Arab citizens are allowed to vote, though they do face other restriction. I suspect, especially given the "more than half" bit, that he was referring to the adult population of the whole territory Israel controls. Both Israel itself and the Occupied territories.
That's correct. Israel doesn't recognize the state of Palestine, and thus the population of Palestine is de facto part of Israel. They are not citizens of Israel, of course, because that would be democracy and the racist war-mongers in the Knesset would be voted out in a week.
Can you imagine if the US decided that all Native Americans (probably the closest analogy, but you'll forgive since there isn't a perfect one) were not US citizens and were denied the franchise? Being able to pick and choose who among your population are considered "citizens" and thus allowed the privilege of participating in democracy is fascism at its most pure.