $1.8 million under this contract.

        In May 2006, we entered into an agreement with a leading European company for the provision of In-Flight Electronic Warfare Simulator (IFEWS). The contract price is approximately $1.7 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely achievement of specific milestones during the lifetime of the project. We expect to complete this project during the second quarter of 2007. As of March 31, 2007, we received $1.2 million under this contract.

        In September 2006, we entered into a major contract with an international customer for the supply of a distributed naval embedded training system.  The contract price is $11.9 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely milestones during the lifetime of the project.  We expect to complete this project during the fourth quarter of 2010. As of March 31, 2007, we received $3.0 million under this contract.

        In December 2006, we entered into an agreement with a European customer, for the Embedded Virtual Avionics (EVA) solution. The contract price is approximately $1.2 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely achievement of specific milestones during the lifetime of the project. We expect to complete this project during the first quarter of 2007. As of March 31, 2007, we received $1.0 million under this contract.

        In January 2007, we entered into Licenses agreement with an aircraft manufacturer, for the Embedded Virtual Avionics (EVA) patent. As of March 31, 2007, BVR expected to receive approximately $0.5 million, which is payable by two equal installments. As of March 31, 2007, we received $0.1 million under this agreement.

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        In March 2007, we entered into a three years maintenance contract for a naval embedded training system supplied by BVR to an international customer. The contract price is approximately $1.0 million, which is payable in accordance to timely milestones during the lifetime of the project. We expect to complete this project during the first quarter of 2010.

        In March 2007, we entered into an agreement with a European customer, for the Embedded Virtual Avionics (EVA) solution for a leading jet trainer. The contract price is approximately $1.0 million, which, as in substantially all of our contracts, is payable in accordance and subject to timely achievement of specific milestones during the lifetime of the project. We expect to complete this project during the first quarter of 2008.

        For a summary of our other material contracts, see:

— "Item 4 - Information on the Company - A. History and Development of the Company," including a description of the Share Purchase Agreement entered into in March 2006 with H.S.N General Managers Holdings L.P., an Israeli limited partnership led by Mr. Nir Dor.

— “Item 4 – Information on the Company – B. Business Overview –Strategic Relationships,” including a description of the Cooperation Agreement entered into with MLM in August 2005.

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

— "Item 7 - Major Shareholders and Related Party Transactions - B. Related Party Transactions."

D. Exchange Controls

        Under current Israeli regulations, we may pay dividends or other distributions in respect of our Ordinary Shares either in non-Israeli or Israeli currencies. If we make these payments in Israeli currency, they will be freely converted into non-Israeli currencies at the rate of exchange prevailing at the time of conversion. Because exchange rates between the NIS and the dollar continuously fluctuate, a U.S. shareholder will be subject to the risk of currency fluctuations between the date when we declare NIS-denominated dividends and the date when we pay them in NIS. See “Item 3. Key Information– D. Risk Factors.”

        Non-residents of Israel may freely hold and trade our securities pursuant to the general permit issued under the Israeli Currency Control Law, 1978. Neither our memorandum of association nor the laws of the State of Israel restrict in any way the ownership of our Ordinary Shares by non-residents, except that these restrictions may exist with respect to citizens of countries which are in a state of war with Israel.

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E. Taxation

Israeli Tax Considerations and Government Programs

        The following is a summary of the current tax structure applicable to companies in Israel, with special reference to its effect on us. The following also contains a discussion of certain Israeli and United States tax consequences to purchasers of our Ordinary Shares and certain Israeli Government programs benefiting us. To the extent that the discussion is based on new tax legislation that has not been subject to judicial or administrative interpretation, there can be no assurance that the views expressed in the discussion will 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 is not exhaustive of 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.

General Corporate Tax Structure

        Israeli companies are subject to corporate tax at the rate of 29% of taxable income. Under current law, the corporate tax rates are scheduled to be reduced to 28% in January 2008, and are expected to be further reduced to 26% in 2009 and 25% in 2010 and thereafter. However, the effective tax rate payable by a company which derives income from an Approved Enterprise (as further discussed below) may be considerably less.

Tax Benefits under the Law for the Encouragement of Capital Investments, 1959

        On March 30, 2005, the Knesset approved a reform of the Encouragement of Capital Investments Law – 1959 (the “Encouragement Reform”).

        Following in Section A is the outline of The Investment Law before the Encouragement Reform. Section B notes several of the significant changes in the Investment Law which are relevant to our company.

        The Investment Law provides that terms and benefits included in any certificate of approval that was granted before the Encouragement Reform came into effect will remain subject to the provisions of the Investment Law as they were on the date of such approval. Therefore the Encouragement Reform will not apply to any of our programs approved under the Investment Law before the Encouragement Reform.

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A. The Investment Law before the Encouragement Reform

        The Investment Law provides 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.” 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, e.g., the equipment to be purchased and utilized pursuant to the program. The tax benefits derived from any such certificate of approval relate only to taxable income attributable to the specific Approved Enterprise. If a company has more than one approval or only a portion of its capital investments are approved, its effective tax rate is the result of a weighted combination of the applicable rates. The tax benefits under the law are not generally available with respect to income derived from products manufactured outside of Israel.

        Taxable income of a company derived from an Approved Enterprise is subject to corporate tax at a maximum rate of 25% (rather than the ordinary corporate tax rate) for the “benefit period”. The “benefit period” is seven years (and under certain circumstances, as further detailed below, ten years) commencing with the year in which the Approved Enterprise first generates taxable income, and is limited to twelve years from commencement of production or 14 years from the date of approval, whichever is earlier. The Investment Law also provides that a company that has an Approved Enterprise is entitled to accelerated depreciation on its property and equipment that are included in an approved investment program.

        A company owning an Approved Enterprise may elect to receive an “alternative package of benefits”. Under the alternative package of benefits, a company’s undistributed income derived from an Approved Enterprise will be exempt from corporate tax for a period of between two and ten years from the first year of taxable income, depending on the geographic location of the Approved Enterprise within Israel, and such company will be eligible for a reduced tax rate for the remainder of the benefits period.

        Our requests for designation of our capital investment at our facility in Rosh Ha’ayin as an “Approved Enterprise” program were approved under the Investment Law. For this Approved Enterprise, we elected the alternative package of benefits.

        A company that has elected the alternative package of benefits and that subsequently pays a dividend out of income derived from the Approved Enterprise during the tax exemption period will be subject to tax in respect of the amount distributed (including the tax thereon) at the rate which would have been applicable had it not elected the alternative package of benefits (generally 10%-25%, depending on the extent of foreign shareholders holding its ordinary shares). In addition, the dividend recipient is taxed at the reduced rate applicable to dividends from Approved Enterprises (15%), if the dividend is distributed during the tax exemption period or within a specified period thereafter. We must withhold this tax at source, regardless of whether the dividend is converted into foreign currency. See “–Taxation of Ordinary Shares–Taxation of Dividends Paid On Ordinary Shares” and Note 18 to the Consolidated Financial Statements.

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        Subject to certain provisions concerning income under the alternative package of benefits, all dividends are considered to be attributable to the entire enterprise and the effective tax rate on the dividends is the result of a weighted combination of the various applicable tax rates. We are not obliged to distribute exempt retained profits under the alternative package of benefits, and we may generally decide from which year’s profits to declare dividends. We currently intend to reinvest the amount of our tax-exempt income and not to distribute such income as a dividend.

        The Investment Center bases its decision as to whether or not to approve an application on the criteria set forth in the Investment Law and regulations, the then prevailing policy of the Investment Center, and the specific objectives and financial criteria of the applicant. Accordingly, there can be no assurance that any such application will be approved. In addition, the benefits available to an Approved Enterprise are conditional upon the fulfillment of conditions stipulated in the Investment Law and its 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, with the addition of the consumer price index linkage adjustment and interest.

        Subject to compliance with applicable requirements, income derived from our Approved Enterprise facilities will be tax exempt for a period of two years after we have taxable income and will be subject to a reduced rate of corporate tax of up to 25% depending on the extent of foreign shareholders holding our ordinary shares for the following five years. Due to cumulative losses for tax purposes, we have not yet utilized tax benefits derived from our Approved Enterprise facilities.

B. Outline of the primary changes of the Encouragement Reform

        The Encouragement Reform provides that “Approved Enterprise” status will continue to be granted by the Investment Center to qualifying investments. However, the Amendment limits the scope of enterprises which may be approved by the Investment Center by setting criteria for the approval of a facility as an Approved Enterprise, such as provisions generally requiring that at least 25% of the Approved Enterprise’s income will be derived from export.

        The Encouragement Reform also provides that Approved Enterprise status will only be necessary for receiving grants from the Investment Center. As a result, it is no longer necessary for a company to acquire Approved Enterprise status in order to receive the tax benefits previously available under the alternative package of benefits. Rather, a company may claim the tax benefits offered by the Investment Law as amended directly in its tax returns, provided that its facilities meet the criteria for tax benefits set out by the Amendment. Such companies are also no longer required to file reports with the Investment Center. Companies are entitled to approach the Israeli Tax Authority for a pre-ruling regarding their eligibility for benefits under the Encouragement Reform.

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        Tax benefits are available under the Encouragement Reform to production facilities (or other eligible facilities), which are generally required to derive more than 25% of their business income from export. In order to receive the tax benefits, the Encouragement Reform states that the company must make an investment which meets all the conditions set out in the Amendment for tax benefits and exceeds a minimum amount specified in the Law. Such investment allows the company to receive a “Benefited Enterprise” status, and may be made over a period of no more than three years ending on the end of the year in which the company requested to have the tax benefits apply to the Benefited Enterprise (the “Year of Election”). Where the company requests to have the tax benefits apply to an expansion of existing facilities, only the expansion will be considered to be a Benefited Enterprise and the company’s effective tax rate will be the weighted average 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 of the value of the company’s production assets before the expansion, as follows:

Production assets	% of required investment			Required investment
Up to NIS 140 million		12	%	Up to NIS 16.8 million
From NIS 140 - 500 million		7	%	From NIS 9.8 - 35 million
Over NIS 500 million		5	%	From NIS 25 million

        The extent of the tax benefits available under the Amendment to qualifying income of a Benefited Enterprise are determined by the geographic location of the Benefited Enterprise. The location will also determine the period for which tax benefits are available.

        Dividends paid out of income derived by a Benefited Enterprise will be treated similarly to payment of dividends by an Approved Enterprise under the alternative package of benefits. Therefore, dividends paid out of income derived by a Benefited Enterprise (or out of dividends received from a company whose income is derived from a Benefited Enterprise) are generally subject to withholding tax at the rate of 15% (deductible at source). The reduced rate of 15% is limited to dividends and distributions out of income derived from a Benefited Enterprise during the benefits period and actually paid at any time up to 12 years thereafter. A company qualifying for tax benefits under the Amendment which pays a dividend out of income derived by its Benefited Enterprise during a period in which the Benefited Enterprise was exempt from tax will be subject to tax in respect of the gross amount of the dividend at the otherwise applicable rate of 25%, (or lower in the case of a qualified company owned by a certain percentage of non-Israeli residents). The dividend recipient would be subject to tax at the rate of 15% on the amount received which tax would be deducted at source.

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Grants under the Law for the Encouragement of Industrial Research and Development, 1984

        Under the Law for the Encouragement of Industrial Research and Development, 1984, research and development programs which meet certain criteria and are approved by the Research Committee, a governmental committee of the Office of the Chief Scientist are eligible for grants of up to 50% of the project’s expenditure, as determined by the Research Committee, in return for the payment of royalties from the sale of the product developed in accordance with the program. Regulations promulgated under the Research Law generally provide for the payment of royalties to the Chief Scientist ranging from 3% to 5% or in some cases, such as ours, ranging from 4% to 6%, on revenues from products developed using such grants until 100% of the dollar-linked grant is repaid. Following the full repayment of the grant, there is no further liability for payment. See “Item 5–Operating and Financial Review and Prospects” and Note 18 to the Consolidated Financial Statements.

