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FORM 20-FSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

|                                |                                                                                                    
|------------------------------- | ---------------------------------------------------------------------------------------------------
|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, 2004;                                                     
|                               
|OR                             
|                                |                                                                                                    
|o                               | TRANSITION REPORT
  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934         
|                                | For
  the transition period from __________ to ___________                                         
|                                |                                                                                                    
|Commission File Number: 0-29442

FORMULA
SYSTEMS (1985) LTD.

(Exact name of registrant as specified in
its charter)

|Israel                                                                                      
|--------------------------------------------------------------------------------------------
|(Jurisdiction of incorporation or
  organization)                                           
|                                                                                            
|3 Abba Eban Boulevard, Herzlia 46725,
  Israel                                              
|(Address of principal executive offices)                                                    
|                                                                                            
|Securities registered or to be registered
  pursuant to Section 12(b) of the Act:           
|None                                                                                        
|                                                                                            
|Securities registered or to be registered
  pursuant to Section 12(g) of the Act:           
|American Depositary Shares                                                                  
|Ordinary Shares, NIS 1 par value                                                            
|(Title of class)                                                                            
|                                                                                            
|Securities for which there is a reporting
  obligation pursuant to Section 15(d) of the Act:
|American Depositary Shares                                                                  
|Ordinary Shares, NIS 1 par value                                                            
|(Title of Class)                                                                            

As of December 31, 2004, the registrant had 13,200,000 outstanding
ordinary shares, NIS 1 par value, of which 412,472_were represented by American
depositary shares as of such date.

Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.

Yes  x   No  o

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

Item 17  o   Item 18  x

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|           |  | 
|---------- |  | 
|P A R T  I
|           |  | 

Some
of the statements in this annual report, including those in the Risk Factors,
Operating and Financial Review and Prospects and Business Overview sections,
are forward-looking statements that involve risks and uncertainties. These
forward-looking statements include statements about our plans, objectives,
strategies, expectations, intentions, future financial performance and other
statements that are not historical facts. We use words like anticipates,
believes, expects, future intends, and similar expressions to mean that
the statement is forward-looking. You should not unduly rely on these
forward-looking statements, which apply only as of the date of this annual
report. Our actual results could differ materially from those anticipated in
the forward-looking statements for many reasons, including the risks described
under Risk Factors.

Beginning
with the fiscal year ended December 31, 2002, we prepare our
consolidated financial statements in accordance with accounting principles
generally accepted in the United States, commonly
referred to as U.S. GAAP. Prior
to 2002, we prepared our consolidated financial statements in accordance with
accounting principles generally accepted in Israel, referred to as Israeli GAAP.
Israeli GAAP and U.S. GAAP vary in certain respects.
As a result, we have restated certain figures
in our financial statements relating to prior periods. In
accordance with U.S GAAP, we use the United States dollar as our reporting
currency. Prior to 2002, we presented our consolidated
financial statements in New Israeli Shekels, or NIS, that have been adjusted to
reflect changes in the Israeli consumer price index, referred to as the Israeli
CPI.

As used in this annual report, references to
dollar refer to the United States dollar and
references to NIS refer to New Israeli Shekels.

As
used in this annual report, references to we, our,
oursand usrefer to Formula Systems
(1985) Ltd. and its subsidiaries, unless otherwise indicated. References to Formula refer to Formula Systems
(1985) Ltd.

All
trademarks appearing in this annual report are the property of their respective
holders.

1

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TABLE OF CONTENTS

|                                                                                        |    | 
|--------------------------------------------------------------------------------------- | -- | 
|ITEM 1. IDENTITY OF DIRECTORS, SENIOR
  MANAGEMENT AND ADVISERS                         | 3  | 
|ITEM 2. OFFER STATISTICS AND EXPECTED
  TIMETABLE                                       | 3  | 
|ITEM 3. KEY INFORMATION                                                                 | 3  | 
|ITEM 4. INFORMATION ON THE COMPANY                                                      | 17 | 
|ITEM 5. OPERATING AND FINANCIAL REVIEW AND
  PROSPECTS                                  | 44 | 
|ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND
  EMPLOYEES                                    | 60 | 
|ITEM 7. MAJOR SHAREHOLDERS AND RELATED
  PARTY TRANSACTIONS                             | 70 | 
|ITEM 8. FINANCIAL INFORMATION                                                           | 76 | 
|ITEM 9. THE OFFER AND LISTING                                                           | 77 | 
|ITEM 10. ADDITIONAL INFORMATION                                                         | 79 | 
|ITEM 11. QUANTITATIVE AND QUALITATIVE
  DISCLOSURES ABOUT MARKET RISKS                  | 92 | 
|ITEM 12. DESCRIPTION OF SECURITIES OTHER
  THAN EQUITY SECURITIES.                      | 93 | 
|ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND
  DELINQUENCIES.                             | 93 | 
|ITEM 14. MATERIAL MODIFICATIONS TO THE
  RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 93 | 
|ITEM 15. CONTROLS AND PROCEDURES                                                        | 93 | 
|ITEM 16. [RESERVED]                                                                     | 93 | 
|ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT                                              | 94 | 
|ITEM 16B. CODE OF ETHICS                                                                | 94 | 
|ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND
  SERVICES                                      | 94 | 
|ITEM 16D. EXEMPTIONS FROM THE LISTING
  STANDARDS FOR AUDIT COMMITTEES                  | 95 | 
|ITEM 16E. PURCHASES OF EQUITY SECURITIES BY
  THE ISSUER AND AFFILIATED PURCHASERS      | 95 | 
|ITEM 17. FINANCIAL STATEMENTS                                                           | 96 | 
|ITEM 18. FINANCIAL STATEMENTS                                                           | 96 | 
|ITEM 19. EXHIBITS                                                                       | 96 | 
|Exhibit Index                                                                           | 98 | 

2

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|        |                                                        
|------- | -------------------------------------------------------
|ITEM 1. | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT
  AND ADVISERS

Not
applicable.

|        |                                        
|------- | ---------------------------------------
|ITEM 2. | OFFER STATISTICS AND EXPECTED TIMETABLE

Not
applicable.

|        |                
|------- | ---------------
|ITEM 3. | KEY INFORMATION

A.Selected Financial Data

The
following tables present our consolidated statement of operations and balance
sheet data for the periods and as of the dates indicated. We derive the consolidated statement of
operations data for the years ended December 31, 2002, 2003 and 2004, and
the balance sheet data as at December 31, 2003 and 2004 from our consolidated
financial statements included elsewhere in this annual report. Our consolidated financial statements have
been audited by Ziv Haft certified public accountants (Isr.) BDO member firm.
The consolidated income statement data for the years ended December 31, 2000 and 2001 and the consolidated balance sheet data
for the years ended December 31, 2000,
2001 and 2002 is derived from our audited financial statements not included in
this annual report. You should read the selected consolidated financial data
together with our consolidated financial statements included elsewhere in this
annual report. See Item 5. Operating and Financial Review and Prospects.

3

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|                                                |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|----------------------------------------------- |  | ------------------------------------- | ------- | ---- | - | ------- | - | ---- | ------- | ---- | - | ------- | - | - | ------- | -
|                                                |  | Year Ended December 31,               |        
|                                                |  |                                       |        
|                                                |  | 2004                                  |         | 2003 |   | 2002    |   | 2001 |         | 2000 |  
|                                                |  |                                       |         |      |   |         |   |      |         |      |  
|                                                |  | $                                     |        
|                                                |  | (In thousands, except per share data) |        
|Consolidated
  Statement of Operations Data:    |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|                                                |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Revenues                                        |  | $                                     | 456,610 |      | $ | 366,830 |   | $    | 283,310 |      | $ | 387,682 |   | $ | 402,469 |  
|Cost of revenues                                |  |                                       | 284,961 |      |   | 230,500 |   |      | 186,908 |      |   | 261,346 |   |   | 239,506 |  
|                                                |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Gross profit                                    |  |                                       | 171,649 |      |   | 136,330 |   |      | 96,402  |      |   | 126,336 |   |   | 162,963 |  
|Research and development
  costs, net           |  |                                       | 25,036  |      |   | 17,368  |   |      | 15,967  |      |   | 21,287  |   |   | 20,465  |  
|Selling, general and administrative expenses    |  |                                       | 128,537 |      |   | 107,103 |   |      | 85,292  |      |   | 151,345 |   |   | 142,006 |  
|Restructuring and non-recurring costs           |  |                                       |        |      |   |        |   |      | 1,829   |      |   | 10,998  |   |   | 2,444   |  
|                                                |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Operating income (loss)                         |  |                                       | 18,076  |      |   | 11,859  |   |      | (6,686  | )    |   | (57,294 | ) |   | (1,952  | )
|Financial income
  (expenses), net              |  |                                       | (8,904  | )    |   | (3,676  | ) |      | 3,605   |      |   | 2,680   |   |   | 8,467   |  
|Gain on realization of
  shareholdings, net     |  |                                       | 8,893   |      |   | 2,756   |   |      | 4,668   |      |   | 773     |   |   | 66,651  |  
|Other expenses, net                             |  |                                       | 332     |      |   | 90      |   |      | 2,100   |      |   | 36,719  |   |   | 315     |  
|                                                |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Income (loss) before taxes
  on income          |  |                                       | 17,733  |      |   | 10,849  |   |      | (513    | )    |   | (90,560 | ) |   | 72,851  |  
|Taxes on income                                 |  |                                       | 4,631   |      |   | 2,540   |   |      | 2,014   |      |   | 6,239   |   |   | 13,131  |  
|Equity in losses of
  affiliated companies, net |  |                                       | (2,523  | )    |   | (1,071  | ) |      | (2,327  | )    |   | (9,926  | ) |   | (5,633  | )
|Minority interest in losses (profit), net       |  |                                       | (2,480  | )    |   | (4,118  | ) |      | 2,448   |      |   | 46,864  |   |   | (16,108 | )
|                                                |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Net income (loss)                               |  |                                       | 8,099   |      |   | 3,120   |   |      | (2,406  | )    |   | (59,861 | ) |   | 37,979  |  
|Earnings
  (loss) per share:                    |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Basic earnings (loss)                           |  |                                       | 0.73    |      |   | 0.29    |   |      | (0.24   | )    |   | (6.42   | ) |   | 4.07    |  
|Diluted earnings (loss)                         |  |                                       | 0.65    |      |   | 0.24    |   |      | (0.24   | )    |   | (6.42   | ) |   | 4.06    |  
|                                                |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Weighted average number of shares outstanding:  |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Basic                                           |  |                                       | 10,800  |      |   | 10,037  |   |      | 10,171  |      |   | 9,325   |   |   | 9,322   |  
|Diluted                                         |  |                                       | 10,800  |      |   | 10,285  |   |      | 10,171  |      |   | 9,325   |   |   | 9,363   |  

|                                   |  |                |                    |      |  |         |  |      |         |      |  |         |  |  |         | 
|---------------------------------- |  | -------------- | ------------------ | ---- |  | ------- |  | ---- | ------- | ---- |  | ------- |  |  | ------- | 
|                                   |  |                | As of December 31, |     
|                                   |  | 2004           |                    | 2003 |  | 2002    |  | 2001 |         | 2000 | 
|                                   |  |                |                    |      |  |         |  |      |         |      | 
|                                   |  | $              |                   
|                                   |  | (In thousands) |                   
|Consolidated
  Balance Sheet Data: |  |                |                    |      |  |         |  |      |         |      |  |         |  |  |         | 
|Total assets                       |  |                | 641,020            |      |  | 544,008 |  |      | 467,245 |      |  | 454,544 |  |  | 551,901 | 
|Total liabilities                  |  |                | 357,663            |      |  | 299,773 |  |      | 241,766 |      |  | 192,532 |  |  | 158,259 | 
|Shareholders equity               |  |                | 186,778            |      |  | 176,004 |  |      | 153,349 |      |  | 166,421 |  |  | 229,672 | 

B.Capitalization
and Indebtedness

Not applicable.

C.Reasons for the
Offer and Use of Proceeds

Not applicable.

4

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D.Risk Factors

Our
business, operating results and financial condition could be seriously harmed
due to any of the following risks. The trading price of our ordinary shares
could decline due to any of these risks.

We may
experience significant fluctuations in our annual and quarterly results, which
makes it difficult for investors to make reliable period-to-period comparisons
and may contribute to volatility in the market price for our ordinary shares
and AmericanDepositaryShares.

Our
quarterly and annual revenues, gross profits and results of operations have
fluctuated significantly in the past and we expect them to continue to
fluctuate significantly in the future. The following events may cause
fluctuations:

| |   |                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------
| |  | acquisitions
  and dispositions of companies
  and consolidation of our subsidiaries;                      
| |   |                                                                                                            
| |  | the size, time and recognition of revenue from significant contracts;                                      
| |   |                                                                                                            
| |  | timing of product releases;                                                                                
| |   |                                                                                                            
| |  | timing of contracts;                                                                                       
| |   |                                                                                                            
| |  | timing of
  completion of specified milestones and delays in implementation;                               
| |   |                                                                                                            
| |  | changes in the proportion of service and license revenues;                                                 
| |   |                                                                                                            
| |  | price and product competition;                                                                             
| |   |                                                                                                            
| |  | increases in selling and marketing expenses, as well as other
  operating expenses;                        
| |   |                                                                                                            
| |  | adverse economic conditions and currency fluctuations;                                                     
| |   |                                                                                                            
| |  | the global business slow-down and the decline in capital spending in the information technology sector;
and
| |   |                                                                                                            
| |  | consolidation of our customers.                                                                            

A
substantial portion of our expenses, including most product development and
selling and marketing expenses, must be incurred in advance of when revenue is
generated. If our projected revenue does not meet our expectations, we are
likely to experience an even larger shortfall in our operating profit relative
to our expectations. The gross margins of our subsidiaries also will vary both
among themselves and over time. As a result, changes in the revenue mix from
these subsidiaries may affect quarterly operating results. In addition, we may
derive a significant portion of our net income from transactions which involve
equity issuances by our subsidiaries, the sale of equity securities of our
subsidiaries or the sale of proprietary software technology.
These events do not occur on a regular basis
and their timing is
difficult to predict. As a result, we believe that period-to-period comparisons
of our historical results of operations are not necessarily meaningful and that
you should not rely on them as an indication for future performance. Also, it
is possible that our quarterly and annual results of operations may be below
the expectations of public market analysts and investors. If this happens, the
price of our ordinary shares will likely decrease.

5

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Capital
spending on information technology, or IT, solutions has declined
significantly. This global trend affected our operating results. If IT spending
continues to slow down, our business might be seriously harmed.

We
have been affected by global economic changes, in particular the sharp decline
in capital spending in the information technology sector and the IT business
slow-down in North America and Europe, as well as in Israel. Uncertainties in the North
American, European and Israeli markets have influenced the purchasing patterns
of leading software developers who delayed their planned orders and caused
developers to reduce the amount of their planned license commitments. These
changes in purchasing patterns in the IT industry directly affect our operating
results. Our revenues decreased from $402.5 million in 2000 to $387.7 million
in 2001 and to $283.3 million in 2002. In 2003 and 2004, as a result of a
slight recovery of the market, and the impact of the consolidation of the
results of operations of Sapiens International Corporation N.V. (beginning with
2003) and Formula Vision Technologies (F.V.T.) Ltd., or Formula Vision (beginning with 2004), this trend
was changed, and our revenues increased to $366.8 million and $456.6 million,
respectively. However, we cannot assure you that we will be able to continue
increasing our revenues or keep our revenues at the same level as in 2004. We
cannot know whether the global market will recover in the future, and how the
economic conditions will continue to affect our business.

Our success
depends upon the development and maintenance of strategic alliances.

We
established relationships with strategic partners to provide international
marketing presence and name recognition, as well as the resources necessary to
implement many of our IT
services. We are dependent upon our strategic partners for the marketing and
selling of certain of our proprietary software solutions. In the past few
years, due to the IT business slow-down, we have encountered difficulties
in entering into new partnerships. If we cannot maintain our existing
relationships with these
partners or
if we fail to establish
effective, long-term relationships with additional partners, or if our partners
enter into relationships with our competitors, our ability to market our
proprietary software solutions in international markets may be limited. If this
happens, our growth, if any, might be delayed or slowed-down. As a result, our business, financial condition, and results of operations
could be seriously harmed.