        The terms of the Israeli government participation also require that the manufacture of products developed with government grants be performed in Israel. However, under the regulations promulgated under the Research Law, in the event that any of the manufacturing is performed outside Israel by any entity other than us, if approval is received from the Office of the Chief Scientist for such foreign manufacturing and the identity of the foreign manufacturers, we may be required to pay increased royalties. If the manufacturing volume that is performed outside of Israel is less than 50%, the total amount to be repaid to the Office of the Chief Scientist may be adjusted to 120% of the grant. If the manufacturing volume that is performed outside of Israel is between 50% and 90% the total amount may be adjusted to 150% of the grant and if it is more than 90%, the total amount may be adjusted to 300% of the grant. Since our manufacturing activities are performed by subcontractors outside of Israel, the consent of the Office of the Chief Scientist is required for these activities and additional consents will be required in connection with the manufacturing of products developed in the future with Office of the Chief Scientist grants. The letters of approval under which we received the grants do not specifically refer to our manufacturing activities outside of Israel; however, we believe that the Office of the Chief Scientist has adequately expressed its consent to such activities. There can be no assurance that the consents granted to date by the Office of the Chief Scientist will be deemed to be adequate under applicable laws and regulations or that such consents will not be reversed or modified in any way or that we will obtain consents for such activities at all from the Office of the Chief Scientist in the future. Failure to comply with the requirements for consents for manufacturing outside of Israel could result in penalties, cancellation of grants and denial of any future applications for grants or for these consents. If the consents obtained from the Office of the Chief Scientist to manufacture our products outside of Israel are terminated or if we are unable to obtain similar consents in the future, our business could be harmed. A transfers of the technology developed pursuant to the terms of these grants may be transferred outside of Israel only subject to the payments promulgated under the Research Law and subject to the prior approval of the Research Committee; technology transfers within Israel are also subject to the prior approval of the Research Committee. Such approval is not required for the export of any products resulting from such research or development. Approval of the transfer of technology in Israel may be granted only if the recipient abides by all the provisions of the Research Law and regulations promulgated thereunder, including the restrictions on the transfer of know-how and production and the obligation to pay royalties in an amount that may be increased. There can be no assurance that such consent, if requested, will be granted under reasonable commercial terms. See “Item 5–Operating and Financial Review and Prospects–Government Grants.”

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

        As governmental incentives, the funds generally available for grants from the Office of the Chief Scientist may be reduced in the future and there is no assurance that the government will not abolish such grants in the future. Even if these grants are maintained, there is no assurance we will receive Office of the Chief Scientist grants in the future. In addition, each application to the Office of the Chief Scientist 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 Office of the Chief Scientist. There is no assurance that applications to the Office of the Chief Scientist will be approved and, until approved, the amounts of any such grants are not determinable.

Tax Benefits and Grants for Research and Development

        Israeli tax law allows, under certain conditions, a tax deduction in the year incurred for expenditures (including capital expenditures) in 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 enterprise and is carried out by or on behalf of the company seeking such deduction. Such expenditures not so approved are deductible over a three-year period. However, expenditures made out of proceeds made available to us through government grants are not deductible, according to Israeli law.

Tax Benefits Under the Law for the Encouragement of Industry (Taxes), 1969

        According to the Law for the Encouragement of Industry (Taxes), 1969, or 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 certain government loans, capital gains, interest and dividends), is derived from an “Industrial Enterprise” owned by it. An “Industrial Enterprise” is defined as an enterprise whose major activity in a given tax year is industrial production activity. We believe that we currently qualify as an “Industrial Company” within the definition of the Industry Encouragement Law.

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        Under the Industry Encouragement Law, Industrial Companies are entitled to the following preferred tax benefits:

    (a)        deduction of purchases of know-how and patents over an eight-year period for tax purposes;

    (b)        right to elect under certain conditions to file a consolidated tax return with additional related Israeli Industrial Companies;

    (c)        accelerated depreciation rates on equipment and buildings;

    (d)        deduction over a three-year period of expenses related to the issuance and listing of shares on a stock exchange;

        Eligibility for the benefits under the Industry Encouragement Law is not subject to receipt of prior approval from any governmental authority. No assurance can be given that we qualify or that we will continue to qualify as an “Industrial Company” or that the benefits described above will be available in the future.

Special Provisions Relating to Taxation Under Inflationary Conditions

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

    (a)        There is a special tax adjustment for the preservation of equity whereby certain corporate assets are classified broadly into fixed (inflation resistant) assets and non-fixed (soft) assets. 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.

    (b)        Subject to certain limitations, depreciation deductions on fixed assets and losses carried forward are adjusted for inflation based on the increase in the consumer price index.

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Capital Gains Tax on Sales of Our Ordinary Shares

         Israeli law generally imposes on residents and non-residents capital gains tax on the sale of capital assets in Israel, including our ordinary shares, 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 the inflationary surplus and the real gain.  The inflationary surplus is a portion of the total capital gain which is equivalent to the increase of the relevant asset’s purchase price that 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. 

        On January 1, 2006, an amendment to the Israeli tax regime became effective (the “2006 Tax Reform”). The 2006 Tax Reform significantly changed the tax rates applicable to income derived from shares.

        According to the 2006 Tax Reform, an individual is subject to a 20% tax rate on real capital gains derived from the sale of shares, as long as the individual is not a “substantial shareholder” (generally a shareholder with 10% or more of the right to profits, right to nominate a director and voting rights) of the company issuing the shares. There will generally be no capital gains tax on the inflationary surplus. The rate on the gains from publicly traded shares applicable to gains that were realized before January 1, 2006 was 15%.

        A substantial shareholder will be subject to tax at a rate of 25% in respect of real capital gains derived from the sale of shares issued by the company in which he or she is a substantial shareholder. The determination of whether the individual is a substantial shareholder will be made on the date that the securities are sold. In addition, the individual will be deemed to be a substantial shareholder if at any time during the 12 months proceeding this date he had been a substantial shareholder.

        With respect to gains accrued before January 1, 2003, regulations promulgated under the Israeli Income Tax Ordinance provided for an exemption from Israeli capital gains tax on gains that were derived from the sale of shares of an “Industrial Company”, as defined by the Industry Encouragement Law. This exemption only applied to shares that were traded on specified non-Israeli markets, including the NASDAQ National Market, provided that the sellers purchased their shares either in the company’s initial public offering or in public market transactions thereafter. The exemption did not apply to shareholders who are in the business of trading securities, or to shareholders that are Israeli resident companies and subject to the Income Tax Law (Inflationary Adjustments) – 1985. We believe that we are currently an Industrial Company, as defined by the Industry Encouragement Law. There can be no assurance that the Israeli tax authorities will not deny our status as an Industrial Company, possibly with retroactive effect.

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           Non-Israeli residents are exempt from Israeli capital gains tax on any gains derived from the sale of shares in an Israeli corporation publicly traded on the TASE and/or on a foreign stock exchange, provided such gains do not derive from a permanent establishment of such shareholders in Israel and that such shareholders did not acquire their shares prior to the issuer’s initial public offering. However, non-Israeli corporations will not be entitled to such exemption if an Israeli resident (i) has a controlling interest of 25% or more in such non-Israeli corporation, or (ii) is the beneficiary of or is 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.

        Pursuant to the treaty between the Governments of the United States and Israel with respect to taxes on income, or the U.S.-Israel tax treaty, the sale, exchange or disposition of our ordinary shares by a person who qualifies as a resident of the United States under the treaty and who is entitled to claim the benefits afforded to him by the treaty, will generally not be subject to Israeli capital gains tax. This exemption shall not apply to a person who held, directly or indirectly, shares representing 10% or more of the voting power in our company during any part of the 12-month period preceding the sale, exchange or disposition, subject to certain conditions. A sale, exchange or disposition of our shares by a U.S. resident qualified under the treaty, who held, directly or indirectly, shares representing 10% or more of the voting power in our company at any time during the preceding 12-month period would be subject to Israeli tax, to the extent applicable; however, under the treaty, this U.S. resident would be permitted to claim a credit for these taxes against the U.S. income tax with respect to the sale, exchange or disposition, subject to the limitations in U.S. laws applicable to foreign tax credits.

Taxation of Dividends

        Non-residents of Israel are subject to income tax on income accrued or derived from sources in Israel.  These sources of income include passive income such as dividends, royalties and interest, as well as non-passive income from services rendered in Israel.  On distributions of dividends other than bonus shares, or stock dividends, to Israeli individuals and foreign resident individuals and corporations we would be required to withhold income tax at the rate of 20%.  If the income out of which the dividend is being paid is attributable to an Approved Enterprise under the Law for the Encouragement of Capital Investments, 1959, the rate is 15%.  A different rate may be provided for in a treaty between Israel and the shareholder’s country of residence.  Under the U.S.-Israel tax treaty, if the income out of which the dividend is being paid is not attributable to an Approved Enterprise, then income tax with respect to shareholders that are U.S. corporations holding at least 10% of our voting power in the twelve-month period preceding the distribution of such dividends, is required to be withheld at the rate of 12.5%. 

Foreign Exchange Regulations

        Dividends (if any) paid to the holders of our Ordinary Shares and any amounts payable upon our dissolution, liquidation or winding up, as well as the proceeds of any sale in Israel of the Ordinary Shares to an Israeli resident, may be paid in non-Israeli currency or, if paid in Israeli currency, may be freely converted into dollars at the rate of exchange prevailing at the time of conversion. Because exchange rates between the NIS and the dollar fluctuate continuously, a U.S. shareholder will be subject to the risk of currency fluctuations between the date when we declare NIS-denominated dividends and the date when we pay them in NIS.

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F. Dividends and Paying Agents

        Not applicable.

G. Statements by Experts.

        Not applicable.

H. Documents on Display

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

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

I. Subsidiary Information

        Not applicable.

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ITEM 11. Quantitative and Qualitative Disclosures About Market Risk

        Market risk represents the risk of changes in the value of a financial instrument caused by fluctuations in interest rates, equity prices and foreign exchange rates.

Interest Rate Risk

        We are exposed to interest rate volatility primarily relating to interest rate changes applicable to our withdrawals under our credit lines. Our credit lines bear interest at rates, which vary with changes in LIBOR. We do not speculate on the future direction of such interest rates. On March 2004, the Company reached an agreement with its principal bank lenders for the repayment of $6.55 million and the deferral of repayment of long-term loans totaling $1.5 million until the years 2005, 2006 and 2007. As of December 31, 2006, current maturities of long – term loans, $ 0.5 million bore interest at variable rates. The weighted average interest rates on short-term bank credit (linked to the U.S. dollar) as at December 31, 2006, 2005 and 2004 are 6.9%, 5.4% and 3.85, respectively. As of December 31, 2006, the interest expenses we attributed to the utilization of our credit lines amounted to $36,000. Interest risk is estimated as the potential increase in interest expenses from a hypothetical 10% increase in the interest rates. Assuming a hypothetical 10% increase, our interest expenses would increase by $3,000.

Equity Price Risk

        As of December 31, 2006, we did not have any marketable securities that were recorded at a fair value; hence there was no exposure to equity price risk

Foreign Currency Exchange Risk

        As of December 31, 2006, we had cash and cash equivalents in New Israeli Shekels (NIS) or in funds linked thereto in the amount of $636,000 (out of $3.4 million in cash and cash equivalents that we had in total). Market risk is estimated as the potential decrease in fair value resulting from a hypothetical 10% increase in the year-end dollar exchange rate. Assuming such increase in the dollar exchange rate, the fair value of our cash and cash equivalents would decrease immaterially by $58,000. As of December 31, 2006, we had accounts receivable in New Israeli Shekels (NIS) or in funds linked thereto in the amount of $72,000. Market risk is estimated as the potential decrease in fair value resulting from a hypothetical 10% increase in the year-end dollar exchange rate. Assuming such increase in the dollar exchange rate, the fair value of our accounts receivable would decrease by $7,000. As of December 31, 2006, we had other receivables in New Israeli Shekels (NIS) or in funds linked thereto in the amount of $28,000. Market risk is estimated as the potential decrease in fair value resulting from a hypothetical 10% increase in the year-end dollar exchange rate. Assuming such increase in the dollar exchange rate, the fair value of our accounts receivable would decrease by $3,000.As of December 31, 2006, we had accounts payable in New Israeli Shekels (NIS) or in funds linked thereto in the amount of $617,000. Market risk is estimated as the potential increase in fair value resulting from a hypothetical 10% decrease in the year-end dollar exchange rate. Assuming such a decrease in the Dollar exchange rate, the fair value of our accounts payable would increase by $56,000. As of December 31, 2006, we had other payable in New Israeli Shekels (NIS) or in funds linked thereto in the amount of $1,302,000. Market risk is estimated as the potential increase in fair value resulting from a hypothetical 10% decrease in the year-end dollar exchange rate. Assuming such a decrease in the dollar exchange rate, the fair value of our accounts payable would increase by $118,000. As of December 31, 2006, we had long-term payable in New Israeli Shekels (NIS) or in funds linked thereto in the amount of $320,000. Market risk is estimated as the potential increase in fair value resulting from a hypothetical 10% decrease in the year-end dollar exchange rate. Assuming such a decrease in the dollar exchange rate, the fair value of our accounts payable would increase by $29,000.

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        As of December 31, 2006, we had cash and cash equivalents in Singapore dollars or SGD or in funds linked thereto in the aggregate amount of $176,000. Market risk is estimated as the potential decrease in fair value resulting from a hypothetical 10% increase in the year-end dollar/SGD exchange rate. Assuming such an increase in the dollar/SGD exchange rate, the fair value of our SGD accounts receivable would decrease by $16,000. As of December 31, 2006 we had accounts receivable in SGD or in funds linked thereto in the aggregate amount of $55,000. Market risk is estimated as the potential decrease in fair value resulting from a hypothetical 10% increase in the year-end dollar/SGD exchange rate. Assuming such an increase in the dollar/SGD exchange rate, the fair value of our SGD accounts receivable would decrease by $5,000. As of December 31, 2006 we had other receivable and other payable in SGD or in funds linked thereto in the aggregate amount of $8,000 and $16,000, respectively. Market risk is estimated as the potential decrease in fair value resulting from a hypothetical 10% increase in the year-end dollar/SGD exchange rate. Assuming such an increase in the dollar/SGD exchange rate, the results of operations of the Company would not have any material effect.

        As of December 31, 2006, we had cash and cash equivalents in Euro or in funds linked thereto in the aggregate amount of $115,000. Market risk is estimated as the potential increase in fair value resulting from a hypothetical 10% decrease in the year-end dollar/Euro exchange rate. Assuming such a decrease in the dollar/Euro exchange rate, the fair value of our other payables in Euro would increase by $10,000. As of December 31, 2006, we had accounts receivable in Euro or in funds linked thereto in the aggregate amount of $1,035,000. Market risk is estimated as the potential decrease in fair value resulting from a hypothetical 10% increase in the year-end dollar/ Euro exchange rate. Assuming such an increase in the dollar/SGD exchange rate, the fair value of our Euro accounts receivable would decrease by $94,000. As of December 31, 2006, we had account payables in Euro or in funds linked thereto in the aggregate amount of $73,000. Market risk is estimated as the potential increase in fair value resulting from a hypothetical 10% decrease in the year-end dollar/Euro exchange rate. Assuming such a decrease in the dollar/Euro exchange rate, the fair value of our other payables in Euro would increase by $7,000.As of December 31, 2006, we had other payables in Euro or in funds linked thereto in the aggregate amount of $217,000. Market risk is estimated as the potential increase in fair value resulting from a hypothetical 10% decrease in the year-end dollar/Euro exchange rate. Assuming such a decrease in the dollar/Euro exchange rate, the fair value of our other payables in Euro would increase by $20,000.

81

PART II

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

        Not applicable.

ITEM 15. Controls and Procedures

        We have established and maintain disclosure controls and procedures that are designed to ensure that material information relating to us that we file or submit under the Securities Exchange Act of 1934 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 the company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

        As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of disclosure controls and procedures. Based on that evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2006.

82

        The Chief Executive Officer and Chief Financial Officer have also concluded that there were no significant changes in the our internal controls or in other factors that could significantly affect the internal controls subsequent to the date that the evaluation was completed, including any corrective actions with regard to significant deficiencies and material weaknesses.

ITEM 16 Reserved

ITEM 16A Audit Committee Financial Expert

        Our board of directors has determined that Orit Stav is our audit committee financial expert.

83

ITEM 16B Code of Ethics

        On May 13, 2004, our company adopted a code of ethics, which applies to all of our employees, officers and directors, including our chief executive officer, our chief financial officer and our principal accounting officer or controller or other persons performing similar functions.

        Copies of our code of ethics will be available at our executive offices upon request.

ITEM 16C Principal Accountant Fees and Services

        The following table presents fees for professional audit services rendered by Somekh Chaikin, a member of KPMG International (independent auditors) for the audit of the Company’s consolidated annual financial statements for the years ended December 31, 2006 and 2005, and fees billed for other services rendered by Somekh Chaikin, a member of KPMG International (independent auditors).

	2006		2005
	(In thousands)
Audit Fees(1)	$	89	$	111
Audit-Related Fees(2)				-
Tax Fees(3)		6		-
All Other Fees(4)		15		-

(1) Audit fees consist of fees for professional services rendered for the audit of the Company’s Consolidated Financial Statements and review of financial statements and services normally provided by the independent auditor in connection with statutory and regulatory filings or engagements.

(2) Audit-related fees are fees principally for assurance and related services that are not reported under Audit Fees.

(3) Tax fees consist of tax compliance fees for the preparation of original and amended tax returns, claims for refunds and tax advice.  

(4) Fees regarding due diligence of a company BVR considered of buying.

Pre-approval Policies and procedures

        The audit committee approves all audit, audit-related services, tax services and other services provided by KPMG. Any services provided by KPMG that are not specially included within the scope of the audit must be pre-approved by our audit committee prior to any engagement.

84

ITEM 16D Exemptions from the Listing and Standards of Audit Committees

        Not applicable.

ITEM 16E Purchases of Equity Securities by the Issuer and Affiliated Purchasers

        For information relating to the purchase of our securities by Chun LP see “Item 7 – Major Shareholders and Related Party Transactions – B. Related Party Transactions.”

PART III

ITEM 17 Financial Statements

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

ITEM 18 Financial Statements

We have responded to Item 17 in lieu of this item

85

ITEM 19 EXHIBITS

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

Exhibit No. Description

1.1* Memorandum of Association of Registrant

1.2* Form of Articles of Association

4.1** Management Services Agreement, dated March 18, 2002, between the Registrant and Elisra Electronic System Ltd. (an English summary accompanied by Hebrew original)

4.2*** Management Services Agreement, dated April 6, 2003, between the Registrant and Elisra Electronic System Ltd. (an English summary accompanied by Hebrew original)

4.3† Lease Agreement, dated September 14, 1999, as amended, between BVR Technologies Ltd. and Minrav Holdings Ltd. (an English summary accompanied by Hebrew original)

4.4† Lease Agreement, dated August 29, 1999, between the Registrant and Electra Real Estate Ltd.(an English summary accompanied by Hebrew original)

4.5**** Share Purchase Agreement, dated March 1, 2004 between the Registrant and the purchasers identified therein

4.6**** Cooperation Agreement, dated August 11, 2005, between the Registrant and Israel Aircraft Industries on behalf of MLM. As this addendum is written in Hebrew, a translation is attached hereto.

4.7**** Share Purchase Agreement, dated March 5, 2006 between the Registrant and Nir Dor on behalf of H.S.N General Managers Holdings L.P., an Israeli Limited Partnership.

8† Subsidiaries of the Registrant

10.1 Consent of Independent Registered Public Accounting firm.

12.1 Certification by Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

12.2 Certification by Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

13.1 Certification by Chief Executive Officer pursuant to 18 U.S.C., Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002

86

13.2 Certification by Chief Financial Officer pursuant to 18 U.S.C., Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002

†     Incorporated by reference to the annual report on Form 20-F for the year ended December 31, 2000.

*     Incorporated by reference to the Registration Statement on Form 20-F (Commission File No. 0-29884).

**     Incorporated by reference to the annual report on Form 20-F for the year ended December 31, 2001.

***     Incorporated by reference to the annual report on Form 20-F for the year ended December 31, 2002.

****     Incorporated by reference to the annual report on Form 20-F for the year ended December 31, 2000.

87

SIGNATURE

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

B.V.R. SYSTEMS (1998) LTD.


By: /s/ Ilan Gillies
——————————————
Ilan Gillies
Chief Executive Officer

By: /s/ Reuven Shahar
——————————————
Reuven Shahar
Chief Financial Officer

Date: May 10, 2007

88

B.V.R. Systems (1998) Ltd.

Financial Statements
As of and For The Year Ended
December 31, 2006

B.V.R. Systems (1998) Ltd.

Consolidated Financial Statements as of December 31, 2006

Contents

	Page
Report of Independent Registered Public Accounting Firm	F-2
Consolidated Balance Sheets as of December 31, 2006 and 2005	F-3 - F-4
Consolidated Statements of Operations for the years
ended December 31, 2006, 2005 and 2004	F-5
Consolidated Statement of Changes in Shareholders' Equity for the years
ended December 31, 2006, 2005 and 2004	F-6
Consolidated Statements of Cash Flows for the years
ended December 31,2006, 2005 and 2004	F-7 - F-8
Notes to Consolidated Financial Statements	F-9 - F-41

Report of Independent Registered Public Accounting Firm
To the Shareholders of B.V.R. Systems (1998) Ltd.

We have audited the accompanying consolidated balance sheets of B.V.R. Systems (1998) Ltd. (the Company) and its subsidiary as of December 31, 2006 and 2005, and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Company’s management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and its subsidiary as of December 31, 2006 and 2005, and the consolidated results of their operations, changes in shareholders’ equity and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with generally accepted accounting principles in Israel.

As discussed in Notes 2O and 2T to the consolidated financial statements, effective January 1, 2006, the Company changed its method of accounting for share-based compensation upon adoption of Israeli Accounting Standard No. 24 “Share-Based Payments”.

Accounting principles generally accepted in Israel vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in Note 21 to the consolidated financial statements. As described in Note 21B, the Company has restated its statements of net income for the years ended December 31, 2005 and 2004.

Somekh Chaikin
Certified Public Accountants (Isr.)
Member Firm of KPMG International

Tel Aviv, Israel

May 10, 2007

F - 2

B.V.R. Systems (1998) Ltd.

Consolidated Balance Sheets as of December 31

			2006		2005
	Note		US$ thousands		US$ thousands
Assets
Current assets
Cash and cash equivalents		2D,3		3,421		3,057
Restricted bank deposits		2D		967		2,271
Trade receivables		4		4,383		1,479
Other receivables and prepaid expenses		5		262		291
Inventories		6		2,021		2,076
Total current assets				11,054		9,174
Other non-current assets		7		1,155		93
Fixed assets, net		8		865		844
Other assets, net		2P		219		-
Total assets				13,293		10,111

/s/ Aviv Tzidon
——————————————
Aviv Tzidon
Chairman of the Board of Directors /s/ Ilan Gillies
——————————————
Ilan Gillies
President and Chief
Executive Officer /s/ Reuven Shahar
——————————————
Reuven Shahar
Chief Financial Officer

Approval date of the financial statements: May 10, 2007

F - 3

B.V.R. Systems (1998) Ltd.

Consolidated Balance Sheets as of December 31

			2006			2005
	Note		US$ thousands			US$ thousands
Liabilities and Shareholders' equity
Current liabilities
Current maturities of long-term bank loans		13		516			517
Short-term loan		9		120			120
Trade payables		10		1,487			1,564
Excess of advances from customers over amounts
recognized as revenue		11		2,952			854
Other payables and accrued expenses		12		2,492			2,077
Total current liabilities				7,567			5,132
Long-term liabilities
Long-term bank loans		13		-			516
Long-term payable in respect of income tax		17H		154			607
Liability for employee severance benefits, net		14		166			79
Total long-term liabilities				320			1,202
Commitments and contingencies		16
Shareholders' equity		15
Share capital:
Ordinary shares, NIS 1.00 par value
400,000,000 and 200,000,000 shares authorized,
116,863,757and 95,863,757 shares issued,
and 116,863,757 and 95,663,757 shares outstanding
as of December 31, 2006 and 2005, respectively				25,861			21,306
Additional paid-in capital				16,992			*17,695
Accumulated deficit				(37,447	)		*(35,224	)
Total shareholders' equity				5,406			3,777
Total liabilities and shareholders' equity				13,293			10,111

* Restated (See Note 2T)

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

F - 4

B.V.R. Systems (1998) Ltd.

Consolidated Statements of Operations for the years ended December 31

			2006			2005			2004
	Note		US$ thousands
Revenues:
Sales				9,827			17,450			12,684
Royalties and commissions		16A		276			1,746			-
Total revenues		19A		10,103			19,196			12,684
Cost of revenues		19B		7,866			(1)* 14,806			(1) 10,291
Gross profit				2,237			* 4,390			2,393
Operating expenses:
Research and development				615			614			294
Selling and marketing				1,430			1,356			1,139
General and administrative				2,155			2,117			1,822
Operating profit (loss)				(1,963	)		303			(862	)
Financial expenses, net		19C		(185	)		(187	)		(496	)
Other income (expenses), net		19D		-			(2	)		192
Profit (loss) before income taxes				(2,148	)		114			(1,166	)
Income tax expense		17		(75	)		(1) -			(1) (59	)
Net profit (loss) for the year				(2,223	)		* 114			(1,225	)
Profit (loss) per share:
Basic and diluted profit (loss) per share (in US $)				(0.02	)		0.00			(0.01	)
Weighted-average number of ordinary
shares of nominal NIS 1.00 par value
outstanding (in thousands) used in
calculation of the basic and diluted profit
(loss) per share				112,361			95,528			106,342

* Restated (see Note 2T).

⁽¹⁾ Reclassified

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

F - 5

B.V.R. Systems (1998) Ltd.