If our products fail to compete successfully with those of our
competitors,we may have to reduce the prices of our products,
which in turn, may adversely affect our business.

We face competition, both in Israel
and internationally, from a variety of companies, including companies with
significantly greater resources than us who are likely to enjoy substantial
competitive advantages, including:

6

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| |   |                                                                             
| | - | ----------------------------------------------------------------------------
| |  | longer operating histories;                                                 
| |   |                                                                             
| |  | greater financial, technical, marketing and other resources;                
| |   |                                                                             
| |  | greater name recognition;                                                   
| |   |                                                                             
| |  | well-established relationships with our current and potential
  clients; and
| |   |                                                                             
| |  | a broader range of products and services.                                   

As a
result, they may be able to respond more quickly to new or emerging
technologies or changes in customer requirements. They may also benefit from
greater purchasing economies, offer more aggressive product and service pricing
or devote greater resources to the promotion of their products and services. In
addition, in the future, we may face further competition from new market
entrants and possible alliances between existing competitors. We also face
additional competition as we continue to penetrate international markets. As a
result, we cannot assure you that the products and solutions we offer will
compete successfully with those of our competitors. Furthermore, several
software development centers worldwide, like in India, offer software
development services at much lower prices than we do. Due to the intense
competition in the markets in which we operate, software products prices may
fluctuate significantly. As a result, we may have to reduce the prices of our
products, which in turn, may adversely affect our business.

If we fail to
compete for acquisitions and investments, we may be unable to grow.

As part of our strategy, we intend to pursue acquisitions
of, and
investments in, other companies. If and when
acquisition or investment opportunities occur, we expect to compete for these opportunities with other established and
well-capitalized
entities. We cannot assure you that we
will be able to locate potential acquisition or investment opportunities in
Israel or internationally on terms which are favorable to us. If we fail to
consummate further acquisitions or investments in the future our ability to
grow may be harmed.

Any future
acquisitions of companies or technologies may distract our management and
disrupt our business.

Our
strategy includes selective acquisitions of, and investments in, companies
offering products and services suitable for integration into our business. We
may acquire or make investments in complementary businesses, technologies,
services or products if appropriate opportunities arise. We may engage in
discussions and negotiations with companies about our acquiring or investing in
those companies businesses, products, services or technologies. We cannot
assure you that we will be able to identify future suitable acquisition or
investment candidates, or if we do identify suitable candidates, that we will
be able to make the acquisitions or investments on commercially acceptable
terms or at all. If we acquire
or invest in another company, or if any of our subsidiaries acquires control in
another subsidiary or affiliate, the acquirer could have difficulty assimilating that
companys personnel, operations, technology or products and service offerings
into its own. The key personnel of the
acquired company may decide not to work for the acquirer. These difficulties could disrupt our
ongoing business, distract our management and employees, increase our expenses
and adversely affect our results of operations. We may incur indebtedness or
issue equity securities to pay for any future acquisitions. The issuance of equity
securities could be dilutive to our existing shareholders.

7

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We
intend to pursue acquisitions outside of Israel as part of our expansion
strategy. These acquisitions, as well
as any future acquisitions of companies located outside of Israel, would pose
additional risks, including monitoring a management team from a great distance
and integrating a potentially different business culture. Our failure to successfully integrate these
new businesses could harm our business.
In addition, the investigation of acquisition candidates outside of
Israel involves higher costs than those associated with pursuing domestic
acquisitions, and we cannot assure you that these investigations will result in
transactions.

If we fail to
raise capital for our subsidiaries, we may be required to borrow money on
unfavorable terms.

Our
business strategy involves raising capital for our subsidiaries through public
or private offerings. Our ability to raise capital for our subsidiaries depends
upon market and other conditions which are beyond our control. If we fail to
raise capital for our subsidiaries, it may hinder their growth. We may
therefore be required to seek alternative capital raising methods, including
borrowing money on terms which are not favorable to us. In the past, due to difficulties we
encountered in raising capital for our subsidiaries, we were required to borrow
monies from banks. Difficulties
in raising capital on favorable terms, may materially and adversely affect our
business, operating results and financial condition.

The terms of our credit facilities contain a
number of restrictive covenants which, if breached, could result in
acceleration of our obligation to repay our debt.

Our
loan agreements contain a number of conditions and limitations on the way in
which we can operate our business, including limitations on our ability to
raise debt and sell or acquire assets.
Our loan agreements also contain various covenants which require us to
maintain certain financial ratios related to shareholders equity and operating results
that are customary for companies of comparable size. These limitations and covenants may force us to pursue less than
optimal business strategies or forego business arrangements which could have
been financially advantageous to us or to our shareholders.

Some of our
assets are pledged to banks. These assets include certain of our shareholdings
in our subsidiaries consisting of our entire shareholdings in BluePhoenix
Solutions Ltd. and a portion of our shareholdings in Matrix IT Ltd. and Magic
Software Enterprises Ltd. If we are unable to repay
the debt, the lenders could foreclose on our assets that are subject to liens
and sell these holdings to satisfy the debt.

8

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Marketing our
products and services in international markets may require increased expenses
and greater exposure to risks that we may not be able to successfully address.

We
intend to continue to focus our efforts on selling proprietary software
solutions in international markets. We expect to continue devoting significant
resources to these efforts. If we are unable to continue achieving market
acceptance for our solutions or otherwise continue to successfully penetrate
international markets, our business will be harmed. In 2003 and 2004, we
received approximately 53% of our total revenues from customers located outside of Israel. The
expansion of our existing operations and entry into additional international
markets will require significant management attention and financial resources.
We are subject to a number of risks customary for international operations,
including:

| |   |                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------
| |  | changing product and service requirements in response to the
  formation of economic and marketing unions, including the European Union;
| |   |                                                                                                                                         
| |  | economic or political changes in international markets;                                                                                 
| |   |                                                                                                                                         
| |  | greater difficulty in accounts receivable collection and longer
  collection periods;                                                   
| |   |                                                                                                                                         
| |  | unexpected changes in regulatory requirements;                                                                                          
| |   |                                                                                                                                         
| |  | difficulties and costs of staffing and managing foreign operations;                                                                     
| |   |                                                                                                                                         
| |  | the uncertainty of protection for intellectual property rights in
  some countries;                                                     
| |   |                                                                                                                                         
| |  | multiple and possibly overlapping tax structures; and                                                                                   
| |   |                                                                                                                                         
| |  | currency and exchange rate fluctuations.                                                                                                

If we fail to address the strain on our
resources caused by changes in our company, we will be unable
to effectively manage our business.

Our
business has grown in complexity over the past few years. The growth of our business, as
well as the corporate organizational changes, have placed and will continue to
place a strain on our personnel and resources. Our ability to manage any future
changes or growth, depends on our ability to continue to implement and improve
our operational, financial and management information control and reporting
systems on a timely basis and to expand, train, motivate and manage our work
force. If we cannot respond effectively to changing business conditions, our
business, financial condition and results of operations could be materially
adversely affected.

If we are
unable to attract, train and retain qualified personnel, we may not be able to
achieve our objectives and our business could be harmed.

In
order to achieve our objectives, we may need to hire additional qualified
software, administrative, operational, sales and technical support personnel.
The process of attracting, training and successfully integrating qualified personnel into our
operations can be lengthy and expensive. We may not be able to compete
effectively for the personnel we need. Our future success depends on our
ability to absorb and retain senior employees and to attract, motivate and
retain highly qualified professional employees. We expect to recruit most of
our software and systems personnel in Israel.
In addition, our operations are dependent on the efforts of certain key
management. Any loss of members of senior management or key technical
personnel, or any failure to attract or retain highly qualified employees as
needed, could materially adversely affect our business.

9

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If we fail to estimate accurately the costs
of fixed-price contracts, we may incur losses.

We
derive a portion of our revenues from engagements on a fixed-price basis. We
price these commitments upon estimates of future costs. We bear the risk of
faulty estimates and cost overruns in connection with these commitments. Our
failure to accurately estimate the resources required for a fixed-price
project, to accurately anticipate potential wage increases, or to complete our
contractual obligations in a manner consistent with the project plan could
materially adversely affect our business, operating results, and financial
condition. In addition, we may agree to a price before the design
specifications are finalized, which could result in a fixed price that is too
low, resulting in lower margins or losses to us.

If our tools or solutions do not function
efficiently, we may incur additional expenses.

In
the course of providing our software solutions, we conduct testing to detect
the existence of failures, errors and bugs. In addition, we have instituted a
quality assurance procedure for correcting errors and bugs in our tools. The
amount of failures, errors and bugs detected to date, and the cost of
correcting them, have not been significant. However, if our solutions fail to
function efficiently or if errors or bugs are detected in our tools, we might
incur significant expenditures in an attempt to remedy the problem. The
consequences of failures, errors, and bugs could have a material adverse effect
on our business, operating results, and financial condition.

If we fail to satisfy our customers
expectations regarding our solutions, our contracts may be cancelled and we may
be the subject of damages claims.

In
the event that we fail to satisfy our customers expectations from the results
of the implementation of our solutions, or if we fail to timely deliver our
solutions to our customers, these customers may suffer damages. When this occurs, customers can cancel our contracts. Any cancellation
of a contract could cause us to suffer damages, since we might not be paid for
costs that we incurred in performing services prior to the date of
cancellation. In addition, from time to time we may be subject to claims as a result of not
delivering our products on time or in a satisfactory manner. Such claims may
lead to material damages.

If we are
unable to accurately predict and respond to market developments or demands, our
business will be adversely affected.

The
IT business is characterized by rapidly evolving technology and methodologies.
This makes it difficult to predict demand and market acceptance for our
services and products. In order to succeed, we need to adapt the products and
services we offer to technological developments and changes in customer needs. We cannot guarantee that we will succeed in
enhancing our products
and services or developing or acquiring new products and services that
adequately address changing
technologies and customer requirements. We also cannot assure you that the
products and services we offer will be accepted by customers. If our products
and services are not accepted by customers, our future revenues and
profitability will be adversely affected. Changes in technologies, industry
standards, the regulatory environment, customer requirements and new product
introductions by existing or future competitors could render our existing
products and services obsolete and unmarketable, or require us to enhance our
current products or develop new products. This may require us to expend
significant amounts of money, time and other resources to meet the demand. This
could strain our personnel and financial resources.

10

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If we are
unable to retain control in our subsidiaries, we would cease to consolidate
them and our operating results may fluctuate significantly.

We
currently hold a controlling interest in our subsidiaries through our direct
equity holdings. From time to time, if and when required, we enter into voting
agreements with other shareholders of the companies, in order to retain control
of our subsidiaries. As a result of our
controlling interests in the subsidiaries, we consolidate their operating
results with ours. If we are unable to maintain a controlling interest in our
subsidiaries, as a result of equity issuances by subsidiaries, failure to reach
voting agreements or otherwise, we would cease to consolidate the operating
results of these subsidiaries. This may result in significant fluctuations of
our consolidated operating results.

We are exposed
to significant claims for damage caused to our customers information systems.

Some
of the products and services we provide involve key aspects of customers information systems. These systems are
frequently critical to our
customers operations. As a result, our customers have a greater sensitivity to
failures in these systems than do customers of other software products
generally. We have never been the subject of a material damages claim related
to our products and services. However, if a customers system fails during or
following the provision of products or services by us, or if we fail to provide
customers with proper support for our software products, we are exposed to the
risk of a claim for substantial damages being filed against us, regardless of
our responsibility for the failure.
When possible, we limit our liability under our product and service
contracts. We cannot guarantee that these limitations of liability, if any,
would be sufficient to protect us against legal claims. We maintain general
liability and professional liability insurance coverage. However, we cannot
assure you that our insurance coverage will be sufficient to cover one or more
large claims, or that the insurer will not disclaim coverage as to any future
claim. If we lose one or more, large claims against us that exceed available
insurance coverage, our business, operating results and financial condition may
be materially adversely affected. In addition, the filing of legal claims
against us in connection with contract liability may cause us negative
publicity and damage to our reputation.

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If third
parties assert claims of infringement against us, we may suffer substantial
costs and diversion of managements attention.

Substantial
litigation over intellectual property rights exists in the software industry.
We expect that software products may be increasingly subject to third-party
infringement claims as the functionality of products in different industry
segments overlaps. Although our products and services have never been the subject
of an infringement proceeding, we cannot predict whether third parties will
assert claims of infringement against us. In addition, our employees and
contractors have access to software licensed by us from third parties. A breach
of the non-disclosure undertakings by any of our employees or contractors may
lead to a claim of infringement against us. Any claims, with or without merit,
could:

| |   |                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------
| |  | be expensive and time-consuming to defend;                                                                             
| |   |                                                                                                                        
| |  | divert managements attention and resources; or                                                                        
| |   |                                                                                                                        
| |  | require us to enter into royalty or licensing agreements to obtain
  the right to use a necessary product or component.

Royalty
or licensing agreements, if required, may not be available on acceptable terms,
if at all. A successful claim of product infringement against us and our
failure or inability to license the infringed or similar technology could have
a material adverse effect on our business, financial condition and results of
operations.

We may be
unable to adequately protect our proprietary rights, which may limit our
ability to compete effectively.

Our
success and ability to compete are substantially dependent upon our internally
developed technology. Substantially all of our intellectual property consists
of proprietary or confidential information that is not subject to patent or
similar protection. In general, we have relied on a combination of technical
leadership, trade secret, copyright and trademark law and nondisclosure
agreements to protect our proprietary know-how. Unauthorized third parties may
attempt to copy or obtain and use the technology protected by those rights. Any
infringement of our intellectual property could have a material adverse effect
on our business, financial condition and results of operations. Policing
unauthorized use of our products is difficult and costly, particularly in
countries where the laws may not protect our proprietary rights as fully as in
the United States. We have placed, and
in the future may place, certain of our software in escrow. The software may,
under specified circumstances, be made available to our customers. We have
provided our software directly to customers. This may increase the likelihood
of misappropriation or other misuse of our software.

Our largest
shareholder, FIMGold LP, controls a significant portion of our ordinary shares
and influences the outcome of matters that require shareholder approval.

Following
a private placement consummated by Formula in March 2005, and the sale by Dan
Goldstein of his entire shareholdings in Formula to FIMGold Limited
Partnership, referred to as FIMGold LP, FIMGold LP owns approximately 33.3% of
our outstanding ordinary shares. FIMGold LP is owned in equal shares by Dan
Goldstein, our chief executive officer and chairman of the board, and FIMI
Opportunity Fund, L.P. and parties related to it, jointly referred to as FIMI
Opportunity Fund. As a result, FIMGold
LP is able to influence significantly
the outcome of those matters requiring shareholder approval, including the
election of directors and approval of significant corporate transactions. This
share ownership may have the effect of delaying or preventing a change in
control. In addition, potential conflicts of interest may arise in the event
that we enter into agreements or transactions with Dan Goldstein or his brother
Gad Goldstein, our president and a member of our board. Although Israeli law
imposes certain procedures (including shareholder approval) for approval of
certain related party transactions, we cannot assure you that these procedures
will eliminate the possible detrimental effects of these conflicts of interest.
If certain transactions are not approved in accordance with required procedures
under applicable Israeli law, these transactions may be void or voidable. See
Item 7.B. Related Party Transactions.

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The market
price of our ordinary shares and AmericanDepositaryShares may be volatile
and you may not be able to resell your shares at or above the price you paid,
or at all.

The
stock market in general has experienced during recent years extreme price and
volume fluctuations. The market prices of securities of technology companies
have been extremely volatile, and have experienced fluctuations that have often
been unrelated or disproportionate to the operating performance of those
companies. These broad market fluctuations could adversely affect the market
price of our ordinary shares and American Depositary Shares, or ADSs. During 2003, for
example, the market price of our ADSs fluctuated between $6.71 and $18.05, and in
2004, the market price of our ADSs fluctuated between $13.44 and $21.80. The market price of the ordinary
shares and the ADSs may fluctuate substantially due to a variety of factors,
including:

| |   |                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------
| |  | any actual or anticipated fluctuations in our or our competitors
  quarterly revenues and operating results;
| |   |                                                                                                              
| |  | shortfalls
  in our operating results from levels forecast by securities analysts;                           
| |   |                                                                                                              
| |  | public announcements concerning us or our competitors;                                                       
| |   |                                                                                                              
| |  | results
  of integrating investments and acquisitions;                                                       
| |   |                                                                                                              
| |  | the introduction or market acceptance of new service offerings by us
  or our competitors;                   
| |   |                                                                                                              
| |  | changes in product pricing policies by us or our competitors;                                                
| |   |                                                                                                              
| |  | changes in security analysts financial estimates;                                                           
| |   |                                                                                                              
| |  | changes in accounting principles;                                                                            
| |   |                                                                                                              
| |  | sales of our shares by existing shareholders; and                                                            
| |   |                                                                                                              
| |  | the loss of any of our key personnel.                                                                        

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In
addition, economic, political and market conditions and military conflicts and
in particular, those specifically related to the State of Israel, may affect
the market price of our shares.

We may be
adversely affected if the market prices of our publicly traded subsidiaries
decrease.

A
significant portion of our assets is comprised of equity securities of publicly
and non-publicly traded companies. Our publicly traded subsidiaries are
BluePhoenix Solutions Ltd. (formerly known as Crystal Systems Solutions Ltd.), Magic Software Enterprises Ltd., Matrix IT Ltd.,
Sapiens International Corporation N.V. and Formula
Vision. The stock prices of these publicly traded companies have been extremely
volatile, and have experienced fluctuations due to market conditions and other
factors which are beyond our control. Fluctuations in the market price and
valuations of our holdings in these companies may affect the value of our
assets. In addition, the stock prices
of many technology companies fluctuate significantly for reasons that may be
unrelated to operating results. If the value of our assets decreases
significantly as a result of the above, our business, operating results and
financial condition, may be materially and adversely affected.

Future sales of
our shares in the public market or issuances of additional securities could
cause the market price for our ordinary shares and ADSs to fall.

As
of June 20, 2005, we had 13,200,000 ordinary shares outstanding, of
which 462,338 were represented by ADSs.
Of the
13,200,000 shares outstanding, 4,725,000 shares are held by affiliates. In addition, we have reserved
300,000 ordinary shares for issuance under our option plans.  We intend to register for resale these
reserved ordinary shares upon issuance. If a large number of our ordinary
shares held by affiliates are sold in a short period, the price of our ordinary
shares would likely decrease.

Our United
States investors could suffer adverse tax consequences if we are characterized
as a passive foreign investment company.

Although
we do not believe that we were a passive foreign investment company, or
PFIC, for U.S. federal income tax
purposes during 2004, we cannot assure you that we will not be treated as a passive foreign
investment company in 2005or in future years. We would be a passive foreign investment company if
75% or more of our gross income in a taxable year is passive income. We would
also be a passive foreign investment company if at least 50% of our assets in a
taxable year produce, or are held for the production of, passive income.
Passive income includes interest, dividends, royalties, rents and annuities. If
we are or become a passive foreign investment company, many of you will be
subject to adverse tax consequences, including having gain realized on the sale
of our ordinary shares or ADSs be treated as ordinary income, as opposed to
capital gain income, and having potentially punitive interest charges apply to
such sale proceeds.  A decline in the
value of our ordinary shares or ADSs may result in our being a PFIC.  United States shareholders should consult
with their own tax advisors with respect to the United States tax consequences
of investing in our ordinary shares.

For
a discussion of how we might be characterized as a PFIC and related tax
consequences, see Item 7. TaxationUnited States Federal Income Tax
Considerations.

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Our operating profit may decrease if the rate of
inflation in Israel exceeds the rate of devaluation of the New Israeli Shekel
against the dollar or against the euro.

Most
of our revenues from sale of our products and services are in dollars and euros or are
linked to the dollar or the euro, while a substantial portion of our expenses,
principally salaries and related personnel expenses, are in New Israeli
Shekels, or NIS. As a result, we are exposed to any of the
following risks:

| |   |                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------
| |  | that the
  inflation rate in Israel will exceed the NIS devaluation rate against the
  dollar or the euro;
| |   |                                                                                                           
| |  | that the
  devaluation process will lag behind the NIS inflation timing; or                               
| |   |                                                                                                           
| |  | that the
  euro experience devaluation against the dollar.                                                

If
any of these occur, the dollar or euro cost of our operations, as well as our
financial expenses, would increase. We cannot predict any future trends of the
rate of inflation in Israel or the rate of devaluation of the NIS or the euro
against the dollar. An increase in our dollar or euro operational cost will
adversely affect our dollar-measured results of operations. In addition, our
operations could be adversely affected if we are unable to hedge against
currency fluctuations in the future. To date, we have not engaged in
significant hedging transactions. In the future, we may enter into currency
hedging transactions to decrease the risk of financial exposure from
fluctuations in the exchange rate of the dollar against the NIS or the euro.
However, we cannot assure you that these measures will adequately protect us
from material adverse effects arising from the impact of inflation in Israel.
For additional information relating to the exchange rates between different
relevant currencies, see Item 5. Operating and Financial Review and
ProspectsOverviewOur Reporting Currency.

Fluctuations in
foreign currency values affect the prices of our products, which in turn may
affect our business and results of operations.

Most
of our worldwide sales are currently denominated in dollars. A decrease in the
value of the dollar relative to foreign currencies, in particular the euro and
the new Israeli shekel (NIS) would make our products more expensive and,
therefore, could adversely affect our results and harm our competitive position
in the markets.

Risks Relating to
Operations in Israel

Political,
economic, and military conditions in Israel could negatively impact our
business.

Our headquarters and principal
research and development facilities are located in Israel. Although we generate approximately 53% of our
revenues from international markets, we are, nonetheless, directly influenced by the political, economic
and military conditions affecting Israel. The execution of
Israels plan of unilateral disengagement from the Gaza Strip and some parts of
the West Bank may affect Israels foreign relations and the stability of the
region. Major hostilities involving Israel or the
interruption or curtailment of trade between Israel and its present trading
partners could have a material adverse effect on our business, operating
results and financial condition. Furthermore, several countries restrict
business with Israeli companies. In addition, nonexempt male adult citizens of Israel,
including some of our officers and employees, are obligated to perform military
reserve duty until the
age of 40 or 45 depending on their function in the army, and
are subject to being called for active duty under emergency circumstances.
While we have operated effectively under these requirements since our
incorporation, we cannot predict the full impact of such conditions on us in
the future, particularly if emergency circumstances occur. If many of our
employees are called for active duty, our operations in Israel and our business
may be adversely affected.

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The tax
benefits available to us from government programs may be discontinued or
reduced at any time, which would likely increase our taxes.

Certain
of our subsidiaries received grants in the past and receive tax benefits under
Israeli government programs, particularly as a result of the Approved
Enterprise status of certain operations in Israel. Approved Enterprise
status is granted by the Israeli Investment Center of the Ministry of Industry
and Trade and entitles the grantee to a variety of tax incentives. The
incentives awarded to certain of our subsidiaries include reduced tax rates and
a tax holiday. Certain of our subsidiaries were granted a two year tax
exemption, followed by a five year tax reduced tax rate of 25% instead of 35%
on income derived from Approved Enterprise investment programs. In order to
qualify for these incentives, the Approved Enterprise is required to provide
minimum paid-in-capital (30% of the investment), to show an increase in its
export activities, and to meet other general investing criteria. As of June 20,
2005, our subsidiaries have met those criteria and received tax benefits from
their Approved Enterprise programs, as presented in Note 16 to our financial
statements. To maintain the eligibility for these programs and benefits, we
must meet the conditions mentioned above. We cannot assure you that these
programs and tax benefits will continue at the same level in the future. If
these tax benefits and programs are terminated or reduced, we could pay increased
taxes in the future, which could decrease our profits.

It may be
difficult to serve process and enforce judgments against our directors and
officers in Israel.

We
are organized under the laws of the State of Israel. All of our executive officers
and directors are nonresidents 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:

| |   |                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | effect service of process within the United States on us or any of
  our executive officers or directors;                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                               
| |  | enforce court judgments obtained in the United States including those
  predicated upon the civil liability provisions of the United States federal
  securities laws, against us or against any of our executive officers or
  directors, in the United States or Israel; and
| |   |                                                                                                                                                                                                                                                                               
| |  | bring an original action in an Israeli court against us or against
  any of our executive officers or directors to enforce liabilities based upon
  the United States federal securities laws.                                                                                

16

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|        |                           
|------- | --------------------------
|ITEM 4. | INFORMATION ON THE COMPANY

A.History and
Development of the Company

We
were incorporated in Israel on April 2, 1985. We maintain our principal
executive offices at 3 Abba Eban Boulevard, Herzlia 46725, Israel and our
telephone number is 011-972-9-959-8800. Our agent in the United States is
Corporation Service Company and its address is 2711
Centerville Road, Suite 400, Wilmington, DE 19808. In 1991, we completed our initial public
offering of ordinary shares on the Tel Aviv Stock Exchange, or the TASE. In
October 1997, we completed the listing of our ADSs on the Nasdaq National
Market.

Since
our inception, we have acquired controlling interest and have invested in
companies which are engaged in the IT solutions and services business. We,
together with our subsidiaries and affiliates, are known as the Formula Group.

We
have adopted a strategy of seeking opportunities to realize gains through the
selective sale of investments and minority interest in our subsidiaries and
affiliates to outside investors. We believe that this strategy provides us with
capital to support the growth of our subsidiaries, as well as increasing
shareholder value. We expect to continue to develop and enhance the products,
services and solutions of our subsidiaries, and to continue to pursue
additional acquisitions of, or investments in, companies that provide IT
services and proprietary software solutions.

Capital
Expenditures and Divestitures

Certain
of our investment and financing activities are described below. For additional
information relating to our investment and financing activities during 2003 and
2004, see Item 5.B. Liquidity and Capital Resources.

In
March 2005, we completed a private placement of 2,400,000 Formula shares for an
aggregate consideration of $36 million. The shares were issued to FIMGold LP,
an entity owned in equal shares by Dan Goldstein and FIMI Opportunity Fund.
Concurrently with the closing of the private placement, Dan Goldstein sold to
FIMGold LP all of his holdings in Formula and in our subsidiary, Formula
Vision. Following these transactions, FIMGold LP holds 33.3% controlling
interest in Formula and approximately 24% interest in Formula Vision.

In
March 2001, we completed a $10 million investment in convertible preferred
shares of Sapiens International Corporation N.V., or Sapiens, a publicly held
company traded on the Nasdaq National Market, representing approximately 24% of
the outstanding share capital of Sapiens on an as converted basis. Under the
agreement with Sapiens, we were also granted an option to invest up to an additional $10 million on the
same terms as our initial investment, subject to certain adjustments. In December 2002, we
exercised the option and invested $10 million in Sapiens in exchange for a
discount conversion price of $0.83 per common share. As part of the
transaction, we converted all of our preferred shares into common shares at the
discount price. Since 2002, we purchased approximately additional 1,500,000
shares of Sapiens for aggregate consideration of approximately $5.1 million and
we currently hold 56% of Sapiens outstanding share capital.

17

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In
November 2002,
we sold to BluePhoenix Solutions Ltd., or BluePhoenix, in a share exchange transaction, our 57.9% interest in Liraz Systems
Ltd., or Liraz, an international software and services company publicly traded
on the TASE. For more information about this share
exchange transaction, see Restructuring of Our Corporate StructureSale of
Liraz Shares to BluePhoenix below.

Agreements with Shamrock, FIMI and IDB

In
September 1999, we entered into an agreement with Shamrock Holdings of
California Inc., or Shamrock, pursuant to which we granted to Shamrock an option,
until March 2000, to invest in companies in which we hold, directly or
indirectly, at least 25% of the outstanding equity. In addition, we granted to
Shamrock an option to exchange the securities it purchased under the above
option for Formulas ordinary shares, exercisable within a 45 day period,
beginning upon the elapse of 27 months from the date of purchase of the
securities or from the date of the agreement, such period to vary based on the
securities involved. The exchange ratio was to be based upon
the original price paid for the securities subject to the exchange and the
market price on the TASE of Formulas ordinary shares at the time of the
exchange, subject to certain requisite adjustments. Notwithstanding the above,
we had the discretion to purchase the securities to be exchanged for cash
instead of exchanging them for Formulas ordinary shares.

In
October 1999, we entered into agreements with the First Israel Mezzanine
Investors Ltd., or FIMI, and Israel Discount Bank, or IDB, each on the same
terms in all material respects as the agreement with Shamrock.

In
September 1999, an extraordinary general meeting of Formulas shareholders
approved the issuance to Shandol Ltd., a subsidiary of Formula at that date, of options to purchase 1 million ordinary shares, in
order to ensure
the availability of ordinary shares, if the above exchange options are
exercised. For
information regarding the terms of the options, see Item 6.E. Share Ownership.

In
August 2000, an extraordinary general meeting of Formulas shareholders
approved the grant of additional options to Shandol to purchase 500,000
ordinary shares, to ensure the availibility of ordinary shares for different
purposes while conducting various transactions, including the availability of
ordinary shares, if the above exchange options are exercised. In December 2003,
Shandol exercised these options to purchase 500,000 ordinary shares. The shares
purchased upon exercise of the options were sold by Shandol in transactions on
the TASE.

In
November 2001 and January 2002, Shamrock exercised the exchange option with
respect to its investment in certain companies of the Formula Group. In
consideration for the securities held by Shamrock, Shandol transferred to Shamrock
1,000,000 of our ordinary shares and an aggregate of approximately $1.6
million. In January 2002, Shamrock sold these shares to Dan and Gad Goldstein.
See Item 7. Major Shareholders and Related Party Transactions.

In April 2002, FIMI and IDB exercised the exchange option
with respect
to their investment in certain companies of the Formula Group in an aggregate amount of
$4.7 million (including accrued interest). In connection therewith, we entered
into an agreement with FIMI and IDB, pursuant to which we exchanged the amount
of $4.7 million with a convertible debenture issued by Formula. The convertible debenture may be
converted into Formulas ordinary shares during a 4-year period. The conversion
price shall be $19 per share, subject to adjustments, but in no event less than
a minimum price agreed to between the
parties. The principal of the convertible debenture shall be payable in
semi-annual installments beginning 30 months from the date of issuance of the
debenture, unless FIMI and IDB request to postpone this date until the end of
the 4-year period. The principal bears interest at an annual rate of 5% to be
paid quarterly.

18

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In
connection with the exercise of the option by Shamrock, we agreed to extend
until October 2006, the term of the put option with respect to the securities
held by Shamrock in ESI  Expert Systems Industries Ltd., or ESI, and in ESIs subsidiaries.
In addition, we agreed to extend the put option to securities held by Shamrock
in additional Formula Vision portfolio companies. It was agreed that Shamrocks
put option, if exercised, shall be exercised for cash. We also agreed to extend
until December 2005, the term of the option granted to
FIMI and IDB to exchange the securities held by them in Transtech Control Ltd., or Transtech, for
Formulas ordinary shares. The options granted to Shamrock, FIMI and IDB with
respect to shares of Sintec Advanced Technologies Ltd. were replaced in November 2002 by options relating
to shares of Matrix IT Ltd., as described under Restructuring of Our Corporate
Structure  Sale of New Applicom, Sintec and Sivan to Matrix, below.

As
part of the agreement between us and Formula Vision described below, we
transferred to Formula Vision our rights and obligations with respect to the
transferred companies under our agreements with each of Shamrock, FIMI and IDB. These companies are ESI and Transtech. If Shamrock,
FIMI or IDB
exercises the option to exchange these securities in the transferred companies
for Formulas shares and to the extent exercised, Formula Vision assumed all
the rights and undertakings in connection with the exercise of the option.

Restructuring
of Our Corporate Structure

During
1999 until 2003, we conducted a restructuring process, to simplify our
corporate structure and business environment by combining some smaller
subsidiaries to create a smaller number of larger subsidiaries with greater
operating efficiencies. The steps of the restructuring that were taken place
since 2001, include the following:

Transactions
with Formula Vision. In July 2001, Formula granted to Formula Vision an option to purchase
our interests in certain privately-held companies that develop products and
services aimed primarily for sale in international markets. In November 2001,
Formula Vision exercised the option.