Statement of Changes in Shareholders' Equity

	Number of Ordinary Shares outstanding (NIS 1 par value)		Share capital		Additional paid-in capital			Accumulated deficit			Total shareholders' equity
			US$ thousands		US$ thousands			US$ thousands			US$ thousands
Balance as of
January 1, 2004		10,660,874		2,529		21,408			(34,113	)		(10,176	)
Issuance of shares and options		66,872,669		14,744		**(2,911)			-			11,833
Issuance of shares in
respect of services		200,000		45		(9	)					36
Exercise of stock options		17,666,667		3,929		**(788)			-			3,141
Net loss for the year		-		-		-			(1,225	)		(1,225	)
Balance as of
December 31, 2004		95,400,210		21,247		17,700			(35,338	)		3,609
Issuance of shares
in respect of services		263,547		59		(12	)		-			47
Employee stock option
compensation		-		-		*7			-			*7
Net profit for the year		-		-		-			*114			*114
Balance as of
December 31, 2005		95,663,757		21,306		*17,695			* (35,224)			3,777
Issuance of shares
in respect of services		1,200,000		262		(41	)		-			221
Issuance of shares and
warrants		20,000,000		4,293		(693	)		-			3,600
Employee stock option
compensation		-		-		31			-			31
Net loss for the year		-		-		-			(2,223	)		(2,223	)
Balance as of
December 31, 2006		116,863,757		25,861		16,992			(37,447	)		5,406

* Restated (see Note 2T)

** Net of issuance expenses of US$ 243 thousand

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

F - 6

B.V.R. Systems (1998) Ltd.

Consolidated Statements of Cash Flows

	Year ended December 31
	2006			2005			2004
	US$ thousands
Cash flows from operating activities
Net profit (loss) for the year		(2,223	)		*114			(1,225	)
Adjustments to reconcile net profit (loss) to net cash flows
from operating activities (A)		(219	)		*905			(727	)
Net cash (used in) provided by operating activities		(2,442	)		1,019			(1,952	)
Cash flows from investing activities
Purchases of fixed assets		(295	)		(339	)		(113	)
Proceeds from sale of fixed assets		-			6			-
Decrease in long-term deposits		-			25			-
Decrease (increase) in restricted bank deposits		310			199			(2,563	)
Other assets		(292	)		-			-
Changes in loans to employees		-			-			(9	)
Net cash used in investing activities		(277	)		(109	)		(2,685	)
Cash flows from financing activities
Short-term bank credit, net		-			-			(6,566	)
Repayment of short-term loan from related party		-			-			(430	)
Repayment of long-term loans from related parties		-			-			(204	)
Repayment of long-term loans from banks		(517	)		(517	)		-
Issuance of shares		3,600			-			9,733
Exercise of stock options and warrants		-			-			3,141
Net cash provided by (used in) financing activities		3,083			(517	)		5,674
Increase in cash and cash equivalents		364			393			1,037
Cash and cash equivalents at the beginning of the year		3,057			2,664			1,627
Cash and cash equivalents at the end of the year		3,421			3,057			2,664

* Restated (see Note 2T)

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

F - 7

B.V.R. Systems (1998) Ltd.

Consolidated Statements of Cash Flows (cont'd)

	Year ended December 31
	2006			2005			2004
	US$ thousands
A.   Adjustments to reconcile net profit (loss) to net
cash flows from operating activities
Income and expenses not involving cash flows:
Gain on sale of fixed assets		-			(2	)		-
Depreciation and amortization		394			364			690
Stock based compensation		31			*7			-
Increase (decrease) in liability for employee
severance benefits, net		87			10			(391	)
Forgiveness of debt		-			-			(177	)
Services in exchange for shares issuance		114			47			36
		626			426			158
Changes in operating asset and liability items:
Decrease (increase) in trade receivables		(2,904	)		2,405			210
Decrease in other receivables and prepaid expenses		68			144			439
Increase (decrease) in excess of advances from customers
over amount recognized as revenue		2,098			(2,425	)		(307	)
Decrease in inventories		55			1,163			164
Decrease in trade payables		(124	)		(640	)		(1,064	)
Decrease in other payables and accrued expenses
(current and non-current)		(38	)		(168	)		(327	)
		(845	)		479			(885	)
		(219	)		*905			(727	)
B.   Non-cash transactions
Accounts payable in respect of fixed assets		47			-			61
Prepaid expenses in respect of share issuance		107			-			-
Conversion of short-term bank credit and long-term
loans from related parties into share capital, additional
paid-in capital and options		-			-			2,100

* Restated (see Note 2T)

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

F - 8

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 1 – General

A. B.V.R. Systems (1998) Ltd. (“Company”), an Israeli incorporated company, was formed on January 6, 1998 in order to receive all of the assets and liabilities of the defense-related business of B.V.R. Technologies Limited (“BVR Tech”), a company formed in 1986, which were spun off to the Company on October 23, 1998 in exchange for the Company’s shares issued to the then shareholders of BVR Tech. In June 1998, the Company formed a subsidiary in Singapore, BVR-S Pacific PTE, which operates in Singapore.

The Company is engaged in developing, manufacturing and marketing of advanced training and computer-based simulation systems for military applications.

The Company’s business is exposed to numerous risks including product development, technological advancement and the introduction of these products to the world’s markets. Companies engaged in this field are required to invest significant resources and constantly update products. The future success of the Company is dependent upon the technological sophistication, price and quality of its products, and the provision of solutions to meet customers’ needs in comparison to competitors. The principal markets for the Company’s products are mainly Europe, Israel and the Far East. Most of the Company’s customers are either government institutions or entities controlled by governments.

B. In December 2003, Chun Holding L.P. (“Chun”), a limited partnership controlled by Aviv Tzidon, Aeronautics Defense Systems Ltd. and Prescient Systems & Technologies Pte. Ltd., gained control of the Company by purchasing the Company’s shares through a tender offer, from other shareholders and through a share issuance in March 2004 (see Note 15C for more details). As of December 31, 2006, Chun holds approximately 50% of the outstanding shares of the Company.

C. At December 31, 2006, the Company has working capital of $3.5 million, and cash and cash equivalents balance of $3.4 million, compared to cash and cash equivalents balance of $3.1 million at December 31, 2005. In addition, during the year ended December 31, 2006, the Company’s total revenues from sales, commissions and royalties totaled $10.1 million compared to $19.2 million during 2005, with a negative cash flow from operations during 2006 of $2.4 million. Based on current forecasts, management believes that the Company has sufficient liquidity to finance operations for the next twelve months.

F - 9

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 2 – Significant Accounting Policies

The financial statements have been prepared in accordance with generally accepted accounting principles in Israel. See Note 21 for reconciliation to accounting principles generally accepted in the United States.

A. Financial statements in U.S. dollars

The currency of the primary economic environment in which the operations of the Company and its subsidiary are conducted is the U.S. dollars (“Dollar”, or “$”).

The majority of the Company’s sales are made outside Israel in dollars, and a substantial portion of the Company’s costs are incurred in dollars. Accordingly, the Company has determined that the dollar is the currency of its primary economic environment and thus its functional currency.

The Company’s transactions and balances denominated in dollars are presented at their original amounts. Transactions denominated in currencies other than dollars are translated into dollars using current exchange rates. All foreign currency transaction gains and losses are reflected in the statements of operations as financial income or expenses, as appropriate.

B. Principles of consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All intercompany transactions and balances were eliminated in consolidation.

C. Use of estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. These are management’s best estimates based on experience and historical data. Actual results could differ from those estimates.

D. Cash equivalents and restricted bank deposits

The Company considers all highly liquid investments with a maturity of three months or less from date of purchase, to be cash equivalents.

Restricted bank deposits are comprised of cash deposited in banks in respect of bank guarantees granted to the Company’s customers as partial collateral for the continued performance of work and advances received from the customers. The withdrawal of these deposits is based on the progress of the work and is subject to customer approval. The Company recorded liens on these deposits in favor of the banks that granted the guarantees. The restricted deposits are linked to the U.S. dollar and bear annual interest of 4.66%.

F - 10

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 2 – Significant Accounting Policies (cont’d)

E. Inventories

Inventories are stated at the lower of cost or market value. Cost is determined as follows:

Raw materials and components	- On the "first-in, first-out" method
Finished products	- On the basis of actual manufacturing cost.

F. Trade receivables

Open accounts include amounts billed to customers relating to transactions arising in the ordinary course of business. Customers of the Company in the context of long-term contracts are billed in accordance with milestones determined in the agreements. In respect of the majority of the contracts, advances are paid upon the signing of the contract.

G. Allowance for doubtful accounts

The financial statements include an allowance which Management believes adequately reflects the loss inherent in receivables for which collection is in doubt. In determining the adequacy of the allowance Management based its estimate on information at hand about specific debtors, including their financial situation, aging of the receivable and evaluation of the security received from them or their guarantors, if any.

H. Fixed assets

Fixed assets are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated using straight-line method using annual rates and periods as follows:

	%
Computer and electronic equipment	20 - 33.3
Manufacturing equipment	10 - 15
Office equipment	6 - 15
Leasehold improvements	The shorter of the estimated useful lives and the
	lease term of the related leasehold

F - 11

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 2 – Significant Accounting Policies (cont’d)

I. Revenue recognition

(1) Recognition of revenues and costs from long-term contracts

Revenue and costs from work in progress under long-term contracts are recognized in accordance with Israeli Accounting Standard No. 4 as follows:

a. Revenues and costs from work performed under long-term contracts are recognized according to the “percentage-of-completion” method, if all of the following conditions are fulfilled: the revenues are known or capable of being reliably estimated, collection of the revenues is probable, the costs involved with execution of the work are known or capable of being reliably estimated, there is no material uncertainty regarding the ability to complete the work and comply with the contractual terms with the customer and the rate of completion can be reliably estimated. If the conditions enumerated above are not met, income is recognized at the level of the costs incurred and expected to be recovered (“zero margin”).

b. The percentage of completion is measured on the basis of cost (the ratio of the costs incurred to the total estimated costs). Work in progress under long-term contracts is stated at cost less amounts charged to cost of revenues in the statement of operations and associated with revenue recognized on the basis of the “percentage-of-completion” method. Cost includes direct costs of materials, labor, subcontractor and other direct costs and allocated indirect manufacturing costs.

c. Anticipated losses on contracts are provided for in full when determined to be expected.

d. Estimated profit or loss from long-term contracts may change due to changes in estimates resulting from differences between actual performance and original forecasts. The effect of such changes in estimates is recognized in the statement of operations at the time of their identification.

e. The Company provides warranties on sales of systems to certain customers for periods of up to 24 months, however not beyond the date of sale. The expenses related to the warranty period are taken into consideration in the direct cost of the contracts, based on management’s estimation and in accordance with the Company’s prior experience.

(2) Revenue from royalties and commissions

Royalties and commission revenues resulting from the cooperation agreement with Israel Aircraft Industries Ltd. (“IAI”) (see Note 16A for more details), are being recognized when the related payments are received by IAI. The Company determines such revenues by receiving confirmation of payments subject to royalties and commissions from IAI.

F - 12

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 2 – Significant Accounting Policies (cont’d)

J. Research and development costs

Research and development costs are charged to the statement of operations, as incurred.

K. Selling and marketing costs

Selling and marketing costs are charged to selling and marketing expenses in the statement of operations.

L. Income taxes

Income taxes for all periods presented have been computed on the basis of income tax rates applicable to the Company and its subsidiary as separate stand-alone entities.

The Company accounts for income taxes under the liability method of accounting.

Under the liability method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, as well as loss carry forwards, and are measured using the prevailing tax rates and laws that will be in effect when the differences are expected to be utilized. The main factors, in respect of which deferred taxes were not calculated is the realization of investment in a subsidiary that management intends to retain. Similarly, deferred taxes have not been provided for future taxable distributions from the subsidiary, since it is the Company’s policy not to initiate a distribution of dividends that involves additional tax liability.

Deferred tax assets for future tax benefits are not included where their realization is less than probable. As such, the Company has recorded a full valuation allowance in regard to all tax loss carry forwards as well as for other temporary differences (see Note 17F).

M. Impairment in value of assets

The Company applies Israeli Accounting Standard No. 15 – Impairment in Value of Assets (hereinafter – Standard No. 15). Standard No. 15 provides procedures which a company must apply in order to ensure that its assets in the consolidated balance sheet (to which the standard applies), are not presented at an amount which is in excess of their recoverable value, which is the higher of the net selling price and the use value (the present value of the estimated future cash flows expected to be derived from use and disposal of the asset).

The standard applies to all the assets in the consolidated balance sheet, except inventory, deferred tax assets and monetary assets. In addition, the standard provides rules for presentation and disclosure with respect to assets whose value has been impaired. When the value of an asset in the consolidated balance sheet is higher than its recoverable value, the Company recognizes a loss from the impairment in value in the amount of the difference between the book value of the asset and its recoverable value. The loss thus recognized will be cancelled only in the event of changes occurring in the estimates that were used to determine the recoverable value of the asset since the date on which the most recent loss from the impairment in value was recognized.

F - 13

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 2 – Significant Accounting Policies (cont’d)

N. Basic and diluted income (loss) per share

Until December 31, 2005, basic profit (loss) per share was computed based on the weighted average number of Ordinary Shares of nominal NIS 1.00 par value outstanding during each year, plus the effect of options and warrants outstanding at year-end the exercise of which is probable. Diluted profit (loss) per share was computed based on the weighted average number of Ordinary Shares used for computing the basic profit (loss) per share plus options and warrants which were not included in the basic profit (loss) per share calculation and which do not have an anti-dilutive effect.

As of January 1, 2006 the Company implemented Israeli Accounting Standard No. 21, “Earnings per Share” (hereinafter – Standard No. 21) of the Israel Accounting Standards Board (hereinafter – IASB). In accordance with the provisions of the Standard, the Company calculates basic earnings or loss per share with respect to earnings or loss, and basic earnings or loss per share with respect to earnings or loss from continuing operations, which is attributable to the ordinary shareholders. The basic earnings per share are calculated by dividing the earnings or loss attributable to the ordinary shareholders by the weighted average number of ordinary shares outstanding during the period. In order to calculate the diluted earnings per share, the Company adjusts the earnings or loss attributable to the ordinary shareholders, and the weighted average number of outstanding ordinary shares, in respect of the effects of all the dilutive potential ordinary shares (such as options).

O. Accounting for stock-based compensation

Until December 31, 2005, the Company recorded expenses with respect to stock options granted to employees and service providers that provide similar services to those provided by employees, in accordance with the intrinsic value method described in United States Accounting Principles Board Opinion No. 25 (APB No. 25) “Accounting for Stock Issued to Employees”. Shares issued to service providers were recorded based on the cost of service provided at the grant date of the shares issued.

As of January 1, 2006, the Company adopted Israeli Accounting Standard No. 24, “Share-Based Payments” (hereinafter – Standard No. 24) which requires that share-based payment transactions, including transactions with employees or other parties that are to be settled by equity instruments, cash or other assets, be recognized in the financial statements. In accordance with Standard No. 24, share-based payment transactions in which goods or services are received will be recognized at their fair value. Standard No. 24 applies to share-based payment transactions conducted after March 15, 2005 that have not yet vested on January 1, 2006. Furthermore, the Standard applies to liabilities deriving from share-based payment transactions existing on January 1, 2006. Standard No. 24 requires that comparative data relating to periods after March 15, 2005 be restated. As of December 31, 2005, the charge for equity-settled share-based payments in the Consolidated Statement of Operations is US$ 7 thousand (see Note 2T).

The Company records salary expense and an increase in its shareholders’ equity, over the vesting periods, based on the fair value of the options on the grant date, using the Black & Scholes pricing model.

F - 14

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 2 – Significant Accounting Policies (cont’d)

P. Other Assets

Other assets are comprised of costs incurred internally for the development of computer software intended for sale, lease or marketing which are reported at the lower of unamortized cost or net realizable value in accordance with the guidelines prescribed by Statement of Financial Accounting Standard (“SFAS”) No. 86 “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed”. Capitalization of software development costs is made upon reaching technological feasibility and is discontinued when the product is available for sale to customers. In 2006, the Company had technological feasibility and capitalized US$ 292 thousand development computer software costs as other assets. Capitalized software development costs are amortized over a period of three years, based on the expected useful life of the software. Amortization expense for the year ended December 31, 2006 was US$ 73 thousand. In 2004 and 2005, the Company recorded US$ 74 thousand and US$ 296 thousand, respectively as research and development expense in regards to the software development.

Q. Concentration of credit risk

Financial instruments that potentially subject the Company to concentration of credit risk consist mainly of cash and cash equivalents, restricted bank deposits and trade receivables.

At December 31, 2006 and 2005, the Company had cash and cash equivalents, and restricted bank deposits which were deposited with major Israeli banks. Management believes that the financial institutions that hold the Company’s investments are financially sound, and, accordingly, minimal credit risk exists with respect to these investments.

Trade receivables include amounts billed to customers. Management periodically evaluates the collectibility of these trade receivables and adjusts the allowance for doubtful accounts to reflect the amounts estimated to be doubtful of collection.

The Company operates on the basis of agreements it signs with its customers. As the Company manages a limited number of projects at the same time, a delay in the execution of a project may have a material effect on the financial results of any given period. The majority of the Company’s transactions in progress are with major customers, see Note 19A.

R. Fair value of financial instruments

The fair market value of the Company’s financial instruments, which are cash and cash equivalents, restricted bank deposits, loan from related party, trade receivables, short and long-term debt, trade payables, other payables and accrued expenses, and excess of advances from customers over amounts recognized as revenues approximate their carrying value as of December 31, 2006 and 2005, due to their short-term nature. The carrying amounts of the Company’s borrowings under its loan agreements approximate their fair value, since they bear interest that changes according to the LIBOR rate.

S. Derivative financial instruments

Derivative financial instruments, held for hedging, are deferred and recognized when the hedged transactions occur.

Derivative financial instruments, not held for hedging, are stated in the financial statements at their fair value. Changes in fair value are recognized as they occur.

The fair value of derivative financial instruments is determined based on their market value and, when there is no market value, then according to a valuation model.

F - 15

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 2 – Significant Accounting Policies (cont’d)

T. Change in accounting principle and reclassification

The consolidated financial statements as of and for the year ended December 31, 2005, were restated in order to give retroactive effect to the change in the method of accounting for share-based payment transactions upon adoption of Standard No. 24 (see Note 2O).

(1) The retrospective effect on the Consolidated Statement of Operations is as follows:

	Year ended December 31, 2005
	As reported		As restated
	US$ thousands		US$ thousands
Cost of revenues		14,739		*14,806
Gross profit		4,457		*4,390
Net profit for the year		121		114

* Income taxes in the amount of US$ 60 thousand were classified to cost of revenues in previous period.

(2) The effect on the consolidated statements of change in Shareholders’ Equity is as follows:

	December 31, 2005
	As reported			As restated
	US$ thousands			US$ thousands
Addition paid-in capital		17,688			17,695
Accumulated deficit		(35,217	)		(35,224	)

U. Disclosure of effect of new accounting standards in the period prior to their implementation

1. In July 2006, the Israel Accounting Standards Board (hereinafter – IASB) published Accounting Standard No. 29, “Adoption of International Financial Reporting Standards” (“IFRS”). The Standard provides that entities subject to the Israeli Securities Law – 1968 that are required to report according to the regulations of this law are to prepare their financial statements for periods beginning as from January 1, 2008, according to IFRS. The Standard permits early adoption for financial statements published after July 31, 2006.

The Company will adopt IFRS with effect from January 1, 2008, based upon the guidance of IFRS 1, “First Time Adoption of IFRSs”. Upon adoption of IFRS in 2008, the Company will be required to present comparative financial statements as of and for the year ended December 31, 2007, prepared in accordance with IFRSs. The Company is examining the effects of the adoption of IFRS, but at this point is unable to evaluate the effect on its consolidated financial statements. The Company does not intend to implement IFRS earlier than required.

F - 16

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 2 – Significant Accounting Policies (cont’d)

U. Disclosure of effect of new accounting standards in the period prior to their implementation (cont’d)

2. In August 2006, the IASB published Accounting Standard No. 26, “Inventory”. The Standard provides guidelines for determining the cost of inventory and its subsequent recognition as an expense as well as for determining impairment in value of inventory written down to net realizable value. The Standard also provides guidelines regarding cost formulas used to allocate costs to various types of inventory. The Standard will apply to financial statements for periods beginning on January 1, 2007, or thereafter. Implementation of the Standard is not anticipated to have a material effect on the Company’s results of operations and financial position.

3. In September 2006, the IASB published Accounting Standard No. 27, “Fixed Assets”. The Standard prescribes rules for the presentation, measurement and derecognition of property, plant and equipment and for the disclosure required in respect thereto. The Standard provides that upon the initial recognition of property, plant and equipment, the entity shall include in the cost of the item all the costs it will be required to incur in respect of a liability to dismantle and remove the asset and to restore the site on which it was located. Furthermore, the Standard provides that a group of similar fixed assets shall be measured at cost net of accumulated depreciation, and less impairment losses, or alternatively, at its revalued amount less accumulated depreciation, whereas an increase in the value of the asset to above its initial cost as a result of the revaluation will be directly included in shareholders’ equity under a revaluation reserve. Any part of a fixed asset with a cost that is significant in relation to the total cost of the item shall be depreciated separately, including the costs of significant periodic examinations. The Standard also provides that a fixed asset that was purchased in consideration for another non-monetary item in a transaction having a commercial substance shall be measured at fair value.

If property, plant and equipment consist of several components with different estimated useful lives, the individual significant components should be depreciated over their individual useful lives.

Standard No. 27 will apply to financial statements for periods beginning on or after January 1, 2007, and will be adopted on a retroactive basis, except for asset retirement obligations for which initial adoption will be in accordance with the provision of Standard No. 27. Implementation of the Standard is not anticipated to have any effect on the Company’s results of operations and financial position.

4. In December 2006, the IASB published Accounting Standard No. 23, “The Accounting Treatment of Transactions between an Entity and its Controlling Shareholder”. The Standard replaces the Israeli Securities Regulations (Financial Statement Presentation of Transactions between a Company and its Controlling Shareholder) – 1996 and provides that assets and liabilities included in a transaction between the entity and its controlling shareholder shall be measured on the date of the transaction at fair value and that the difference between the fair value and the consideration from the transaction shall be included in shareholders’ equity. A debit difference is recorded as a dividend and, accordingly, reduces retained earnings. A credit difference is recorded as an investment of the shareholder and shall, therefore, be presented under a separate item of shareholders’ equity called “capital reserve from transaction between an entity and its controlling shareholder”.

F - 17

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 2 – Significant Accounting Policies (cont’d)

U. Disclosure of effect of new accounting standards in the period prior to their implementation (cont’d)

The Standard discusses three issues relating to transactions between an entity and its controlling shareholder, as follows: (1) the transfer of an asset to the entity by the controlling shareholder, or conversely, transfer of an asset from the entity to the controlling shareholder; (2) the controlling shareholder assuming upon itself a liability of the entity to a third party, all or part, indemnification of the entity by the controlling shareholder in respect of an expense, and the controlling shareholder waiving the entity’s debt to it, all or part; and (3) loans that were granted to the controlling shareholder or loans that were received from the controlling shareholder. The Standard also provides the disclosure that is to be made in the financial statements regarding transactions between the entity and its controlling shareholder during the period. The Standard shall apply to transactions between an entity and its controlling shareholder that are executed after January 1, 2007 and to a loan that was granted to a controlling shareholder or that was received from it before the date this Standard came into effect as from the date of it coming into effect. In the opinion of the Company, implementation of the new standard is not anticipated to have a material effect on the Company’s results of operations and financial position.

5. In March 2007 the IASB published Accounting Standard No. 30, “Intangible Assets”. The Standard explains the accounting treatment of intangible assets and defines how to measure the book value of these assets, as well as the disclosures that are required. The Standard is implemented retroactively.

A research and development asset shall be recognized in the amount of its value less the amortization that would have accumulated from the date of creation until December 31, 2006 on the basis of the useful life of the asset, and less any accrued impairment losses. The amount of the adjustment shall be included in the balance of retained earnings of January 1, 2007.

Implementation of the Standard is not anticipated to have effect on the Company’s results of operations and financial position.

Note 3 – Cash and Cash Equivalents

	December 31
	2006		2005
	US$ thousands		US$ thousands
In U.S. dollars		2,494		1,968
In New Israeli Shekels		636		657
In other foreign currencies (Euro and Singapore Dollar)		291		432
		3,421		3,057

F - 18

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 4 – Trade Receivables

	December 31
	2006		2005
	US$ thousands		US$ thousands
Open accounts		1,176		331
Unbilled revenue *		2,991		934
Receivables from related parties (see Note 20A)		51		180
Receivables from IAI (see Note 16A)		165		34
		4,383		1,479

* Unbilled revenue is comprised as follows:

Accumulated amounts recognized as revenues	24,646	19,524
Less - advances from customers	21,655	18,670
	2,991	854
Other income receivable	-	80
Unbilled revenue	2,991	934

Information on contracts for long-term projects

	December 31 2006 and the year then ended		December 31 2005 and the year then ended
	Contracts for projects		Contracts for projects
	US$ thousands		US$ thousands
Amount of contracts for long-term projects
signed during the year		17,694		8,157
Portion of the cumulative amount of contracts
for long-term projects not yet recognized as
income at the year end		19,193		8,848

F - 19

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 5 – Other Receivables and Prepaid Expenses

	December 31
	2006		2005
	US$ thousands		US$ thousands
Prepaid expenses		122		178
Receivables in respect of work in progress		104		59
Loans to employees		23		-
Others		80		116
		329		353
Less - allowance for doubtful accounts		67		62
		262		291

Note 6 – Inventories

	December 31
	2006		2005
	US$ thousands		US$ thousands
Finished products		1,969		1,969
Components for systems manufacturing		-		55
Raw materials		52		52
		2,021		2,076

Note 7 – Other Non-Current Assets

	December 31
	2006		2005
	US$ thousands		US$ thousands
Non-current restricted bank deposits		1,087		93
Non-current prepaid expenses		68		-
		1,155		93

F - 20

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 8 – Fixed Assets

	December 31
	2006		2005
	US$ thousands		US$ thousands
Computer and electronic equipment		7,192		6,899
Manufacturing equipment		2,001		1,981
Office equipment		912		903
Leasehold improvements		274		254
		10,379		10,037
Less - accumulated depreciation and amortization		9,514		9,193
Net book value		865		844

Depreciation and amortization expense recorded for the years ended December 31, 2006, 2005 and 2004 was US$ 321 thousand, US$ 364 thousand and US$ 690 thousand, respectively.