In
connection therewith, Formula Vision issued to Formula, in December 2001, a
series of debentures of $58.9 million in the aggregate, linked to the Israeli
CPI and bearing interest at an annual rate of 5%. Formula Vision is required to repay the debentures in
five annual installments, subject to adjustments based on the income of Formula
Vision during each of the five years. The payments on account of the debentures plus linkage differences will
be no less than 30% and no more than 70% of the income arising from the sale of
the transferred companies in any calendar year. Income for these purposes is
defined as the amounts received by Formula Vision, if any, in consideration for
a sale of any of the transferred companies in any given calendar year, less
selling expenses, as well as amounts received by Formula Vision from
distributions to be made by any of the transferred companies in any given
calendar year. Payments to be made on account of the debentures, in any given
calendar year, will be no less than 20% of the annual profit as recorded in the
financial statements of Formula Vision. Any amounts which remain outstanding will be payable at the end of the
5-year period. In connection with this transaction, we lent to Formula Vision
on March 31, 2002 an additional $19.4 million and Formula Vision issued to us
an additional series of debentures for this amount, with similar terms as the
debentures issued in December 2001.

19

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In
the event that during the term of the indebtedness, Formula Vision issues to a
third party convertible debentures, Formula is entitled to convert the
indebtedness into the same class of convertible debentures, having the same
terms of the convertible debentures issued to the third party.

As
part of the agreement related to the exercise of the option by Formula Vision
to purchase from Formula its interest in privately held companies, we also
transferred to Formula Vision our rights and obligations with respect to the
transferred companies under our agreements with each of Shamrock, FIMI and IDB. These companies are ESI and Transtech. If either of
Shamrock, FIMI or
IDB exercises the option to exchange the securities in these transferred
companies for Formulas shares and to the extent exercised, Formula Vision
assumed all the rights and undertakings in connection with the exercise of the
option.

In
January 2004, Formula exchanged approximately $35 million of the aggregate
amount of the debentures for 38,000,000 shares of Formula Vision issued to
Formula and constituting 59.4% of the outstanding share capital of Formula
Vision. The price per share was NIS 4.11 ($0.93) which reflects the average
closing price of Formula Visions shares on the TASE during the 30 days
preceding Formulas resolution approving the transaction. Following the
exchange of a portion of the debentures, the outstanding amount of the
debentures was $43.2 million. Management believes that by holding a controlling interest in Formula Vision, Formula would
benefit from capital gains generated by Formula Vision from realization of its
assets. Based on this determination, it was in the best interests of Formula to
exchange a portion of the debentures for a 59.4% interest in Formula Vision. For more information, see Item 7.B.
Related Party Transactions Transactions between Formula and Formula Vision.

Sale
of Liraz to BluePhoenix. In November 2002,
we sold to BluePhoenix, in a share exchange transaction, 3,912,999 ordinary shares of Liraz, representing our entire 57.9% interest in
Liraz. In consideration, BluePhoenix issued to us 2,343,113 BluePhoenixs ordinary shares. The
number of shares issued to us by BluePhoenix was calculated based on an
exchange ratio of 1:1.67, such that BluePhoenix issued to us one BluePhoenixs share for every
1.67 shares of Liraz.
As part of this transaction, BluePhoenix purchased from certain additional
shareholders of Liraz an aggregate of
1,896,303 Liraz ordinary shares in exchange for BluePhoenix shares, based on
the same exchange ratio as in the transaction between BluePhoenix and us. As a
result, BluePhoenix owned approximately 86.0% of the outstanding share capital
of Liraz. Following
this transaction, BluePhoenix
purchased from the public all the remaining outstanding shares of Liraz through two public tender
offerings. In March 2003, Lirazs shares ceased to be traded on the
TASE.

20

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Sale of New
Applicom, Sintec and Sivan to Matrix. In November 2002,
we completed a sale to Matrix of our entire shareholdings in New Applicom Ltd., or New
Applicom, Sintec
Advanced Technologies Ltd., or Sintec, and Sivan Training and Systems Ltd., or Sivan, then publicly held companies traded
on the TASE, for aggregate consideration of $29.7 million. In this transaction,
we sold to Matrix 3,870,498 shares of New Applicom, representing approximately
60.8% of New Applicoms outstanding share capital, for an aggregate of $16.9
million, 15,330,309 shares of Sintec, representing Sintecs entire outstanding
share capital, for an aggregate of $12.5 million, and 8,930,100 shares of
Sivan, representing approximately 69.0% of Sivans outstanding share capital,
for an aggregate of $346,000. The shares we sold to Matrix were comprised of
(i) shares previously held by us; (ii) shares that we purchased from third
parties in October 2002; and (iii) shares that we bought in tender offers we
conducted in October 2002. The price per share paid to us by Matrix for each of
New Applicoms, Sintecs and Sivans shares previously held by us and those we
purchased from third parties was equal to the equity per share of each of the
companies.

The
shares that we purchased from third parties in October 2002 and sold to Matrix
were bought in the following transactions:

(i)
552,789 shares of New Applicom that we purchased in exchange for 1,436,096
shares of Matrix. As part of this transaction, we granted to the selling
shareholders a put option to sell to us Matrixs shares during the fourth
quarter of 2003 for cash at an exercise price based on the cost of New
Applicoms sold shares;

(ii)
an aggregate of 4,200,000 shares of Sintec that we purchased in exchange for
2,180,780 shares of Matrix. As part of this transaction, we granted to the
selling shareholders a put option to sell to us Matrix shares during the
fourth quarter of 2003 and the first quarter of 2004 at a cash price based on
the cost of Sintecs sold shares. This option was previously granted to the
selling shareholders in 1999 with respect to Sintecs sold shares; and

(iii)
an aggregate of 1,100,000 shares of Sintec that we purchased in exchange for
608,080 shares of Matrix. As part of this transaction, we granted to the
selling shareholders a put option to sell to us Matrixs shares during November
2003 for cash.

During
the fourth quarter of 2003, the selling shareholders exercised the put options
described above and sold to us an aggregate of 4,224,956 shares of Matrix for
aggregate consideration of $10 million.

As part of the sale
of the shares of New Applicom, Sintec and Sivan to Matrix, we conducted in
October 2002, cash tender offers for the shares of New Applicom, Sintec and
Sivan not owned by us. As a result, Sintecs shares ceased to be traded on the TASE.
Following the closing of the tender offers, we sold to Matrix the shares that
we purchased in the tender offers for the same purchase price we paid for the
tendered shares; $3.7 for each New Applicom share, $0.8 for each Sintec share
and $0.15 for each Sivan share. In November 2002, Matrix conducted tender
offers for the shares of New Applicom and Sivan held by the public. In June
2003, Matrix conducted an additional tender offer to purchase the shares of New
Applicom, in which Matrix purchased the remaining outstanding share capital of
New Applicom held by the public. In January 2004, Matrix conducted an
additional tender offer to purchase the shares of Sivan, in which Matrix
purchased the remaining outstanding share capital of Sivan held by the public.
Matrix currently holds the entire share capital of New Applicom, Sintec and
Sivan.

21

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B.Business Overview

General

We
are a global information technology, or IT, solutions and services company
based in Israel. We are principally engaged in providing software consulting
services, developing proprietary software products and providing computer-based
business solutions. We currently deliver our solutions in over 50 countries
worldwide to customers with complex IT services needs, including a number of
Fortune 1000 companies. We operate in two principal business areas, IT
services and proprietary software solutions. Following is a description of our business areas:

IT
Services

We
design and implement IT solutions which improve the productivity of our
customers existing IT assets. In delivering our IT services, we at times use
proprietary software developed by members of the Formula Group. We provide our IT services
across the full system development life cycle, including definition of business
requirements, system analysis, technical specifications, coding, testing,
training, implementation and maintenance. We perform our projects on-site or at
our own facilities.

Proprietary Software Solutions

We
design, develop and market proprietary software solutions for sale in selected
niche markets worldwide. We regularly seek opportunities to invest in or
acquire companies with attractive proprietary software solutions under
development which we believe to have market potential. The majority of our
investments and acquisitions in this area have been in companies with products
beyond the prototype stage. In addition, we selectively invest in companies
with proven technology where we believe we can leverage our experience to
enhance product positioning and increase market penetration. We provide our
management and technical expertise, marketing experience and financial
resources to help bring these products to market. We also assist the members of
our group to form teaming agreements with strategic partners to develop a
presence in international markets.

The
Formula Group

Formula
is the parent company of subsidiaries and affiliates, referred to collectively
as the Formula Group. We currently hold a controlling interest in our subsidiaries
through our equity holdings. From time to time, if and when required, we enter
into voting agreements with other shareholders of the companies, in order to
retain control of our subsidiaries. We appoint a majority of the boards of directors
of our subsidiaries through our equity holdings and, if required, through
voting agreements with shareholders who are often members of our management or
of our subsidiaries management. We provide our subsidiaries with our management,
technical expertise and marketing experience to help them to penetrate their
respective markets.

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We
direct the overall strategy of our subsidiaries. While the subsidiaries each
have independent management, we monitor the growth of our subsidiaries through
the active involvement in the following matters:

| |   |                                                             
| | - | ------------------------------------------------------------
| |  | strategic planning;                                         
| |   |                                                             
| |  | marketing policies;                                         
| |   |                                                             
| |  | senior management recruitment;                              
| |   |                                                             
| |  | investment and budget policy;                               
| |   |                                                             
| |  | financing policies; and                                     
| |   |                                                             
| |  | overall ongoing monitoring of each subsidiarys performance.

We
promote the synergy and cooperation among our subsidiaries by encouraging the
following:

| |   |                                                                                        
| | - | ---------------------------------------------------------------------------------------
| |  | transfer of technology and expertise;                                                  
| |   |                                                                                        
| |  | leveling of human resources demand;                                                    
| |   |                                                                                        
| |  | combining skills for specific projects;                                                
| |   |                                                                                        
| |  | formation of critical mass for large projects; and                                     
| |   |                                                                                        
| |  | marketing and selling the groups products and services to the
  groups customer base.

We, through our subsidiaries, offer
a wide range of integrated IT solutions and services, and design, develop and
market proprietary software solutions for sale in selected niche markets, both
in Israel and worldwide.

Our Subsidiaries

Matrix

Matrix
IT Ltd. is one of Israels leading integration and information technology
services companies, according to Duns 100 Israel Largest Enterprises 2004.
Matrix employs over 2,000 software, hardware, integration and training
personnel, which provide advanced IT services to more than 500 customers in the
Israeli market. Matrix also markets in Israel software and hardware products
manufactured by a broad range of international manufacturers.

The
solutions, services and products supplied by Matrix are designed to improve
Matrixs customers competitive capabilities, by providing a response to their
unique IT needs in all levels of their operation.

23

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Areas
of Operation

Matrix
is active in four principal areas: software solutions and services, software
products, infrastructure solutions and hardware products, and training and
assimilation.

Software
solutions and services. Matrix provides
software services, software development projects, outsourcing, integration of
software systems and services  all in accordance with its customers specific
needs. Matrix also provides upgrading and expansion of existing software
systems. Matrix software solutions include the following components: (i)
development of dedicated customer software; (ii) customization of software
developed by Matrix or by third parties to provide a response to customers
requirements; (iii) systems assimilation; and (iv) integration of all or part
of these components. The scope of the work invested in each individual
component varies from one customer to the other, based on each customers
specific requirements.

Software
Products. Matrixs operations in this
area include the marketing and assimilation of software products in various
categories, mainly customer relationship management (CRM) software products,
systems management and service management products, software products for
content management, software products for business intelligence (BI), data
warehouses and extract/transform/load (ETL), software products for integration,
database systems, open-code operating systems, software products for knowledge
management, and software development tools.

Infrastructure solutions and hardware products. These
include: (i) supply of infrastructure solutions for computer and communication
systems; (ii) sale and marketing of PCs, laptops, Intel servers, peripheral
equipment, operating systems, servers and workstations operating on Unix and
VMS operating systems, and sales and marketing of storage and backup systems
for mainframe computers such as HP and IBM; and (iii) maintenance for computers
and peripheral equipment, lab services and a help desk.

Training
and assimilation. Matrix operates
hi-tech training and qualification centers providing advanced professional
courses for hi-tech personnel, training and assimilation of computer systems,
applications courses and professional training.

Matrix
provides solutions, services and products primarily to the following four
market sectors (or verticals): communications and security, banking and
finance, industry and trade, and the public sector.

Matrix
offers to each market sector a broad range of solutions and services,
customized for the specific needs of that sector. Matrix operates dedicated
departments, each of which specializes in a particular sector. Each such
department supplies customers in that sector with a product basket providing a
response to most of its IT requirements, based on an in-depth business
understanding of the challenges which are typical to that sector. Matrix
established separated headquarters for each particular market sector, which
manages the operations relating to that sector.

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Specialization
in the various sectors is reflected in the applications, professional and
marketing aspects of each sector. Accordingly, the professional and marketing
infrastructure required to support each market sector is developed to address
such sectors specific needs.

In
addition to the four sector-based areas of operations, Matrix operates two
horizontal entities providing specialist services for all of the different
sectors of operations. These entities include:

| |   |                                                                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | A technology
  center providing development services, which include mainly cross-sector
  applications (applications which can be used in more than one business
  sector), as well as the development of applications that require specialist
  resources and professional know-how; and
| |   |                                                                                                                                                                                                                                                                                          
| |  | A strategic
  consulting center that provides customers with diverse consultation services
  on topics such as organization, strategy, business development and
  technological development.                                                                                             

Customers

Matrixs
customers include large enterprises in Israel, such as Israel Electric Company,
Social Security, Israeli Defense Force, Mekorot, Amidar, governmental ministries and
the Knesset (the Israeli parliament); commercial banks (such as Bank Leumi, Bank Hapoalim, The
First International Bank, Discount Bank,
United
Mizrahi Bank and Igud Bank), loan and mortgage banks (such as Leumi Mortgage and Tfahot),
telecommunications services providers(Bezeq,
Bezeq International and Barak, credit card companies (Visa, Isracard and Leumicard), leasing companies,
insurance companies (such as Harel Hamishmar, Phoenix, Clal, Migdal), security agencies, cellular
operators  (Cellcom, Orange and
Pelephone), satellite operators (YES), hi-tech companies  (Comverse, Motorola and Amdocs) and media and publishing
entities  (Yediot Ahronot).

Matrixs
customers also include Israel Electric Company, leasing companies and security agencies.

Magic

Magic Software Enterprises Ltd. is a leading provider of
rapid application development and deployment, business integration technology
and business solutions to corporations worldwide. Users of Magics solutions and
technology include tens of thousands of independent software vendors, system integrators
and corporations worldwide, supported by an extensive global services organization. In
addition to technology, Magic also provides its customers with consulting, professional
services, and training.

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Magic Core Technology

Magic develops, markets and supports its software
development and deployment technology, eDeveloper.
eDeveloper enables enterprises to accelerate the process of building and
deploying business software applications that can be rapidly customized to meet
current and future needs. eDeveloper is based on a revolutionary programming
paradigm that eliminates wasted time and repetition from the development cycle.
eDeveloper is built around the concept of a smart application engine that
provides unique platform and database independence for both Web and
client/server deployment. eDeveloper integrates with standard computing architectures,
including J2EE and .NET and can act as a bridge between these and other diverse standards like XML and Web services.

eDeveloper significantly reduces maintenance time and
costs. Magics research and
development department continues to develop and integrate new technologies into eDeveloper to ensure
that customers receive a
state-of-the-art, efficient, development environment.

In addition, Magic provides customers with an extensive
framework for
business integration, called the iBOLT Integration Suite. The iBOLT Integration Suite enables
companies to utilize their existing business processes and legacy investments,
and rapidly customize solutions to meet specific enterprise needs. iBOLT provides affordable enterprise
application integration to mid-sized businesses, system integrators and
application vendors which require integration capabilities. As a comprehensive
suite for application integration, iBOLT allows the simple integration and
interoperability of diverse solutions, including legacy applications in a quick
and efficient manner. iBOLT has been identified by leading industry analysts as
a challenger in the market for enterprise application integration solutions.

As
a comprehensive suite for application integration, iBOLT includes a robust set
of capabilities for handling integration and exchanging transactions in a
heterogeneous environment. It includes support for business process management,
monitoring and real time reporting.

iBOLT
provides integration and connectivity capabilities that include database
interoperability, the ability to work with multiple databases in the same
process, and the capacity to deploy on a range of systems on varied platforms.
iBOLT also includes an assortment of smart connectors and adapters and
ready-to-use components.

Magic
development and integration products empower customers to significantly improve
their business performance and return on investments by enabling the
affordable and rapid integration of diverse applications, systems and databases
to streamline business processes.

Magics technologies adhere to
open standards and deliver high levels of portability and scalability, crucial for todays
dynamic business environment, and
operate as a uniform application paradigm independent of
architecture (Internet, Client/Server, Mobile, LAN/WAN), operating systems
(Windows, Linux, UNIX, iSeries), database (DB2, Oracle, Informix, MS SQLServer,
Pervasive, etc.), or platform (.NET, J2EE).

Enabling Business

Magic technology and solutions are particularly in demand
when time-to-market is critical, budgets are tight, integration with multiple platforms, databases or existing systems and
business processes is required, compliance to industry regulations is needed or a high degree of
application maintenance and customization is anticipated.

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Magic
addresses customers critical business need to respond quickly to changing
market demands. Magic creates, deploys and maintains robust business solutions
with unrivaled productivity and time to results. Magics unique development
methodology enables developers to create better solutions in less time and with
fewer resources.

Development
communities have become increasingly disjointed, creating an even greater need
for a development environment that provides open interfaces to leading
technologies and standards. Magics eDeveloper and iBOLT products provide
developers with the ability to rapidly build integrated applications in a more
productive manner, lowering IT maintenance costs and decreasing time-to-market.

A wide variety of developers use Magics products,
including in-house corporate
development teams and software houses. Large and medium sized system integrators use Magics products in large
customized system integration projects and for developing industry-specific
vertical applications.

Professional
Services

Magic, together
with Magics partners, offers customers application integration and development
services that assist customers to maximize their development investments. These services include project
management, technical support, installation services, application development,
integration, consulting and training. All projects are subject to a rigorous
standard for project management and quality assurance.

Strategic
Alliances

Magic forms strategic alliances to help deliver complete
solutions to customers. These solutions encompass application
integration, development, vertical domain expertise and hardware
implementation. Magic maintains strategic alliances with leading vendors, like SAP, IBM, Iway, IDS
Scheer and Pervasive Software. Magics partnership with SAP, entered into in
2004, focuses on providing a special edition of iBOLT as a collaboration
platform for SAP business one product. In addition, Magic has alliances with system
integrators, software and hardware vendors and consulting organizations. These
partnerships enable Magic to better serve its customers worldwide.

Vertical Solutions

Magic
also develops, markets, and supports, through its subsidiaries and affiliates,
vertical applications, including long-term care, criminal justice, and
multi-facility car and truck rental management solutions.

| |   |                                                                                                                                                                                                                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Healthcare  Advanced Answers on Demand Holding Corp. develops and
  markets application software targeted at the long-term care industry. This
  comprehensive solution is designed to meet the management information needs
  of retirement homes, nursing homes, assisted living facilities, continuing
  care retirement communities, and home health and rehabilitation agencies.

27

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Cargo Handling  Hermes (formerly Magic eCargo) is designed expressly for the cargo industry and is a
comprehensive solution for
  cargo handling and inventory control that is designed to increase
  productivity, improve efficiency, and reduce costs. Hermes handles many
  aspects of a cargo operation including inventory control, automated build-up
  of flights/manifesting, messaging to CARGO-IMP standards, customs clearance,
  weight and balance DCS interfacing, scanning and verification of cargo,
  secured tracking and a comprehensive financial package for all aspects of
  charging, collecting fees and invoicing.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Rental Car Leasing  CarPro Systems Ltd. develops, markets and sells
  CarPro, a solution that includes more than 90% of the functions usually
  required by multi-facility car and truck rental companies worldwide. CarPro
  can manage such varied functions as purchasing and selling vehicles,
  reservations management, leasing and rental arrangements, and fleet control
  and management.                                                                                                                                                                                                                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Banking  Nextstep Infotech PVT Ltd. develops and markets Cheq Mate,
  a banking application that provides most of the functionality needed to run a
  retail branch, including support for various deposit types, advances, time
  deposits, bank guarantees, letters of credit and portfolio management.                                                                                                                                                                                                                                                                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Professional
  Services  CoreTech is an information technology consulting firm offering
  flexible and creative solutions in the areas of infrastructure design and
  delivery, application development, technology planning and implementation
  services, and supplemental staffing.                                                                                                                                                                                                                                                                                                                                                      

Markets
and Customers

Magic markets and sells its products and services
in approximately 50 countries worldwide. Industries that are significantly
represented in the Magic community base include finance, retail, media, telecommunications,
manufacturing, healthcare, and government agencies. Among the tens of thousands of end-users running their business systems
with Magics technology are the following:

| |   |                     
| | - | --------------------
| |  | Adidas-Solomon      
| |   |                     
| |  | Allstate            
| |   |                     
| |  | Athlon Group        
| |   |                     
| |  | Bank of France      
| |   |                     
| |  | Burger King         
| |   |                     
| |  | Chase Manhattan Bank
| |   |                     
| |  | Club Med            
| |   |                     
| |  | Compass Group PLC   
| |   |                     
| |  | Deka Bank           
| |   |                     
| |  | Fiat                
| |   |                     
| |  | Financial Times     
| |   |                     
| |  | Hitachi             
| |   |                     
| |  | John Menzies        
| |   |                     
| |  | Kodak               
| |   |                     
| |  | Marconi Mobile      
| |   |                     
| |  | NEC                 
| |   |                     
| |  | Merrill Lynch       
| |   |                     
| |  | Matsushita          
| |   |                     
| |  | McDonalds           
| |   |                     
| |  | McKesson HBOC       
| |   |                     
| |  | Minolta             
| |   |                     
| |  | Nestle Nespresso    
| |   |                     
| |  | Nintendo            
| |   |                     
| |  | Philip Morris       
| |   |                     
| |  | GAP                 
| |   |                     
| |  | State of Washington 
| |   |                     
| |  | Vodafone            
| |   |                     
| |  | The United Nations  
| |   |                     
| |  | Victorinox          

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BluePhoenix

BluePhoenix
Solutions Ltd. (formerly known as Crystal Systems Solutions Ltd.) develops and markets unique
enterprise IT modernization, or EIM, solutions that enable companies to
automate the process of modernizing and upgrading their mainframe and
distributed IT infrastructure and to effectively compete in todays
environment. BluePhoenixs solutions, which include technology for Understanding,
Presentment, Migration, Remediation, and Redevelopment, allow
companies to fully leverage their current systems and applications, speed up
and reduce the cost of the renewal process, and effectively update their
systems in order to adapt to new business demands.

BluePhoenixs solution portfolio includes
invasive and noninvasive software products, software tools and support services
that address the most pressing challenges organizations and companies face
today.

BluePhoenixs
comprehensive enterprise technologies span mainframe, midrange, and
client/server computing platforms. BluePhoenix has
enhanced its expertise through the successful completion of projects for many
large organizations over the past 18 years, establishing its credibility and
achieving international recognition and presence. Based on BluePhoenixs technology and that of its
affiliates, BluePhoenix develops and
markets software products, tools, and related methodologies. BluePhoenix delivers its tools and methodologies
together with training and support in order to provide enterprises with
comprehensive solutions, primarily for the modernization of existing IT
systems.

In
1997, BluePhoenix introduced its
C-MILL millennium conversion tool, which was developed based on its generic modernization
technology, and BluePhoenix was awarded significant contracts
from leading international system integrators. In 1997 and 1998, BluePhoenix derived substantially all of its revenues
from millennium conversion projects. Since 2000, BluePhoenix has derived all of its revenues from
providing legacy modernization and porting solutions.

Among
the various alternatives to modernization, such as renewing legacy systems,
buying packaged software, or rebuilding entire applications, EIM has proven to
be the most efficient and viable way for companies to protect their existing
investments. BluePhoenix provides a range of solutions designed to efficiently
address the challenge of retaining the business knowledge built into the
application code while updating the system to reflect new requirements.

The
EIM market is divided into the following categories: enterprise IT
understanding, enterprise IT presentment, enterprise IT migration, enterprise
IT remediation, and enterprise
IT redevelopment. BluePhoenix provides solutions for each market area, as
follows:

Enterprise
IT Understanding  BluePhoenix understanding solutions provide automated, detailed mapping
of system-wide IT activity and the interconnections between all software components.
This detailed road map serves as the basis for optimizing the reuse of existing
IT systems, tailoring the modernization plan for the companys unique IT
environment and corporate requirements, and reducing future ongoing maintenance
costs. BluePhoenix IT Discovery provides fast and
convenient access to application inventory, dependency, and operational
information. This tool performs the complete audit necessary to enable
companies to define and analyze all application assets in order to make
informed decisions about ongoing modernization activities.

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Enterprise
IT PresentmentBluePhoenix enterprise IT presentmentsolutions
enable companies to more effectively use the large amount of information
produced by batch reports generated from legacy systems and to turn mainframe
applications into Web services directly from the existing development
environment. The presentment process extracts and manages report and document
content and then selectively redisplays it in graphical form over the Web. The
results are easy to access, read, and distribute, fully secure, and do not
require large amounts of storage space. BluePhoenix enterprise IT presentment suite includes the following solutions:

| |   |                                                                                                                                                                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | BluePhoenix PowerTextprovides companies with the
  ability to define XML (Extensible Markup Language)-based data views from
  their existing reports. Each data view can be associated with an XSL
  (Extensible Stylesheet Language) definition used to create a graphical presentation
  of the data.                                         
| |   |                                                                                                                                                                                                                                                                                                                                                  
| |  | BluePhoenix
  WS4 Legacy enables
  companies to adapt their existing development environment by providing access
  to mainframe systems through Web services protocols, a standard in todays
  market. WS4Legacy makes legacy systems appear as modern systems, and enables
  them to communicate with other applications in the same language.

Enterprise
IT MigrationBluePhoenix comprehensive, integrated set of enterprise
IT migration solutions enable companies to standardize and consolidate
their IT systems by automatically converting and redeploying applications,
databases, platforms, programming languages, and data that are implemented on
outdated computing platforms.

Buying a
packaged application or rebuilding one can often be an expensive and risky
proposition. Therefore, companies often look toward migrating their existing
applications. This option is much more cost-effective and time-efficient as it
leverages their existing investments in custom applications. Additionally,
BluePhoenix migration solutions enable companies to operate their IT systems
independently, without relying on previous technology support providers. Thus,
the migration process provides significant cost savings on development,
maintenance, and human resources. BluePhoenix enterprise ITmigration suite includes the following solutions:

| |   |                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | BluePhoenix
  DBMSMigratorAn automated migration tool that converts
  applications from nonrelational databases, such as IDMS, ADABAS, and VSAM, to
  relational databases, such as DB2, Oracle and SQL Server.                        
| |   |                                                                                                                                                                                                                                          
| |  | BluePhoenix
  PlatformMigratorAn automated migration tool that converts a
  range of platforms, including VSE, MVS, and Bull GCOS, and can be customized
  to fit the unique IT configuration and business rules of each customer site.
| |   |                                                                                                                                                                                                                                          
| |  | BluePhoenix
  LanguageMigratorAn automated migration tool for converting
  COBOL and 4GLs (fourth generation languages) such as ADSO, Natural Mantis and
  COOL:Gen.                                                                   

30

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| |   |                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | BluePhoenix
  DataMigratorA Windows-based tool for migrating data between various data system
  environments. Coupled with a step-by-step proven methodology, the tool
  provides a fully structured but still versatile automated data migration
  process.

Enterprise
IT RemediationBluePhoenix integrated set of enterprise IT remediation solutions enable
companies to extend the life of their existing IT systems when faced with
ongoing regulatory changes and new business requirements. BluePhoenix remediation
solutions address a variety of corporate needs and include:

| |   |                                                                                                                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | BluePhoenix
  FieldEnablerFieldEnabler is a rule-based tool that
  enables a step-by-step, comprehensive process for making these kinds of
  modifications across an enterprise in a reliable and time-efficient manner.                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                                                        
| |  | BluePhoenix
  StandardsEnablerA highly automated solution for reliably
  facilitating system consolidation into a single set of naming standards.
  Since all resources being converted must be changed in parallel, the large
  task of manually standardizing the naming of system components is not
  practical. BluePhoenix solution provides automated solution to this problem.
| |   |                                                                                                                                                                                                                                                                                                                                                                                        
| |  | BluePhoenix
  COBOL/LE-EnablerA highly automated solution that
  facilitates the migration of COBOL code from non-LE compliant environments to
  LE compliant environments.                                                                                                                                                                                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                                        
| |  | BluePhoenix
  EuroEnablerA highly automated solution that enables
  the transformation of applications to be euro compliant.                                                                                                                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                                                                                                                                                        
| |  | BluePhoenix
  LiraEnablerA highly automated solution that enables
  applications to be compliant with the Turkish currency requirements for entry
  into the European Community.                                                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                        
| |  | BluePhoenix
  GTIN/UPCEnablerA highly automated solution that enables
  companies to quickly and easily comply with the 2005 Sunrise and GTIN/GLN
  initiatives.                                                                                                                                                                                                                     

Enterprise
IT RedevelopmentBluePhoenix enterprise
IT redevelopmentsuite
enables companies to efficiently mine, reuse, and rewrite their existing
applications, thus incrementally redeveloping their legacy systems, extending
them into new technologies, and saving on development and programmer costs.

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | BluePhoenix
  AppBuilderBluePhoenix primary redevelopment legacy
  environment has been used for managing, maintaining, and reusing the
  complicated applications needed by large businesses. It provides the
  infrastructure for enterprises worldwide, across several industries, with
  applications running millions of transactions daily on legacy systems.
  Enterprises using AppBuilder can build, deploy, and maintain large-scale
  custom-built business applications for years without being dependent on any
  particular technology until they cease using their legacy infrastructure.

31

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Visual
  MainWin® for the Unix and Linux platforms (formerly MainWin)Visual
  MainWin® for the Unix and Linux platforms is an advanced application-porting
  platform that enables IT organizations to develop applications in Visual C++
  and deploy them natively on Unix and Linux without the investment that is
  usually associated with such an undertaking.                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |   | BluePhoenixs subsidiary, Mainsoft Corporation, has entered into a
  licensing agreement with Microsoft, pursuant to which Microsoft granted
  Mainsoft access to specified Microsoft source code, including new versions,
  service packs, and upgrade releases for Windows. Microsoft also granted
  Mainsoft distribution rights to the Windows object code licensed as a
  component in Mainsofts products.                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | Visual MainWin® for the J2EE platformIn February 2004, Mainsoft
  launched its new generation product: Visual MainWin® for the J2EE platform
  (formerly named Grasshopper). The Visual MainWin® for J2EE Platform is a
  cross-platform development solution that bridges the .NET/J2EE divide,
  enabling Visual Basic .NET and C# developers to develop J2EE Web Applications
  and Web services using the Visual Studio .NET development environment.

In
2003, BluePhoenix completed the acquisition of the entire outstanding share
capital of Liraz Systems Ltd. Lirazs business included the operations of
BluePhoenix Solutions B.V. and its international subsidiaries. Through its
subsidiaries, BluePhoenix develops and markets the
AppBuilder, formerly developed and marketed by Liraz, a software product used
for the development of sophisticated and robust applications needed by large
enterprises. Following the acquisition, BluePhoenix has benefited from Lirazs large installed
base that includes leading international banks and financial institutions,
whose information systems operate in various legacy environments.

BluePhoenix believes that following the Liraz
acquisition, utilizing its combined broad technology offering and its worldwide
marketing capabilities, BluePhoenix became a leading global player in the
enterprise IT modernization market. With 12 offices in 10 countries, five full
service delivery centers, and representatives, BluePhoenix provides its products and services
worldwide.

Customers

BluePhoenix
provides its modernization solutions directly or through its strategic
partners, such as IBM, Capgemini, EDS, Cook Systems, Temenos, Millennium and
TACT. Additionally, from time to time, other IT services companies license the
technologies for use in modernization projects in various markets. BluePhoenix
customers include, among others:

| |   |                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In the
  financial services sectorBanca Carige S.p.A., CitiBank, Credit Suisse, Fidelity International
  Resource Management, Rabobank Netherland BV, Rural Servicios Informaticos
  (Spain), SDC Udvikling (Denmark) and Temenos Group;
| |   |                                                                                                                                                                                                                                          
| |  | In the
  insurance sectorAXA Sunlife Services PCL(UK), Barmenia Krankenversicherung A.G.,
  Friends Provident Management Services Ltd., LBS (Germany), Legal and General
  Resources and Mutual of America.                             