Note 9 – Short-Term Loan

On October 1, 2003, shareholders of the Company (at that date) granted loans in the total amount of US$601 thousand, for a period of two years, bearing no interest. On March 2, 2004, loans in the amount of US$ 100 thousand were converted into shares of the Company, at a price of US$ 0.18 per share. On April 20, 2004, the Company reached an agreement for the repayment of US$ 204 thousand and a waiver of US$ 177 thousand out of the then outstanding loan amount.

As of December 31, 2006 and 2005, a loan in the amount of US$120 thousand is outstanding, bearing no interest. The Company expects to repay this loan during 2007.

Note 10 – Trade Payables

	December 31
	2006		2005
	US$ thousands		US$ thousands
Payables to IAI (see Note 16A)		207		129
Open accounts		995		1,228
Sub-contractor payables		285		207
		1,487		1,564

F - 21

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 11 – Excess of Advances from Customers over Amounts Recognized as Revenue

	December 31
	2006		2005
	US$ thousands		US$ thousands
Advances from customers		9,565		11,326
Less - cumulative amounts recognized as revenue		6,613		10,472
		2,952		854

Note 12 – Other Payables and Accrued Expenses

	December 31
	2006		2005
	US$ thousands		US$ thousands
Payroll and related accruals		721		525
Provision for losses and completion		282		353
Government authorities		562		480
Other accrued expenses		927		719
		2,492		2,077

Note 13 – Long-Term Bank Loans

A. Balances according to linkage basis and rates of interest

	Linkage Basis	Rates of Interest		December 31
				2006			2005
		%		US$ thousands			US$ thousands
Long-term bank loans	US dollar		6.929		516			1,033
Less - current maturities					(516	)		(517	)
					-			516

B. During the second quarter of 2004, the Company reached an agreement with its principal bank to reschedule the repayment of loans in the amount of US$ 1,550 thousand, in three equal annual installments for the years 2005, 2006 and 2007.

F - 22

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 14 – Liability for Employee Severance Benefits, Net

A. Under Israeli law, the Company is required to make severance payments to dismissed employees and to employees terminating employment under certain other circumstances. The Company’s liability for severance pay is fully provided for through insurance policies and by accrual.

Due to a reduction in salaries effective from October 1, 2002 and in accordance with an agreement between the Company and its employees, the liability for severance pay calculation is divided into two periods, until the salary reduction and subsequently.

The calculation was based on the number of years of employment until September 30, 2002 multiplied by the latest salary paid as of September, 2002, plus the number of years of employment commencing October 1, 2002 multiplied by the latest salary paid.

	December 31
	2006		2005
	US$ thousands		US$ thousands
Severance pay		1,477		1,212
Less - amounts funded*		1,311		1,133
		166		79

* The Company may only withdraw amounts funded for the purpose of severance pay disbursement.

B. Severance pay expenses (income) recorded for the years ended December 31, 2006, 2005 and 2004 were US$ 90 thousand, US$ 8 thousand and US$ (78) thousand, respectively.

Note 15 – Shareholders’ Equity

A. The Company’s ordinary shares are traded in the United States on the Over the Counter Bulletin Board (OTCBB) under the symbol BVRSF.OB.

B.

	Issued				Outstanding
	December 31				December 31
	2006		2005		2006		2005
Ordinary shares of
NIS 1.00 par value		116,863,757		95,863,757		116,863,757		95,663,757

The authorized share capital of the Company as of December 31, 2005 was NIS 200,000,000 divided into 200,000,000 shares.

On July 25, 2006, the shareholders of the Company approved the increase of the authorized share capital of the Company to NIS 400,000,000, divided into 400,000,000 ordinary shares par value NIS 1.00 each.

F - 23

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 15 – Shareholders’ Equity (cont’d)

C. On March 1, 2004, and during 2004, the Company completed the issuance of 66,872,669 shares, in the amount of US$ 11.8 million, of which US$ 9.8 million was issued in exchange for cash and $2.1 million was issued in exchange for the conversion of loans from banks and from a controlling shareholder.

In addition, Chun (see Note 1B) was granted an option (the “Options”) to purchase 40,000,000 ordinary shares of the Company, for an additional investment amount of up to US$7.2 million at an exercise price per share of US$ 0.18, for a period of four years. The option will expire in March 2008.

Chun has resolved, and instructed the Company, accordingly, that even though the shareholders of the Company have voted for the grant of all the options to Chun, Chun shall only be entitled to 28,531,111 of the options and the remaining 11,468,889 options shall be distributed as follows: 10,000,000 among the other shareholders of the Company, pro-rata to the cash invested by them during 2004, and 1,468,889 to the Company’s principal banks.

During the third quarter of 2004, Chun exercised 17,666,667 options into shares for the amount of US$ 3,180 thousand. At December 31, 2006 and 2005, there are 22,333,333 options outstanding.

D. On March 21, 2006, the Company issued to a group of new investors 20,000,000 ordinary shares, for a total consideration of $ 3.6 million, together with three separate warrants for the purchase of 6,000,000 ordinary shares per each warrant, with exercise prices of $ 0.36, $ 0.54 and $ 1.00, exercisable for a period of three years, with a mandatory exercise mechanism under certain conditions.

E. In January 2004, the Company signed a three-year consulting agreement with Wise Pte Ltd. (“Wise”), a company owned and controlled by the brother of Aviv Tzidon, the Company’s Chairman of the Board of Directors.

According to the agreement, Wise will provide the Company marketing services in the Far East, in consideration of a monthly payment of US$ 3,000 each month by way of issuance of 16,667 of the Company’s ordinary shares each month.

During each of the years 2004, 2005 and 2006, the Company issued 200,000 ordinary shares, totaling 600,000 ordinary shares issued in respect to this agreement.

F. On June 8, 2005, the Company issued to Tact Computers and Systems Ltd. (“Tact”) 63,547 ordinary shares of the Company in consideration for the services provided by Tact under a service agreement signed on February 2004.

G. On January 1, 2006, the Company signed an expansion to the agreement signed with Electra Real-Estate Ltd. (“Electra”) during August 1999. According to the expansion, the Company issued to Electra 1,000,000 ordinary shares of the Company in consideration for part of the lease payments for the premises occupied by the Company.

F - 24

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 15 – Shareholders’ Equity (cont’d)

H. Share-based compensation

1. In August 2001, the Board of Directors of the Company approved an option plan to grant options for the purchase of up to 707,900 ordinary shares to the Company’s employees, directors and subcontractors. Each option is exercisable into one ordinary share of the Company at exercise prices of US$ 0.90 – US$ 2.69, equal to the market price of the share on the date of issuance.

The aforesaid options are exercisable in two increments, one third after one year from the date of issuance and two thirds after two years from the date of issuance. The options will expire after three years from the vesting date of each increment. At December 31, 2006, there are 32,600 options outstanding under this plan. No other options are available for additional grants under this plan.

2. In 2004, the Company granted Aviv Tzidon, the Chairman of the Board of Directors, an option to purchase 9,000,000 ordinary shares of the Company vested in five equal increments subject to him serving as an active Chairman of the Board of Directors. The exercise price per share shall be US$ 0.18. The options will expire after three years from the vesting date of each installment. As at December 31, 2006, there are 9,000,000 options outstanding, 5,400,000 of which are exercisable.

At the same date, the Company also granted to each of the Company’s directors (not including Aviv Tzidon), options to purchase 72,000 shares of the Company (total of 648,000 shares), at an exercise per share of US$ 0.18. The options were subject to the completion of a full year of service. As at December 31, 2006, there are 576,000 options outstanding and exercisable, after the cancellation of 72,000 options of one director who did not complete a full year of service.

3. In January 2004, the Company’s Board of Directors approved the grant of up to 5,000,000 options to the Company’s employees and service providers. In 2006, the Company’s Board of Directors approved an increase to the total option program to 5,200,000 options. Each option is exercisable into one ordinary share of the Company. At December 31, 2006, there are 3,924,000 options outstanding for employees and there are 1,064,000 options outstanding for service providers, 1,661,600 and 586,000 of which are exercisable for employees and service providers, respectively. As of December 31, 2005, there were 3,657,000 options outstanding for employees, of which 83,000 options were cancelled during 2006.

The options are exercisable at prices of US$ 0.145 to US$ 0.65 per share, and are exercisable in five equal increments commencing one year after their issuance. The options will expire after three years from the vesting date of each increment.

The cost of the benefit inherent in the options based on the fair value on the day of their grant in accordance with the provisions of Standard No. 24 of the Israel Accounting Standards Board (see Note 2O) amounts to approximately US$ 68 and US$ 29 thousand for 2006 and 2005, respectively. This amount will be recognized as an expense over the vesting period of each portion. An expense in the amount of US$ 31 thousand and US$ 7 thousand was recorded in 2006 and 2005, respectively.

F - 25

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 15 – Shareholders’ Equity (cont’d)

H. Share-based compensation (cont’d)

4. Data in respect of the option plans

a. A summary of the status of the Company’s stock option plans as of December 31, 2006, 2005 and 2004, and changes during the years then ended, is as follows:

	As of December 31,
	2006					2005					2004
	Number of options			Weighted average exercise price (US$)		Number of options			Weighted average exercise price (US$)		Number of options			Weighted average exercise price (US$)
Options
outstanding at
the beginning
of the year		14,695,300			0.24		16,026,136			0.52		1,660,686			3.90
Granted		350,000			0.20		208,000			0.17		14,833,000			0.19
Forfeited		(448,700	)		1.97		(1,538,836	)		3.23		(467,550	)		1.93
Outstanding at
the end of
the year		14,596,600			0.19		14,695,300			0.24		16,026,136			0.52
Options
exercisable at
year-end		8,256,200			0.19		5,805,300			0.33		3,529,136			1.70

b. The following table summarizes information relating to stock options at December 31, 2006:

	Number of Options
	Outstanding		Exercisable
Exercise price (US$)
2.69		16,600		16,600
2.06		10,000		10,000
0.9		6,000		6,000
0.65		80,000		32,000
0.55		30,000		12,000
0.23		120,000		6,000
0.185		260,000		-
0.18		13,896,000		8,138,000
0.17		138,000		27,600
0.145		40,000		8,000
		14,596,600		8,256,200

F - 26

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 15 – Shareholders’ Equity (cont’d)

H. Share-based compensation (cont’d)

4. Data in respect of the option plans (cont’d)

c. Outstanding options as at December 31, 2006 may be exercised as follows:

	Number of options		Weighted average exercise price (US$)
Immediately		8,256,200		0.19
First year		2,719,600		0.18
Second year or thereafter		3,620,800		0.18
		14,596,600

d. The fair value of the options granted and accounted for under Standard No. 24 was calculated on the basis of the Black & Scholes model for the pricing of options. The parameters that were used in order to implement the model are as follows:

	Option Granting date
	June 2005			August 2005			March 2006			June 2006			August 2006
Share price(in US$)		0.17			0.145			0.19			0.23			0.185
Exercise price
(in US$)		0.17			0.145			0.19			0.23			0.185
Expected volatility		175	%		173	%		167	%		165	%		163	%
Life of options
(in years)		2-4			2-4			2-4			2-4			2-4
Risk-free
interest rate		3.74	%		4.24	%		4.74	%		4.96	%		4.95	%
Rate of anticipated
dividends		0			0			0			0			0

The expected volatility was determined on the basis of the historical volatility in the Company’s share prices.

The life of the option warrants was determined on the basis of the management’s estimate of the period the employees will hold the options, taking into consideration their position with the Company and the Company’s experience regarding the turnover of employees.

The risk-free interest was determined on the basis of the yield to maturity of US$-denominated Government debentures with a remaining life equal to the anticipated life of the option warrants.

F - 27

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 16 – Commitments and Contingent Liabilities

A. Cooperation agreement

The Company developed, manufactured and marketed the “Ehud” system pursuant to a joint venture agreement entered into in 1992 with the MLM division of Israel Aircraft Industries Ltd. (the “IAI Agreement”). Pursuant to the IAI Agreement, the Company and IAI agreed to jointly develop, manufacture and market the “Ehud”, with IAI subcontracting certain of the manufacturing and integration work with respect to the “Ehud” product to the Company. The IAI Agreement expired pursuant to its terms in October 1997.

During August 1999, the Company signed a new agreement with IAI (the “1999 Agreement”) which governs the cooperation between the parties and which also provides guidelines for fair competition between the parties, this without adversely impacting existing agreements previously signed with third parties.

The parties have agreed that the “Ehud” system will be marketed by each of the parties, in various territories, in consideration of the payment of various royalties to the other party.

As part of the 1999 Agreement, the following worldwide territories have been delineated:

1. A territory in which one party operates exclusively requires payment of royalties to the other party at the rate of 4.75% – 12.5% of the contract consideration with respect to contracts executed in such countries until 2008. The party receiving the royalty shall not operate in this territory in any manner whatsoever.

2. A territory in which the parties may compete, the selling party is required to pay the other party royalties at the rate of 4%-8% of the contract consideration, with respect to contracts executed in such countries until 2008.

3. Countries not included in a. and b., above, shall be covered by a separate arrangement.

The agreement, whose terms are set forth above, apply to the sale of the “Ehud”systems. With regard to other product, separate royalty payment arrangements were set up.

On August 11, 2005, the Company and IAI signed a new agreement (the “2005 Agreement”) which continues and expands the 1999 Agreement. The 2005 Agreement expands cooperation between the parties in the marketing of Naval Combat Maneuvering Instrumentation Systems in various countries worldwide through the transfer of work share from the leading party to the other. The 2005 Agreement also sets the rate of royalties in all territories to 5% with respect to “Ehud” Systems. In addition, the 2005 Agreement resolved all disagreements between the parties prior to January 1, 2005. The term of the 2005 Agreement is for 10 years. As result of the resolution of the disagreements between the parties, the Company released during 2005, certain previously accrued liabilities in the amount of $780 thousand that are no longer payable as a result of the new agreement signed with IAI in 2005, this amount was credited to the cost of revenues during 2005. In 2006 and 2005, the Company recognized royalty revenue from IAI in the amount of US$ 0.3 million and US$ 1.7 million, respectively.

Furthermore, the Company recorded royalty fees to IAI in the amount of US$ 0.2 million and US$ 0.3 million for the years ended December 31, 2006 and 2005, respectively.

F - 28

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 16 – Commitments and Contingent Liabilities (cont’d)

B. Lease commitments

The premises occupied by the Company are rented under various operating leases expiring at the end of September 2009. The future minimum annual rental payments as of December 31, 2006 are as follows:

Year ending December 31,	US$ thousand
2007		406
2008		274
2009		196
		876

C. Spin-off

In connection with the 1998 spin-off (see Note 1) the Company and BVR Tech entered into several agreements for the purpose of giving effect to the spin-off and defining the Company’s and BVR Tech’s working relationship, as follows:

1. The Company and BVR Tech each undertook to indemnify and/or compensate the other (the “Injured Party”) for any amount, damage or expense that the Injured Party incurs in consequence of a third-party claim relating to a field of activity of the indemnifying party, concerning events occurring before the effective date of the spin-off, provided that the Injured Party notified the indemnifying party of the third-party claim and allowed the indemnifying party to manage and defend such claim. As of December 31, 2006, the Company has no information that would indicate that any material payments will be required in respect of this agreement.

2. The Company and BVR Tech entered into an agreement concerning technology transfers and cross licenses between each of the parties. Under this agreement, BVR Tech transferred to the Company the rights to co-ownership of BVR Tech’s intellectual property as related to the defense-related operations transferred to the Company pursuant to the spin-off agreement. In January 2003, the Company and BVR Tech entered into a Technology Transfer and Assignment Agreement pursuant to which the Company purchased from BVR Tech all rights, title and interest to all patents that were in the co-ownership of the parties, in consideration for US$12 thousand.

3. BVR Tech will only be entitled to exploit such intellectual property rights for its activities that do not conflict with the Company’s activities as conducted at the time of consummation of the spin off plan other than with respect to applications relating to simulation and training systems for commercial applications which shall be exploited solely by the Company. The Company and BVR Tech further agreed not to compete with each other’s business activities.

F - 29

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 16 – Commitments and Contingent Liabilities (cont’d)

D. Liabilities and guarantees

1. In order to provide security for the credit received from banks and for the bank guarantees provided in favor of the Company, the Company registered first degree fixed and floating liens on money deposits, a floating lien on all its property, assets and related insurance benefits and a floating lien on its unpaid share capital, its goodwill and its plant, assets and rights.

2. On certain occasions the Company deposits cash and cash equivalents with certain financial institutions that have issued guarantees on behalf of the Company in favor of its customers. In order to fulfill the above-mentioned commitments, the Company places a charge on its bank deposits (including the insurance rights attached thereto). At December 31, 2006, there are US$ 2,054 thousand in current and non-current restricted bank deposits (as at December 31, 2005 – US$ 2,364 thousand current and non-current restricted bank deposits).

3. Guarantees issued by banks in favor of the Company are as follows:

	December 31
	2006		2005
	US$ thousands		US$ thousands
Performance guarantees		6,087		6,294
Advance payment guarantees		5,423		2,266
Other bank guarantees		602		492

The expiration dates of the guarantees are up to October 31, 2012. Bank charges on those guarantees are attributed to financial expenses.

E. Derivative financial instruments

The Company enters, from time to time, into foreign currency future contracts and put and call options contracts to reduce the impact of fluctuations of certain currencies against the U.S. dollar resulting primarily from firm commitments not denominated in U.S. dollars. Gains or losses resulting from qualified hedges of firm commitments are deferred and recognized when the hedged transactions occur, while results of transactions which do not meet all the criteria specified in SFAS No. 52 and SFAS No. 80 are recorded as financial income or expense.

F. In November 2006, the Board of directors approved the new service agreement signed with Wise (see Note 15E) effective as of January 1, 2007. According to the agreement, Wise will provide marketing and support services in Singapore in exchange for a gross monthly fee of US$ 3,500 for marketing services and a gross monthly fee of US$ 3,500 for the support services. In the event that during the term of the new agreement, the Company shall receive a purchase order for its products or services based on the marketing services, Wise shall be entitled to a commission as follows: (a) on the first US$ 1,000,000 received from a purchase order a commission equal to 3%; (b) on amounts between US$ 1,000,000 and up to US$ 3,000,000 – a commission equal to 2%; (c) on amounts over US$ 3,000,000-a commission equal to 1%.

The new agreement is for a period of two years from the effective date.

F - 30

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 17 – Income Taxes

A. Tax benefits under the Israeli 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, mainly accelerated depreciation of machinery and equipment, as prescribed by regulations published under the Israeli Income Tax (Inflationary Adjustments) Law, 1985 (see Note 17C), the right to claim public issuance expenses and amortization of patents and other intangible property rights as a deduction for tax purposes.

B. Tax benefits under the Israeli law for the Encouragement of Capital Investments, 1959 (“the law”)

Pursuant to the law, the Company was awarded “Approved enterprise” status under the government alternative benefits track. The main benefits to which the Company will be entitled is to a full exemption on its taxable income arising from the second and third plan for a period of two years and a reduced tax rate of 25% for an additional five years from the date on which the investments are significantly completed and the Company has taxable income as defined by the law.

The benefits, to which the Company will be entitled, will be granted on the proportionate part of the income, deriving from a future increase in its income in excess of the base turnover, which is not entitled to benefits. The utilization of the seven years of benefits for the second and third plans is limited to 2012 and 2016, respectively.

In 1998, the Company applied for approval of the expansion of its facilities in Rosh Ha’ayin (“the second plan”).

In addition, in 2001 the Company filed a request for an additional new plan to expand its production facilities in Rosh Ha’ayin (“the third plan”). The request was approved in 2002.

As of December 31, 2006, due to losses, the Company had not yet utilized the tax benefits provided in the second and third plans.

The Company’s Board of Directors has determined that such tax-exempt income will not be distributed as dividends. Accordingly, no deferred income taxes have been provided on income attributable to the Company’s “Approved Enterprise”.

If the retained tax-exempt income is distributed in a manner other than 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 –25%). As of December 31, 2006, the Company has accumulated losses (see Note 17I).

The aforementioned benefits are conditional upon compliance with the terms and regulations as prescribed by law, and the approvals according to which the investments were carried out. Non-compliance with the terms may result in the cancellation of the benefits, in whole, or in part, and the refund of the benefit amounts in addition to accrued interest.

As of December 31, 2006, the Company’s management is of the opinion that it is in compliance with all of the aforementioned terms.

F - 31

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 17 – Income Taxes (cont’d)

C. Measurement of taxable income under the Income Tax (Inflationary Adjustments) Law, 1985 (“TheInflationary Adjustments Law”)

Under the Inflationary Adjustments Law, results for tax proposes are measured in real term, taking into consideration the change in the Israeli Consumer Price Index (CPI).

D. Tax rates applicable to income from other sources in Israel

Income derived from sources other than the Approved Enterprise is not eligible for the aforementioned benefits and is taxed at the regular rate of 31%.

1. On June 29, 2004, the Knesset passed the Israeli “Law for the Amendment of the Income Tax Ordinance (Amendment No. 140 and Temporary Order) – 2004” (hereinafter – Amendment 140). Amendment 140 provides for a gradual reduction in the company tax rate from 36% to 30% in the following manner: in 2004 the tax rate will be 35%, in 2005 – 34%, in 2006 – 32% and from 2007 onward the tax will be 30%.

2. On July 25, 2005, the Knesset passed the Israeli “Law for the Amendment of the Income Tax Ordinance (No.147 and Temporary Order) – 2005” (hereinafter – the Amendment).

The Amendment provides for a gradual reduction in the company tax rate in the following manner: in 2006 the tax rate will be 31%, in 2007 – 29%, in 2008 – 27%, in 2009 - 26% and from 2010 onward 25%. Furthermore, as from 2010, upon reduction of the company tax rate to 25%, real capital gains will be subject to tax of 25%.

E. Taxation of foreign subsidiary

The Company’s subsidiary in the Far East is taxed under the tax laws in force in that country.

F. Deferred income taxes

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

Deferred tax assets for future tax benefits from realization are included where their realization is probable. As such, the Company has recorded a valuation allowance in regard of all its tax losses carried forward as well as for other temporary differences.

F - 32

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 17 – Income Taxes (cont’d)

F. Deferred income taxes (cont’d)

Significant components of the Company’s deferred tax liabilities and assets are as follows:

	December 31
	2006			2005
	US$ thousands			US$ thousands
Deferred tax assets:
Provision for vacation		79			54
Liability for employees severance benefit, net		41			20
Net operating loss carryforwards		11,756			10,226
Research and development costs, net		162			124
Issuance expenses		22			20
Capitalized software expenses		(60	)		-
Others		12			(6	)
		12,012			10,438
Less: Valuation allowance		(12,012	)		(10,438	)
Deferred tax asset		-			-

The Company recognized deferred taxes based on a tax rate of 25% according to the tax rate anticipated to be in effect on the date of reversal as stated in Note 17D above.

As of December 31, 2006, the Company has not provided for deferred income taxes on the undistributed earnings of approximately US$ 190 thousand of it foreign subsidiary in Singapore since these earnings are intended to be reinvested indefinitely. A deferred tax liability will be recognized when the Company no longer demonstrates that it plans to permanently reinvest the undistributed earnings. The Company estimated that additional taxes of approximately US$ 47.5 thousand will be payable when these earnings are remitted.

G. A reconciliation of the theoretical tax expense, assuming all income is taxable at the statutory rates applicable in Israel, and the actual tax expense, is as follows:

		Year ended December 31
		2006			2005			2004
		US$ thousands			US$ thousands			US$ thousands
Profit (loss) before taxes on income			(2,148	)		114			(1,166	)
Statutory tax rate in Israel			31	%		34	%		35	%
Theoretical tax cost (benefit)			(666	)		39			(408	)
Losses, deductions and expenses in respect of
which deferred tax assets were not recorded			640			(113	)		350
Taxes in respect of previous years			75			-			54
Non-deductible expenses	��		26			74			63
Actual tax expense			75			(1) -			(1) 59

⁽¹⁾ Reclassified

F - 33

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 17 – Income Taxes (cont’d)

H. Income tax assessments

During 2005, the Company reached an agreement with the Israeli Tax Authorities which finalized the income tax assessments of the 1998-2000 tax years. According to the agreement the Company should pay the tax authorities $1.3 million, including interest in 36 monthly payments commencing April 2005 up to March 2008.

I. Net operating losses carryforwards

Net operating loss carryforwards as of December 31, 2006, totaled approximately US$ 47 million. The net operating loss carryforwards have no expiration date.