32

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In other
  industriesAltera
  Corporation, Cadence Design Systems, Inc., Cognos, Commonwealth of Australia,
  Computer Associates Islandia, CSC Denmark A/S, Crystal Decisions, Electronic
  Data Systems Corp., Fudicia Informationszentra AG, Global Exchange Services
  Inc., IBM Japan Ltd., IBM (Rational Software), Intesa Sistemi E Servizi,
  Mentor Graphics Corporation, Microsoft Corporation, Israeli Ministry of Defense,
  Scottish Equitable Plc. and Synopsys MT VIEW.

Sapiens

Sapiens
International Corporation N.V. is a global provider of IT solutions that
modernize business processes to enable insurance and other leading companies to
quickly adapt to change. Sapiens solutions, sold as customizable software
modules, align IT with business demands for speed, flexibility and efficiency.
Sapiens solutions are supplemented by its technology, methodology and
consulting services, which address the complex issues related to the life-cycle
of enterprise business applications. Sapiens solutions include scalable
insurance applications it has developed for leading organizations such as AXA,
Norwich Union, Liverpool Victoria, OneBeacon, Fortis, Principal Financial Group,
the Surplus Line Association of California and Menorah Insurance in Israel.
Sapiens service offerings include a standard consulting offering that helps
customers make better use of IT in order to achieve their business objectives.

Sapiens core
technology, Sapiens eMerge, is a
rules-based application development suite which enables rapid solution
development for complex mission-critical enterprises to deliver new
functionality, achieve legacy modernization and enterprise application
integration. The primary building block of Sapiens solution offerings is
Sapiens eMerge, Sapiens business rules engine that has evolved and matured
over the course of thousands of man-years of research and development efforts.
The use of Sapiens eMerge reduces the complexity of programming so that new
applications and modifications of existing ones can be produced in a much
shorter time than through conventional programming.

Another key
advantage of Sapiens eMerge is the ability to extend the productive life of
older computer systems, while at the same time providing the basis for using
new generation Internet and service-oriented technologies. The use of rapid
application development allows enterprise-specific enhancements to be made in a
shorter time and with a greatly reduced maintenance burden when compared to
other technologies.

Development,
deployment, integration and administration of applications are all accomplished
through the technology components of Sapiens eMerge, providing customers with
flexible, scalable and feature-rich systems. Sapiens eMerge, which serves over
100 of Sapiens customers worldwide, reduces the cost of business software
development and maintenance.

33

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Sapiens
markets its solutions globally through its direct sales force and through
marketing alliances with global IT providers, such as IBM Corporation and
Electronic Data Systems Corporation. Sapiens has cooperated with IBM
Corporation for over 10 years at what IBM refers to as a Premier Partner
level. Currently, Sapiens is an Advanced Partner of IBM and works with IBM on
solutions, joint development, testing, validation and marketing. Through this
and other business alliances, Sapiens has developed extensive knowledge in
mainframe and mid-range systems, including CICS, DB2, MQSeries and the
WebSphere e-business platform. Sapiens is also a member of the IBMs insurance
application architecture (IAA) group and the ISV advantage program for the
small and medium business insurance market segment.

Sapiens
Business Solutions for the Insurance Industry

Sapiens has formulated
INSIGHT, a suite of modular business software solutions that make use of
existing assets to quickly and cost-effectively modernize business processes
that are the key to survival in the current, challenging insurance landscape.
Sapiens insurance solutions, which include the INSIGHT family, are based on
Sapiens core technology, Sapiens eMerge.

Sapiens INSIGHT is designed for the general (property and casualty)
and life insurance markets. These solutions can be customized to match specific
legacy systems and business requirements, while providing pre-configured
functionality. These solutions can be used independently or together as
follows:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | INSIGHT for Property & Casualty
  (formerly known as Policy INSIGHT) is a fully functional, general insurance
  policy administration solution that makes it easier for brokers and agents to
  do business with carriers. By automating the process, this web-enabled
  solution reduces the cost of doing business and optimizes risk selection
  through the use of rules based underwriting.                                                                                                                                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | INSIGHT for Life & Pensions(formerly
  Life & Pensions INSIGHT) is a powerful and comprehensive framework-based
  life and pensions solution that serves companies administering life
  insurance, pension funds, health insurance and saving plans. INSIGHT for Life
  & Pensions is dynamic, highly customizable and can be easily accommodated
  to administer changes in processes. It is fully web-enabled, prepared to
  utilize the advantages of the internet and intranet.                                                                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | INSIGHT for Underwriting (formerly
  MediRisk INSIGHT) is an underwriting solution for life, health and
  disability insurance. It reduces customers costs by automating a larger
  portion of the process of evaluating the risks of new business and by
  streamlining the procedures for handling new business. By using this
  solution, an insurance company can make underwriting assessments on new cases
  earlier in the business cycle and achieve greater consistency in its
  decision-making. Sapiens markets INSIGHT for Underwriting on the basis of
  licensing and distribution agreements with MediRisk Solutions Ltd. which
  developed the solution and holds the intellectual property rights to it.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | INSIGHT for Reinsurance (formerly
  Reinsurance INSIGHT) is a sophisticated solution for the insurance market,
  designed to support carriers and reinsurers in the management of all types of
  reinsurance for the general (property and casualty) and life insurance
  markets, according to the rapidly changing requirements of the international
  reinsurance market. This state-of-the-art, web-enabled solution streamlines
  and reduces the cost of handling all reinsurance functions through
  automation, is based on ACORD standards and B2B XML technology, and is
  designed for a multi- language, multi- currency, multi- company environment.                                                          

34

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | INSIGHT for Claims (formerly Claims
  INSIGHT) is a solution that effectively manages and streamlines the
  information flow of claim handling across an insurance providers entire
  organization. This solution uses highly accessible business rules and
  messaging standards and allows the use of a companys existing information
  assets.                                                                                                                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | INSIGHT for Closed Books (formerly Closed
  Books INSIGHT), also known as LifeLite, is a solution for life insurance
  companies and pension funds seeking ways to reduce the cost of maintaining
  long-term closed books of business, that is, lines of business that are no
  longer current. Sapiens provides customizable solutions that enable companies to efficiently and more
  effectively administer policies and claims relating to closed books. In
  September 2004, Sapiens purchased the technologies underlying the INSIGHT
  for Closed Books solution from Liverpool Victoria.

Sapiens
collaborates with its customers to tailor the INSIGHT solutions to achieve the
unique operational performance goals of each organization. In addition, Sapiens
has executed independent projects for the insurance market, providing enhanced
information access and visibility to empower the sales, agent and broker
community, thus accelerating transaction processing for improved customer
service and business efficiency. Sapiens insurance solutions are compatible
with a variety of platforms including IBM zSeries, IBM iSeries and HP UNIX at
the host-side and Intel-based Web servers. They are also compatible with open
architecture standards such as .NET, J2EE, XML, Web Services and application
server platforms such as IBMs WebSphere.

Services

Outsourcing
of application maintenance. Sapiens
outsourcing services were developed from its strong, long-term relationships
with its customers. Sapiens is currently servicing multi-year outsourcing
contracts with blue-chip customers involving mission-critical systems. The
outsourcing projects are performed either on or off the customers premises.
Sapiens asset discovery solution contributes to the maintenance and management
of an enterprises IT environment.

IT
Services. Sapiens
provides customers with specialized IT services in many areas, including
project management and technical assistance. Sapiens personnel work with the customer for the duration of the entire project,
collectively undertaking design, development and deployment tasks, coupled with
hands-on-training, to achieve a rapid software solution that matches the customers
business and IT goals. Sapiens has also evolved its service offerings to
include a strategy-based discovery and analysis blueprint that helps improve
the IT impact on a companys business objectives.

Customers

Sapiens
markets its solutions primarily to corporate customers and government entities
with large information technology budgets and ongoing maintenance and
development needs. Sapiens corporate customers include, among others,
insurance companies, banks and other companies offering financial services and
companies in the manufacturing and transportation sectors. The principal
markets in which Sapiens competes are located in North America, Europe, Israel
and Japan.

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nextSource Inc.

nextSource
Inc. designs, develops and implements web-based, high quality, innovative human
capital management solutions. These offerings allow customers to save money
while managing the business processes related to sourcing, procuring, and
accounting of their workforce.

nextSources
human capital management solutions include:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | A web-based
  vendor management solution for managing customers internal and external
  contingent workforce. nextSources Talent
  Acquisition Management Solution, also known as TAMS makes it
  easier for customers to find, engage and deploy talented personnel, faster
  and more effectively, while ensuring competitive labor costs. TAMS
  streamlines the hiring process, allowing for enhanced communication with
  candidates, more efficient distribution of open positions to vendors and a
  decrease in time spent on administrative tasks.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Agency services through
  nextSources value-added reseller program.
  This solution provides staffing vendors with opportunities to increase
  revenue, bringing added value to existing business relationships. nextSource
  has also created The Multiple Listing Staffing Association, an industry-wide
  network of independent staffing suppliers working collectively to staff
  openings for customers with the best candidates in the shortest time
  intervals.                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | The
  People Ticker
  provides businesses with real-time views of market rates for both contingent
  and full time workers, based upon skill-set, years of experience and
  geographic location. This one-of-a-kind tool enables corporate customers
  to truly benchmark their contingent labor costs against the most current
  information available.                                                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | The nextSource People Auction utilizes an
  extensive resume database and comprehensive searching capabilities to provide
  an online marketplace that links qualified talent with progressive talent
  seekers. nextSource also offers a unique reverse auction that allows
  potential candidates to bid on a posted opening thereby driving down the cost
  to the customer.                                                                                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Human resources, or HR,
  services, include services of a professional
  employer organization for payroll processing, benefits administration,
  recruiting, and other HR related services. nextSource also offers payrolling
  services to minimize the co-employment risks and eliminate the administrative
  burdens associated with the employment of independent contractors, retirees,
  summer interns and other temporary workers.                                                                                                                

36

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| |   |                                                                                                                                                                                                                                                                                                                                                   
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | A wide range
  of procurement services and vendor management services to complement
  the implementation of nextSources TAMS solutions and People Ticker
  solutions.  Through its value-added
  procurement service, nextSource offers a fully outsourced procurement/vendor
  management solution to customers looking for a complete solution.

Formula Vision

Formula Vision Technologies (F.V.T.) Ltd. is a
managing and holding
company, guiding a group of privately held IT companies with innovative,
proprietary technologies and solutions targeting international markets. Formula
Vision holds a controlling interest in some of these privately held companies
and a minority interest in the other members of the group.

Formula
Visions affiliated companies provide IT solutions for broadly diverse sectors,
including telecom and broadcast, aviation, travel, insurance, retail, customer
relations management, 3D-modeling, software testing, system reliability
applications which meet the demand for Web-based systems, legacy mainframe and
mobile networks.  Formula Vision
provides its affiliated companies with guidance and support at all levels 
management, strategy, technology, marketing, business intelligence and finance.

Formula
Visions companies have built their success on a solid customer base and
strategic partnerships with Fortune 500 multinationals, systems integrators,
media groups, and service and solution providers worldwide, such as IBM,
Oracle, Sun, Cap Gemini Ernst & Young, Lockheed Martin and Microsoft.

Formula
Visions principal affiliated companies include:

Transtech

Transtech
Control Ltd. is a market-leading provider of comprehensive airfield control and
management systems. Transtechs systems comprise a wide range of solutions,
applications, and products for critical airfield operational elements.
Transtechs airfield lighting control system is currently operating at more
than 130 international, domestic and military airports worldwide.

Transtechs
innovative ground surveillance system addresses the industrys urgent needs by
enhancing airport safety and accommodating increased capacity. The system
overcomes the limitations and problems inherent in traditional surveillance
systems using technologies based on unique radar and optical sensors.  Transtechs systems have been installed in
various airports, including JFK Airport, New Denver Airport, Beijing Airport,
New Bangkok Airport and San Paolo Airport.

F.T.S.  Formula
Telecom Solutions Ltd.

F.T.S.
 Formula Telecom Solutions Ltd., referred to as FTS, is a global provider of
converged end-to-end CRM and billing solutions for telecom operators and
service providers. Enabling advanced voice, data and video services, FTS
integrated triple-triple play solutions cater to a trio of wireline, wireless
and other operators, while supporting prepaid, postpaid and converged billing.
FTS maintains a global presence with worldwide installations supported by sales
and service offices in three continents. Combining a proven track record of
on-time, on-budget project delivery with solid backing and extensive resources
from the Formula group, FTS is a CRM and billing one-stop-shop. FTS
cutting-edge solutions enable operators to increase customer acquisition,
customer retention and profitability  all at a low total cost of ownership.
FTS customers include, among others, MobilTel, Freenet.de, Comverse,
Cross-Israel Road No. 6  Israels National Toll Road and MDC Velcom.

37

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Babylon

Babylon
Ltd. is a leading provider of single-click information access solutions. In
1997, Babylon introduced its flagship product  a desktop application that
delivers translations, conversions and information in a single click. Since
2001, Babylons products have been sold online and direct to personal and
business users worldwide. Babylon has now leveraged its patented technology in
an integrated server and client system that gives business customers a unified
platform for instant retrieval of critical information from corporate
information systems.

Babylon
also offers add-on premium content from world-renowned dictionary publishers,
including Oxford University Press, Larousse, Langenscheidt, Van Dale,
Melhoramentos, Signum and Taishukan. Babylons customers include industry
leaders such as Avnet, BASF, Daimler Chrysler, Ericsson, Ernst &
Young, Eurocontrol, Fujitsu Siemens, Gillette/Braun, IBM, John Deere,
Lufthansa, Motorola, Nestlé France, Océ, Petrobras, Philips, UBS and Xerox.

A
major shareholder in Babylon is Reed Elsevier Ventures, the venture arm of Reed
Elsevier (LSE: REL, NYSE: RUK), a leading publisher and information
provider.

FIS
Software

FIS
Software Ltd. is dedicated to developing and delivering global package-based
solutions that enable life and pensions companies to run their businesses more
efficiently, and respond to territorial legislation and regulations. FIS
solutions are based on ALIS, FIS flagship product. ALIS is a single packaged,
comprehensive and modular software platform that incorporates all activities
along the policy lifecycle and enables insurers to manage life insurance,
pensions and investment products, for individual and group customers in line
with the territorial legislation and regulations. Founded in 1984, FIS
established its international business in 1999 and currently employs 360
insurance domain experts and IT software professionals across offices in the
UK, France, Spain, Greece, Israel, South Africa and Australia.

FIS
customers include AXA, Unum Provident, CNP Assurances, Swiss Life, Scottish
Equitable, Bright Grey, AMP, NPI, Ethiniki, Clal and Eliahu. FIS also has a
number of strategic partnerships with leading systems integrators and
consulting firms such as IBM and TCS.

GigaSpaces

GigaSpaces
Technologies Ltd. is a fast-growing provider of innovative grid-based solutions
that solve the performance, reliability and scalability problems of
transaction-intensive, business critical applications. GigaSpaces was founded
in 2000 and is headquartered in New York, with a research and development
center in Israel.

GigaSpaces
customers include AIG, Nortel Networks and Hutchison 3G, among other major
organizations in the financial, telecom and manufacturing industries.

38

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GigaSpaces
Enterprise Application Grid (EAG) is a middleware product that provides a rich
set of tightly-integrated application services (such as Java massaging services
(JMS), clustering, caching and Java database connectivity (JDBC)  on top of a
federated shared memory platform. This allows developers to rapidly build and
deploy high-performance and highly-reliable business-critical applications that
run on a distributed set of IT resources. GigaSpaces EAG enables an
organization to dynamically distribute data across low-cost servers such as
Linux Blades and achieve in-memory levels of performance with significantly
less administration and costs than dedicated hardware solutions.

Clockwork
Solutions

Clockwork
Solutions Ltd.s  predictive modeling software tools provide
life cycle system-engineering solutions for capital-intensive major industrial
companies, military organizations and government agencies throughout the world.
Clockwork focuses on the defense, process and petrochemical and power
industries, offering products and services to customers such as the US Army, US
Air Force, Raytheon, Lockheed Martin, General Dynamics, GE Aircraft Engines, GE
Energy, DOW Chemical, Conoco Philips, Chevron Texaco and the Israeli Defense
Forces. Clockworks solutions improve the economic performance of systems by
reducing costs, increasing production, and operating with greater
effectiveness.

Clockworks
propriety technology and modeling platform, SPAR, tracks the behaviors of
systems over time, exposing effects of equipment aging, maintenance policies,
and operating procedures. These unique capabilities enable the users of SPAR
technology to relate cause and effect, to quantify risks, and to guide capital
investment and major operation and maintenance improvements.
Clockworks current focus is on the performance based logistic
(PBL) defense market and the service parts planning (SPP) commercial
and defense market. Clockwork has been identified by Gartner, Inc. and AMR Research,
both leading
technology market analysts,
as a unique player and provider of innovative solutions
in these markets.

IDIT

IDIT
I.D.I. Technologies Ltd., or IDIT, is an international vendor of enterprise
application software for the administration and full life-cycle support of
insurance products and financial services in a unique business package
combining know-how, software and business procedures. IDITs flagship product
is a fully implemented, comprehensive online system for the insurance industry.

IDIT
also provides solutions for the insurance industry to enhance existing systems,
add web capabilities and online call center components. Capitalizing on new,
distributed capabilities while saving investment on legacy technology, IDIT
leverages channel opportunities for rapid return on investment. IDIT has gained
a leading position amongst European suppliers of enterprise solutions for
insurance.

IDITs
customers include AON International, Groupama and Rosiya.

39

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Sintec
Media

Sintec
Media Ltd. is a developer and manufacturer of broadcast management systems.
Sintec Medias product, OnAir, is an all-in-one software system designed to
meet the rapidly changing management needs of broadcasters. OnAir is intended
for small stations as well as entire networks and station groups, operating
multi-channels over multiple regions and time zones. OnAir features a set of
powerful sales and content-inventory tools that increase efficiency and raise
profits.

Sintec
Medias customers include the BBC, Canadian Broadcasting Corporation (CBC) and
RTL.

Sales and Marketing

Our
subsidiaries conduct sales and marketing efforts primarily through division or
product managers. In certain cases, the companies devote sales managers who,
aided by their staffs, are responsible for ongoing customer relationships, as
well as sales to new customers. In addition, the IT services companies
participate in competitive bidding processes, primarily for turnkey and
government projects, as well as large IT services contracts. Our subsidiaries
attend trade shows and exhibitions in the high technology markets, while
further supplementing their sales efforts with space advertising and products
and services listing in appropriate directories. In addition, our subsidiaries
organize user group meetings for their customers, where new products and
services are highlighted.  We typically
enter into strategic alliances and intend to pursue acquisitions in order to
penetrate various international markets and promote sales of our proprietary
software solutions in international markets.

The
following table summarizes our revenues by operating segments for the periods
indicated:

| |                         |                     |  |                                   |  |       |         |  |  |         | 
| | ----------------------- | ------------------- |  | --------------------------------- |  | ----- | ------- |  |  | ------- | 
| |                         | Software
  Services |  | Proprietary
  Software
  Products |  | Total |        
| |                         |                     |  |                                   |  |       |        
| |                         | $ thousands         | 
| |                         |                     | 
| | Year ended December 31, |                     |  |                                   |  |       |         |  |  |         | 
| |                         |                     |  |                                   |  |       |         |  |  |         | 
| | 2004                    |                     |  | 227,262                           |  |       | 229,348 |  |  | 456,610 | 
| |                         |                     |  |                                   |  |       |         |  |  |         | 
| | 2003                    |                     |  | 196,782                           |  |       | 170,048 |  |  | 366,830 | 
| |                         |                     |  |                                   |  |       |         |  |  |         | 
| | 2002                    |                     |  | 171,342                           |  |       | 111,968 |  |  | 283,310 | 

The
following table summarizes the revenues from our IT products and services by geographic regions of our customers, for the periods
indicated:

| |                                                      |                           |  |         |  |      |         |  |  |         | 
| | ---------------------------------------------------- | ------------------------- |  | ------- |  | ---- | ------- |  |  | ------- | 
| |                                                      | Year
  ended December 31, | 
| |                                                      |                           | 
| |                                                      | 2004                      |  | 2003    |  | 2002 |        
| |                                                      |                           |  |         |  |      |        
| |                                                      | $ thousands               | 
| |                                                      |                           | 
| |                                                      |                           |  |         |  |      |         |  |  |        
| | Israel                                               |                           |  | 213,020 |  |      | 171,108 |  |  | 156,212 | 
| |                                                      |                           |  |         |  |      |         |  |  |         | 
| | International:                                       |                           |  |         |  |      |         |  |  |         | 
| |                                                      |                           |  |         |  |      |         |  |  |         | 
| | United States                                        |                           |  | 106,849 |  |      | 93,695  |  |  | 65,654  | 
| |                                                      |                           |  |         |  |      |         |  |  |         | 
| | Other (includes various countries, mainly in
Europe) |                           |  | 136,741 |  |      | 102,027 |  |  | 61,444  | 
| |                                                      |                           |  |         |  |      |         |  |  |         | 
| |                                                      |                           |  | 243,590 |  |      | 195,722 |  |  | 127,098 | 
| |                                                      |                           |  |         |  |      |         |  |  |         | 
| | Total                                                |                           |  | 456,610 |  |      | 366,830 |  |  | 283,310 | 

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Competition

The
markets for the IT products and services we offer are rapidly evolving and highly
competitive. Our ability to compete successfully in IT services markets depends
on a number of factors, like breadth of service offerings, sales and marketing
efforts, service, pricing, and quality and reliability of services. The
principal competitive factors affecting the market for the proprietary software
solutions include product performance and reliability, product functionality,
availability of experienced personnel, price, ability to respond in a timely
manner to changing customer needs, ease of use, training and quality of
support.

We
face competition, both in Israel and internationally, from a variety of
companies, including companies with significantly greater resources than us who
are likely to enjoy substantial competitive advantages, including:

| |   |                                                                             
| | - | ----------------------------------------------------------------------------
| |  | longer operating histories;                                                 
| |   |                                                                             
| |  | greater financial, technical, marketing and other resources;                
| |   |                                                                             
| |  | greater name recognition;                                                   
| |   |                                                                             
| |  | well-established relationships with our current and potential
  clients; and
| |   |                                                                             
| |  | a broader range of products and services.                                   

As
a result, they may be able to respond more quickly to new or emerging
technologies or changes in customer requirements. They may also benefit from
greater purchasing economies, offer more aggressive product and service pricing
or devote greater resources to the promotion of their products and services. In
addition, in the future, we may face further competition from new market
entrants and possible alliances between existing competitors. We also face
additional competition as we continue to penetrate international markets. As a
result, we cannot assure you that the products and solutions we offer will
compete successfully with those of our competitors. Furthermore, several
software development centers worldwide, such as in India, offer software
development services at much lower prices than we do. Due to the intense
competition in the markets in which we operate, software products prices may
fluctuate significantly. As a result, we may have to reduce the prices of our
products.

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Matrixs
principal competitors in the domestic Israeli market are Israeli IT services
companies and systems integrators, the largest of which are Ness Technologies
Inc. and Team Computers.  Matrixs
international competitors in the Israeli marketplace include H.P., EDS, IBM and
Microsoft.  These international
competitors often use local subcontractors to provide personnel for contracts
performed in Israel.

Magics
principal competitors in the market for the eDeveloper technology are Visual
Basic (Microsoft), Progress, Delphi and Jbuilder (Borland), Java, Oracle,
Compuware, Lansa and packaged applications such as SAP and PeopleSoft. The
principal competitors in the market for Magics iBOLT Integration Suite are
WebMethods, Tibco, Vitria, Seeburger, IBMs WebSphere, Microsofts BizTalk and
Sonic Software (Progress).

BluePhoenixs
principal competitors consist of system integrators and tool vendors, including
leading software developers, who enable customers to replace or modernize their
legacy systems. Major system integrators in the market include IBM, Capgemini,
and EDS. In addition, BluePhoenix faces competition from niche companies
operating in each of the five principal areas of the enterprise IT modernization
market (enterprise IT understanding, presentment, migration, remediation and
redevelopment). For example, Micro Focus International markets its solutions to
the COBOL market, Software Technologies addresses the Natural/ADABAS arena, and
other competitors focus on collecting sufficient information about application
portfolios to enable improved working processes. Other solution developers
provide legacy and distributed repository solutions that are important for a
variety of modernization processes.

Sapiens
competitors in the market for solutions offered to
the insurance industry fall into several categories. Examples of competitors
are: CSC, SOLCORP, Fineos, SAP, SunGard Sherwood, Navisys, FIS, ePolicy
Solutions, Taliant, OneShield, Ascendant One, Insurity, The Innovation Group,
Duck Creek and AQS in the United States; Marlborough Sterling Group, Unisys,
Sherwood and RebusIs in the United Kingdom; Falmeyer (FJA) and COR AG Insurance
Technologies in Germany. Examples of large integrators in the insurance field
are Electronic Data Systems and CSC (companies that also have customer or
alliance relationships with Sapiens in other fields). An example of a
competitor that is a local integrator is Ness Technologies in Israel.

Sapiens
competitors in the business rule engines and management marketplace include
include Fair-Isaac (Blaze), Pegasystems, ILOG, Computer Associates, Haley,
RulesPower, Corticon, Versata, Gensym and ESI.

Transtechs
competitors in the market of airfield lighting control systems are Siemens and
Honeywell, and in the ground surveillance systems market, Transtechs
competitors are Sensis and Raytheon.

FTS
principal competitors are Amdocs Ltd., Convergys Corp., CSG Systems
International Inc., Portal Software Inc., Intec Telecom Systems PLC and LHS
Group Inc. (formerly known as the SchlumbergerSema Group).

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FIS
principal competitors are CSC, Sunguard, Unisys, TIA (The Insurance
Application), Aquila, Fineos Corporation, and RebusIS. GigaSpaces competitors
are distributed caching vendors such as Gemstone and Tangosol, as well as
compute-grid vendors such as DataSynapse and Platform Computing.

Sintec
Medias main competitors are Harris, Pilat Media and in-house solutions.

Software
Development

The
software industry is characterized by rapid technological developments.  In order to maintain technological
leadership, we engage in ongoing software development activity through our
subsidiaries, aimed at both creating new proprietary software and services, as
well as enhancing and customizing existing products and services. This effort
includes introducing new supported programming languages and database
management systems; improving functionality and flexibility and enhancing ease
of use. We work closely with current and potential end-users, our strategic
partners and leaders in certain industry segments to identify market needs and
define appropriate product enhancements and specifications.

Intellectual
Property Rights

We
rely on a combination of trade secret, copyright and trademark laws and
non-disclosure agreements, to protect our proprietary know-how. Some members of
our group have patents and patent applications pending. Our proprietary
technology incorporates processes, methods, algorithms and software that we
believe are not easily copied.  Despite
these precautions, it may be possible for unauthorized third parties to copy
aspects of our products or to obtain and use information that we regard as
proprietary.  We believe that, because
of the rapid pace of technological change in the industry, patent and copyright
protection are less significant to our competitive position than factors such
as the knowledge, ability and experience of our personnel, new product development
and ongoing product maintenance and support.

C.Organizational
Structure

Formula
is the parent company of the Formula Group.

The
following table presents certain information regarding the control and
ownership of our significant subsidiaries, as of June 20, 2005.

|                                          |  |                          |                              |                           |  |  |       |   | 
|----------------------------------------- |  | ------------------------ | ---------------------------- | ------------------------- |  |  | ----- | - | 
|Subsidiary                                |  | Country of Incorporation |                              | Percentage
  Of Ownership | 
|                                          |  |                          |                              |                           | 
|Matrix
  IT Ltd.                          |  |                          | Israel                       |                           |  |  | 50.6  | % | 
|                                          |  |                          |                              |                           |  |  |       |   | 
|Magic
  Software Enterprises Ltd.         |  |                          | Israel                       |                           |  |  | 50.2  | % | 
|                                          |  |                          |                              |                           |  |  |       |   | 
|BluePhoenix
  Solutions Ltd.              |  |                          | Israel                       |                           |  |  | 58.8  | % | 
|                                          |  |                          |                              |                           |  |  |       |   | 
|Sapiens International Corporation N.V.    |  |                          | Netherlands Antilles Islands |                           |  |  | 56.0  | % | 
|                                          |  |                          |                              |                           |  |  |       |   | 
|nextSource
  Inc.                         |  |                          | United States                |                           |  |  | 100.0 | % | 
|                                          |  |                          |                              |                           |  |  |       |   | 
|Formula Vision Technologies (F.V.T.) Ltd. |  |                          | Israel                       |                           |  |  | 56.0  | % | 

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The
ordinary shares of BluePhoenix, Magic and Sapiens are
traded on the Nasdaq National Market and on the TASE, and the ordinary shares of Matrix and Formula Vision are
traded on the TASE.

D.Property, Plants
and Equipment

Our
corporate headquarters, as well as the research and development and sales and
marketing headquarters of a majority of our subsidiaries, are located in
Herzlia, Israel.  We lease approximately
70,000 square feet of office space in Herzlia, pursuant to a lease which will
expire on October 31, 2005 with an option to extend for an additional 36
months. In addition, several of our subsidiaries lease approximately 75,000 square feet of office space
in another building in Herzlia pursuant to leases ending in December 2006, with
an option to extend for an additional 24 or 48 months. We also lease
approximately 145,000 square feet of office space in several other locations in
Israel.

We
own a 34,000 square feet facility in Or-Yehuda, Israel used for office space
of Magic.

In
addition, Sapiens leases approximately 45,000 square feet of office space in
Rechovot, Israel and several of our subsidiaries lease approximately 184,000
square feet of office space and sales and support premises in the United
States, Europe and Asia.

The
aggregate amount we paid pursuant to our lease agreements in 2004 was
approximately $10.1 million.

We
believe that our properties are adequate for our present uses. If in the future
we will require
additional space to accommodate our growth, we believe that we will be able to
obtain this additional space without difficulty and at commercially reasonable
prices.

|        |                                             
|------- | --------------------------------------------
|ITEM 5. | OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Overview

Formula
is the parent company of subsidiaries and affiliates, referred to collectively
as the Formula Group. We are principally engaged in providing software consulting
services, developing proprietary software products and providing computer-based
business solutions.  We currently hold a
controlling interest in five publicly traded subsidiaries: BluePhoenix, Magic, Matrix, Sapiens and Formula Vision. In addition,
we wholly
own nextSource. We consolidate the results of operations of our subsidiaries
with ours. Our operating results are directly influenced by the consolidation
and cessation of consolidation of our subsidiaries. This could cause
significant fluctuations of our consolidated operating results. As a result, we
believe that period-to-period comparisons of our results of operations are not
necessarily meaningful and you should not rely on these comparisons as
indications of our future performance.

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In
the first quarter of 2003, our interest in Sapiens exceeded 50% of Sapiens
outstanding share capital. As a result, we began consolidating Sapiens results
of operations. The consolidation of Sapiens contributed, among others, to the
increase in our revenues in 2003 and in our selling, general and administrative
expenses.

In
January 2004, we acquired a controlling interest in Formula Vision and
accordingly began consolidating Formula Visions results of operations,
beginning with the first quarter of 2004. Formula Visions revenues in 2004
were $61.5 million and its net loss was $10.4 million.

In
March 2005, we completed a private placement of 2,400,000 Formula shares for
aggregate consideration of $36 million. The shares were issued to FIMGold LP,
an entity owned in equal shares by Dan Goldstein, our chief executive officer
and chairman of the board, and FIMI Opportunity Fund.

In
June 2005, we distributed to our shareholders a cash dividend of approximately
$4 per share. The aggregate amount distributed by Formula was approximately $53
million.

We
recognize revenues in two categories: the delivery of software services and the
delivery of proprietary software solutions. All of our subsidiaries, including
IT services companies and proprietary software solutions companies, recognize
revenues from the delivery of software services, and most of them recognize
revenues in both revenue categories. We have separated our subsidiaries into
these categories in accordance with the category in which each subsidiary has earned most of its revenues.

We
recognize, in non-operating income, gains and losses arising from the sale of
previously un-issued capital stock by a subsidiary or an affiliate to outside
investors, if the sale changes our ownership percentage in this entity. We
measure the gain or loss by the difference between our share in the proceeds
from this stock offering and the carrying amount, on an equity basis, of the
proportionate reduction in our investment. Transactions of this nature do not
occur on a regular basis and it is difficult for us to predict their timing.