Note 18 – Monetary balances in Currencies Other than the US Dollar

	December 31, 2006				December 31, 2005
	Israeli currency		Other foreign currencies		Israeli currency		Other foreign currencies
	US$ thousands		US$ thousands		US$ thousands		US$ thousands
Assets
Current assets		736		1,389		920		632
Total assets		736		1,389		920		632
Liabilities
Current liabilities		1,919		306		1,935		462
Long-term liabilities		320		-		686		-
Total liabilities		2,239		306		2,621		462

F - 34

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 19 – Supplementary Statement of Operation Information

A. Summary information about geographical areas:

Total revenues are attributed to geographic areas based on the location of the customers.

	Year ended December 31
	2006			2005			2004
	US$ thousands			US$ thousands			US$ thousands
Total revenues from:
Israel		2,284			1,068			824
Far East		2,120			6,274			4,596
Europe		4,557			8,358			2,710
Africa		-			397			-
America		1,142			3,099			4,554
		10,103			19,196			12,684
Major customers data as a
percentage of the total revenues:
Customer A		18	%		*			*
Customer B		17	%		*			-
Customer C		16	%		*			*
Customer D		12	%		15	%		27	%
Customer E		-			31	%		*
Customer F		*			14	%		*
Customer G		*			11	%		34	%
		63	%		71	%		61	%

* Less than 10%.

B. Cost of revenues

	Year ended December 31
	2006		2005		2004
	US$ thousands		US$ thousands		US$ thousands
Raw materials and components		985		2,420		1,829
Salaries, wages and employees' benefits		2,696		*2,645		2,548
Subcontractors		2,026		6,181		3,217
Agents fees		438		2,253		691
Depreciation		201		263		327
Other manufacturing costs		1,520		1,044		1,679
		7,866		(1)*14,806		(1)10,291

* Restated (see Note 2T)

⁽¹⁾ Reclassified

F - 35

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 19 – Supplementary Statement of Operation Information (cont’d)

C. Financial expenses, net

	Year ended December 31
	2006			2005			2004
	US$ thousands			US$ thousands			US$ thousands
Financial income:
Interest on short-term deposits		140			69			7
Interest on loans to others and interest from
non-current receivables		-			-			17
Other		40			102			37
		180			171			61
Financial expenses:
Bank charges and interest on long-term loan		203			275			469
Other		162			83			88
		365			358			557
Total financial expenses, net		(185	)		(187	)		(496	)

D. Other income (expenses), net

	Year ended December 31
	2006		2005			2004
	US$ thousands		US$ thousands			US$ thousands
Gain on waiver of long-term loan from
former related party		-		-			177
Others		-		(2	)		15
		-		(2	)		192

E. Other

	Year ended December 31
	2006		2005		2004
	US$ thousands		US$ thousands		US$ thousands
Rent costs		376		401		349
Advertising costs		40		33		16
Royalties expenses		173		268		365

F - 36

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 20 – Related Parties

A. Balances

Related parties are comprised of principal shareholders (holding 10% or greater of the Company’s share capital) and their subsidiaries and affiliates as well as affiliates of the Company. Transactions with related parties are mainly as follows:

1. Sales of the Company’s products, and expenses related to such sales.

2. Interest payable on loans received.

3. Payment of management fees.

4. Purchases of services and products.

All transactions and terms with related parties were comparable to those applied to transactions with other customers or suppliers.

			December 31
			2006	2005
			US$ thousands	US$ thousands
Due from:
Cash and cash equivalents	-	Bank Leumi Ltd.	1,516	419
Restricted bank deposits	-	Bank Leumi Ltd.	707	268
Trade receivables	-	ST Training and Simulation Pte Ltd.	51	180
Other receivables	-	Bank Leumi Ltd.	8	5
		Prescient Systems and Technologies Pte Ltd	30	-
Other Non-current assets	-	Bank Leumi Ltd.	169	93
Due to:
Short-term bank credit	-	Bank Leumi Ltd.	229	229
Other payable	-	Bank Leumi Ltd.	4	7
		Prescient Systems and Technologies Pte Ltd	40	59
		ST Training and Simulation Pte Ltd.	360	-
Long-term loan	-	Bank Leumi Ltd.	-	228

B. Transactions with related parties

	Year ended December 31
	2006		2005		2004
	US$ thousands		US$ thousands		US$ thousands
Sales(1)		577		775		940
Cost of sales(1) (2) (5)		408		59		-
Marketing expenses(2) (5)		4		65		15
General and administrative expenses(4)		167		137		181
Finance expenses, net(3)		37		66		215
Other income(5)		-		-		15

⁽¹⁾ To ST Training and Simulation Pte Ltd.

⁽²⁾ To Prescient Systems and Technologies Pte Ltd.

⁽³⁾ To Bank Leumi

⁽⁴⁾ Including the salary of the CEO and fees paid to directors.

⁽⁵⁾ From Aeronautics

F - 37

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 21 – Differences between Israeli GAAP and U.S. GAAP

A. The effect of the differences between Israeli GAAP and US GAAP on the financial statements

As discussed in Note 2, the accompanying consolidated financial statements were prepared in accordance with Israeli generally accepted accounting principles (“Israeli GAAP”), which differ in certain respects from those generally accepted in the United States of America (“U.S. GAAP”). Information related to the nature and effect of such differences is presented below.

1. Reconciliation of:

a. Israeli GAAP net income to net income according to U.S. GAAP:

	Year ended December 31
	2006			2005		2004
	US$ thousands			US$ thousands		US$ thousands
Net profit (loss) as reported, according to
Israeli GAAP		(2,223	)		* 114		(1,225	)
GAAP differences:
Reversal of restatement according to Standard
No. 24 (see Note 2T)		-			*7		-
Allocation of share expense issued to service providers
under the fair value based method		-			**(14)		**(40)
Compensation expense for all stock-based awards
using the modified prospective method
(see Note 21C(2))		(130	)		-		-
Net profit (loss) according to U.S. GAAP		(2,353	)		107		(1,265	)
I.      Basic and diluted net profit (loss) per
share
As reported, according to Israeli GAAP		(0.02	)		0.00		(0.01	)
According to U.S. GAAP		(0.02	)		0.00		(0.02	)
II.     Weighted average number of ordinary
shares outstanding (in thousands)
used in basic profit (loss) per share
calculation according to U.S. GAAP		112,361			95,528		75,962
Weighted average number of ordinary
shares outstanding (in thousands)
used in diluted profit (loss) per share
calculation according to U.S. GAAP		112,361			96,921		75,962

* Restated (See Note 2T)
** Restated (see Note 21B).

F - 38

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 21 – Differences between Israeli GAAP and U.S. GAAP (cont’d)

A. The effect of the differences between Israeli GAAP and US GAAP on the financial statements (cont’d)

1. Reconciliation of (cont’d):

b. Shareholders’ equity according to US GAAP:

	Share capital
	Number of shares		Amount		Additional paid-in capital			Accumulated deficit			Total shareholders' equity
			US$ (thousands)		US$ (thousands)			US$ (thousands)			US$ (thousands)
Balance as of January 1, 2004		10,660,874		2,529		21,408			(34,113	)		(10,176	)
Net loss for the year		-		-		-			(1,265	)		(1,265	)
Issuance of shares and options		66,872,669		14,744		(2,911	)		-			11,833
Issuance of shares in respect of
services		200,000		45		(9	)		-			36
Exercise of stock options		17,666,667		3,929		(788	)		-			3,141
Stock-based compensation**		-		-		40			-			40
Balance as of December 31, 2004		95,400,210		21,247		17,740			(35,378	)		3,609
Net profit for the year		-		-		-			107			107
Issuance of shares
in respect of services		263,547		59		(12	)		-			47
Stock-based compensation**		-		-		14			-			14
Balance as of December 31, 2005		95,663,757		21,306		17,742			(35,271	)		3,777
Net loss for the year		-		-		-			(2,353	)		(2,353	)
Issuance of shares and warrants		20,000,000		4,293		(693	)		-			3,600
Issuance of shares
in respect of services		1,200,000		262		(41	)		-			221
Stock-based compensation		-		-		161			-			161
Balance as of December 31, 2006		116,863,757		25,861		17,169			(37,624	)		5,406

** Restated (See Note 21B).

2. Condensed balance sheet items

	December 31
	2006						2005
	US$ thousands
	As Reported		Adjustment		As per US GAAP		As Reported		Adjustment		As per US GAAP
Severance pay fund		-		1,311		1,311		-		1,133		1,133
Total assets		13,293		1,311		14,604		10,111		1,133		11,244
Liability for employee
severance benefits, net		166		1,311		1,477		79		1,133		1,212
Total liabilities		7,887		1,311		9,198		6,334		1,133		7,467
Total shareholders' equity		5,406		-		5,406		3,777		-		3,777

F - 39

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 21 – Differences between Israeli GAAP and U.S. GAAP (cont’d)

B. Restatement

The statements of operations in accordance with U.S. GAAP for the years ended December 31, 2004 and 2005 have been restated in order to reflect a correction in 2004 and 2005, relating to compensation expense to certain service providers which should have been treated as employees. In accordance with APB No. 25, in the years 2004 and 2005 no compensation expense should have been recorded in respect to these service providers, who should have been treated as employees.

	Year ended December 31
	2005			2004
	US$ thousands			US$ thousands
Non-employee stock option expenses under the
fair value method - as reported		(125	)		(410	)
Non-employee stock option expenses under the
fair value method - as restated		(14	)		(40	)
Net loss according to US GAAP - as reported		(4	)		(1,635	)
Net profit (loss) according to US GAAP - as restated		107			(1,265	)
Basic and diluted net loss per share - as reported		(0.00	)		(0.02	)
Basic and diluted net profit (loss) per share - as restated		0.00			(0.02	)

C. Accounting principles generally accepted in Israel compared to accounting principles generally acceptedin the United States

1. Liability for termination of employer-employee relations

According to Israeli GAAP

Amounts funded by purchase of insurance policies are deducted from the related severance pay liability.

According to U.S. GAAP

According to U.S. GAAP, the amounts funded should be presented as long-term investments and the gross amount of the liability should be presented as a long-term liability.

2. Stock options granted to employees, service providers and other non-employees and stock issued toservice providers

According to Israeli GAAP

Until December 31, 2005, the Company recorded expenses with respect to stock options granted to employees and service providers that provide similar services to those provided by employees, in accordance with the intrinsic value method described in APB 25 “Accounting for Stock Issued to Employees”. Shares issued to service providers were recorded based on the cost of service at the grant date of the shares issued.

As of January 1, 2006, the Company applies Standard No. 24 and records expense for share-based payment transactions conducted after March 15, 2005 and not yet vested at January 1, 2006, the expenses recorded in accordance with the fair value of the options on the grant date using the Black & Scholes model.

F - 40

B.V.R. Systems (1998) Ltd.

Notes to the Consolidated Financial Statements

Note 21 – Differences between Israeli GAAP and U.S. GAAP (cont’d)

C. Accounting principles generally accepted in Israel compared to accounting principles generally acceptedin the United States (cont’d)

2. Stock options granted to employees, service providers and other non-employees and stock issued toservice providers (cont’d)

According to U.S. GAAP

Stock options granted to employees

Prior to fiscal 2006, the Company applied the intrinsic value method as prescribed in APB No. 25, and related interpretations, in accounting for stock options granted under the stock option plan. Under the intrinsic value method, no compensation cost is recognized if the exercise price of the Company’s employee stock options was equal to or greater than the market price of the underlying stock on the date of the grant. Accordingly, no compensation cost was recognized in the accompanying consolidated statements of operation prior to fiscal year 2006 on stock options granted to employees, since all options granted under the Company’s stock option plan had an exercise price equal to the market value of the underlying common stock on the date of grant.

As of January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payments”) (SFAS 12SR) using the modified prospective method, which requires measurement of compensation cost for all stock-based awards based upon the fair value on the date of grant and recognition of such compensation cost over the service period for awards expected to vest. Under this method, the Company recognizes compensation cost for awards granted on or after January 1, 2006, based on the Black-Scholes option-pricing model. In addition, the Company recognizes compensation cost for unvested share-based awards as of January 1, 2006 based on the grand date fair value of those awards, as previously calculated and reported for pro-forma disclosure purposes, over the requisite service period of the awards.

Stock warrants granted to service providers and other non-employees and stock issued to service providers

The Company accounts for such awards in accordance with the provisions of EITF 96-18, “Accounting for Equity Instruments That are Issued to Other than employees for Acquiring, or in conjunction of Selling, Goods or Services”. Since the warrants issued by the Company are not fully vested, and no performance commitment as defined in EITF 96-18 has been reached, the Company estimates the cost of the unvested warrants based on the fair value of the warrants at each reporting period (using the Black & Scholes model) and accounts for the portion of the services that the recipient has rendered to date using that estimate.

F - 41