Beginning
with the fiscal year ended December 31, 2002, we prepare our consolidated financial statements
in conformity with accounting principles generally accepted in the United
States, referred to as U.S. GAAP. Under U.S.GAAP, we cannot use adjusted NIS reflecting changes in the Israeli
consumer price index, as we have used in the past. Instead, we use nominal values of the NIS translated into
dollars as described below. As a result, we have restated certain figures in our financial
statements relating to prior
periods.

Our functional and
reporting currency

Formula and some of our subsidiaries operate
primarily in the economic environment of the New Israeli Shekel (NIS). The
functional currency of our other subsidiaries is the dollar. We use the dollar as our reporting currency.

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We
translate our financial
statements into dollars, as
well as the financial statements of our subsidiaries whose functional currency is the NIS, under the principles described in
Financial Accounting Standards Board Statement No. 52. Assets and liabilities have been translated at period-end exchange rates.
Results of operations
have been translated at the exchange rate at the dates on which those
transactions occurred or at an average rate. We present material differences resulting from translation
under shareholders equity in the
item accumulating other
comprehensive income (loss). If gains and losses arising from these
translations are immaterial, we record them as financial
expenses included in the statements of income. In the consolidation, we present the financial
statements of
subsidiaries whose functional currency is the dollar, at the original amounts.

Critical
Accounting Policies

In preparation of
our financial statements, we are required to make certain estimates, judgments and assumptions that
we believe are reasonable based upon the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the periods presented. The significant accounting policies
which we believe are the most critical to aid in fully understanding and
evaluating our reported financial results include the following:

Revenue
Recognition

The revenue recognition policy of each of our
significant subsidiaries is
material because our revenue is a key
component of our results of operations. Our revenue recognition determines the timing of certain expenses,
such as commissions and royalties. We follow very specific and detailed
guidelines in measuring revenue; however, certain judgments affect the
application of our revenue policy. Revenue results are difficult to predict and
any shortfall in revenue or delay in recognizing revenue could cause our
operating results to vary significantly from quarter to quarter and could
result in future operating losses. Should changes in conditions cause our
subsidiaries managements to determine that these guidelines are not met for
certain future transactions, revenue recognized for any reporting period could
be adversely affected.

Revenues
derived from direct software license agreements are recognized in accordance
with Statement of Position (SOP) 97-2 Software Revenue Recognition (as
amended by SOP 98-4 and SOP 98-9), upon delivery of
the software when collection is probable, the license fee is otherwise fixed or
determinable and persuasive evidence of an arrangement exists. When a project
involves significant modification of software, revenue is generally recognized
according to the percentage of completion method. Under this method, estimated
revenue is generally accrued based on costs incurred to date as a percentage of
total updated estimated costs. If our subsidiaries do not accurately estimate the resources required or
the scope of work to be performed, or do not manage their projects properly
within the planned periods of time or satisfy their obligations under the
contracts, then future margins may be significantly and negatively affected or
losses on existing contracts may need to be recognized. Any such resulting
reductions in margins or contract losses could be material to our results of
operations. Our subsidiaries recognize contract losses, if any, in the period
in which they first become evident.

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Under some
of our subsidiaries agreements, the customer may have the right to receive
unspecified upgrades on a when-and-if available basis. These upgrades are
considered post-contract customer support, referred to as PCS, and the fair
value allocated to this right is recognized ratably over the term of the PCS.

There are
no rights of return, price protection or similar contingencies in our
subsidiaries contracts. Accordingly they do not establish a provision due to
the lack of warranties claims in the past. Some of our subsidiaries contracts
include client acceptance clauses. In determining whether revenue can be
recognized, when an acceptance clause exists, they consider their history with
similar arrangements, the customers involvement in the progress, the existence
of other service providers and the payments terms.

Our
subsidiaries revenue recognition policy does not permit any revenue
recognition when the payment term exceeds 12 months or when there is an
uncertainty related to the relationship with the customer.

We recognize revenues from projects billed on a time and
material basis,
based on SOP 81-1 Accounting for Performance of Construction  Type and
Certain Production  Type Contracts, using contract accounting on a percentage
of completion method, based on the relationship of actual costs incurred to
total costs estimated to be incurred over the duration of the contract.
Provision for estimated losses on uncompleted contracts is made in the period in
which such losses are first determined, in the amount of the estimated loss on
the entire contract. As of December 31, 2004, no such estimated losses were identified.

We recognize revenues from consulting fees with respect
to fixed fee
contracts, based upon the percentage of completion method. We recognize contract
losses, if any, in the period in which they first become evident.

Revenues
from contractual maintenance contract and training are recognized ratably over the contract
period.

Revenues
from sales of hardware are recognized when the merchandise is delivered to the
customer, provided no significant vendor obligations remain.

Our management believes that our revenue recognition
policies are in accordance
with the Securities and Exchange Commission Staff Accounting Bulletin No. 101
and Staff Accounting Bulletin No. 104, Revenue Recognition in Financial
Statements.

Impairment
of Goodwill

Goodwill
represents excess of the costs over the net assts of businesses acquired. Under
SFAS No. 142, goodwill acquired in a business combination on or after December
31, 2001 is not amortized. Goodwill arising from acquisitions prior to December
31, 2001 was amortized until December 31, 2001, on a straight-line basis over
10 years.

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SFAS
No. 142 requires goodwill to be tested for impairment on adoption and at least
annually thereafter or between annual tests in certain circumstances, and
written down when impaired, rather than amortized as previous accounting
standards required. Goodwill is tested for impairment at the reporting unit
level by comparing the fair value of the reporting until with its carrying
value. Fair value is determined using discounted cash flows. Significant
estimates used in the methodologies include estimates of future cash flows,
future short-term and long-term growth rates, and weighted average cost of
capital for the reportable unit. As of December 31, 2004, no impairment losses
were identified.

A.      Operating Results

Years
Ended December 31, 2003 and 2004

Revenues. Revenues increased 24% from $366.8
million in 2003 to $456.6 million in 2004. The increase in revenues was mainly
attributable to the consolidation of Formula Vision which had revenues of $61.5
million in 2004 and to an increase in revenues of our other subsidiaries, in
particular Matrix and nextSource. Such increase was partially offset by a
decrease in Sapiens revenues. Revenues from the two categories of our
operation were as follows: Revenues from the delivery of software services increased
16% from $196.8 million in 2003 to $227.3 million in 2004. This increase was
attributable to the growth in Matrixs and nextSources revenues due to an
increased demand for their services. Revenues from the sale of proprietary
software solutions increased 35% from $170.0 million in 2003 to $229.3 million
in 2004. This increase was primarily due to consolidation of Formula Vision,
beginning with the first quarter of 2004.

Cost
of Revenues. Cost of revenues consists
primarily of wages and related expenses and hardware and other materials costs.
Cost of revenues increased 24% from $230.5 million in 2003 to $285.0 million in
2004. As a percentage of revenues, cost of revenues remained relatively the
same in 2003 and 2004. The increase in cost of revenues was primarily due to
the consolidation of Formula Vision which had cost of revenues of $31.5 million
in 2004 and to an increase in the cost of revenues of our other subsidiaries
such as Matrix and nextSource. This increase was slightly offset by a decrease
in Sapiens cost of revenues.

Software
Development Costs, net. Software development costs consist primarily of wages and related
expenses and, to a lesser degree, consulting fees we pay to independent
contractors engaged in research and development. Software development costs,
net, consist of software development costs, gross, less capitalized software
costs. Software developments costs, gross, in 2004 and 2003 were $40.4 million
and $27.6 million, respectively. In 2004, we capitalized software costs of
$15.4 million compared to $10.2 million in 2003. Capitalization of software
costs in 2004 was attributable to our proprietary software solutions
subsidiaries. Software development costs, net, increased 44% from $17.4 million
in 2003 to $25.0 million in 2004. As a percentage of revenues, software
development costs, net increased from 4.7% in 2003 to 5.5% in 2004. The
increase in software development costs was attributed primarily to the
consolidation of Formula Vision which had research and development expenditures
of $9.7 million in 2004. The increase was partially offset by a decrease in the
research and development expenditures of Sapiens and Magic of $1.0 million and
$900,000, respectively. Amortization of capitalized software costs were $10.1
million in 2004 and $8.1 million in 2003, which amounts were included in cost
of revenues.

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Selling,
General and Administrative Expenses. Selling, general and administrative
expenses consist primarily of salaries, severance and related expenses, travel
expenses, selling expenses, rent, utilities, depreciation, amortization and
professional fees. Selling, general and administrative expenses increased 20%
from $107.1 million in 2003 to $128.5 million in 2004. As a percentage of
revenues, selling, general and administrative expenses remained relatively the
same in 2003 and 2004. The increase in selling, general and administrative
expenses was primarily attributable to the consolidation of Formula Vision
which incurred selling, general and administrative expenses of approximately
$21.9 million in 2004.

Operating
Income.
Our operating income increased 52% from $11.9 million in 2003 to $18.1 million
in 2004. The operating income in 2004 is attributable to the improvement in the
operating results of our subsidiaries, in particular Matrix which had operating
income of $15.5 million and BluePhoenix which had operating income of $3.5
million. This improvement was partially offset by the operating loss of $1.7
million of Formula Vision. The operating income in 2003 is attributable to the
improvement in the operating results of our subsidiaries Magic, BluePhoenix and
Matrix which were offset by the operating loss of Sapiens.

Financial
Expenses, net. Financial expenses, net increased 140% from $3.7 million in 2003 to
$8.9 million in 2004. Financial expenses, net, is influenced by various
factors, including our cash balance, changes in the exchange rate of the NIS
against the dollar, changes in the exchange rate of the dollar against the euro
and changes in the Israeli CPI. The increase in financial expenses, net was
mainly attributable to the consolidation of Formula Vision which incurred
financial expenses of $3.1 million in 2004, as well as to the influence of the
interest expenses paid on the debentures issued by us to the public and
interest expenses incurred by our subsidiaries, Matrix, Sapiens and
BluePhoenix.

Other
Expenses, net. Other expenses, net in 2004 and 2003 were $332,000 and $90,000.

Gain
on Realization of Shareholdings. Gain on realization of shareholdings in
2004 was $8.9 million compared to $2.8 million in 2003. Gain on realization of
shareholdings in 2004 was attributable to the sale of a portion of the shares
we hold in Magic, Matrix and Formula Vision in the open market which resulted
in a gain to Formula of $1.1 million, $3.6 million and $383,000, respectively.
In addition, gain on realization of shareholdings in 2004 included gain from
realization of unrealized gains in Matrix of $2.8 million and a gain of
$651,000 in Formula Vision due a decrease in its shareholdings in its
subsidiary Babylon. Gain on realization of shareholdings in 2003 was primarily
attributable to the sale of a portion of Magic shares in the market which
resulted in gain to Formula of $722,000, gain from a decrease in our
shareholdings in Matrix due to the issuance of Matrix shares to former
shareholders of New Applicom and the issuance of Matrix shares to the
shareholders of an acquired company resulting in gain of $1.1 million, the sale
of Matrix warrants in the market which resulted in gain of $300,000 and the
sale of Level 8 shares by BluePhoenix which resulted in gain of $376,000 to
BluePhoenix.

Taxes
on Income.Taxes on income in 2004 were $4.6 million compared to $2.5 million in
2003. The increase in taxes on income in 2004 was mainly attributable to the
consolidation of Formula Vision which had taxes on income of $1 million and to
the increase in taxes of Matrix.

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Companys
Equity in Results of Affiliates, net. Our equity in losses of affiliates, net
were $2.5 million in 2004 compared to $1.1 million in 2003. Our equity in
losses of affiliates, net relates primarily to affiliates of Formula Vision.

Minority
Interest, net. Minority interest, net, includes the minority interest in companies
which are not wholly owned by the Formula Group during each of the periods
indicated. Minority interest in profits of subsidiaries in 2004 was $2.5
million compared to $4.1 million in 2003. This decrease in minority interest,
net is attributable to the consolidation of Formula Vision in 2004 which had
net loss of $10.4 million and the increase in the net loss of Sapiens. These
losses were offset by the increase in net profit of our subsidiaries, Matrix,
BluePhoenix and Magic.

Years
Ended December 31, 2002 and 2003

Revenues. Revenues increased 29% from $283.3
million in 2002 to $366.8 million in 2003. The increase in revenues was mainly
attributable to the consolidation of Sapiens results of operations beginning
with the first quarter of 2003, the significant increase in nextSources
revenues and an increase in demand for certain of our products and services. Revenues from the two categories of
our operation were as follows: Revenues from the delivery of software services
increased from $171.3 million in 2002 to $196.8 million in 2003. Revenues from the sale of proprietary software
solutions increased from $112.0
million in 2002to $170.0 million in 2003.

Cost
of Revenues.Cost of revenues increased 23% from $186.9 million in 2002 to $230.5 million in 2003. As a percentage
of revenues, cost of revenues decreased from 66% in 2002 to 63% in 2003. The increase in cost of revenues was primarily due to the
consolidation of Sapiens results of operations beginning with the first quarter
of 2003 and the increase in cost of revenues of nextSource due to the increase
in its volume of activities.

Software
Development Costs, net.Software development costs, net, consist of
software development costs, gross, less capitalized software costs. Software
developments costs, gross, in 2003 and 2002 were $27.6 million and $20.4
million. In 2003, we capitalized software costs of $10.2 million compared to
$4.4 million in 2002. Software development costs, net, increased 9% from $16.0
million in 2002 to $17.4 million in
2003. As a percentage of revenues, software development costs, net decreased
from 5.6% in 2002 to 4.7% in 2003. The increase in software development costs
was attributed primarily to the
consolidation of Sapiens results of operations which was offset by the
decrease in software development costs of BluePhoenix and Magic, due to
efficiency measures taken by them. Amortization of capitalized software costs
were $8.1 million in 2003 and $5.1 million in 2002, which amounts were included
in cost of revenues.

Selling,
General and Administrative Expenses. Selling, general and administrative
expenses increased from $85.3 million in 2002 to $107.1 million in 2003. As a percentage
of revenues, selling, general and administrative expenses remained relatively
the same in 2002 and 2003. The increase in selling, general and administrative
expenses was primarily attributable to the consolidation of Sapiens results of
operations.

Restructuring Costs. We had no
restructuring costs in 2003 compared to restructuring costs of $1.8 million in 2002. Restructuring costs in 2002
consist primarily of wages and relocation expenses, as well as expenses
incurred by Magic related to closing of branches.

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Operating
Income (Loss). In 2003, we had operating income of $11.9 million compared to
operating loss of $6.7 million in 2002. The operating income in 2003 is
attributable to the improvement in the operating results of our subsidiaries
Magic, BluePhoenix and Matrix which were offset by the operating loss of
Sapiens. The operating loss in
2002 is attributable to the operating loss of certain of our subsidiaries which were harmed by the global and
local slow-down.

Financial
Income (Expenses), net. Financial expenses, net in 2003 were $3.7 million compared to
financial income, net of $3.6 million in 2002. Financial income (expenses),
net, is influenced by various factors, including our cash balance, changes in
the exchange rate of the NIS against the dollar, as well as changes in the
Israeli CPI.

Other
Expenses, net. Other expenses, net in 2003 and 2002 were $90,000 and $2.1 million. Other expenses, net
in 2002 was caused primarily by a partial write off of an investment by
BluePhoenix.

Gain
on Realization of Shareholdings. Gain on realization of shareholdings in
2003 was $2.8 million compared to $4.7 million in 2002. Gain on realization of shareholdings in 2003 was
primarily attributable to the sale of a portion of Magic shares in the market which resulted in
gain to Formula of $722,000, gain from a decrease in our shareholdings in
Matrix due to the issuance of Matrix shares to former shareholders of New
Applicom and the issuance of Matrix shares to the shareholders of an acquired
company resulting in gain of $1.1 million, the sale of Matrix warrants in the
market which resulted in gain of $300,000 and the sale of Level 8 shares by
BluePhoenix which resulted in gain of $376,000 to BluePhoenix. Gain on realization of
shareholdings in 2002 was attributable to the sale of Level 8 shares by
BluePhoenix which resulted in gain of $5.5 million to BluePhoenix.

Taxes
on Income. Taxes on income in 2003 were $2.5 million compared to $2.0 million in 2002. Our effective tax rate
relates to a portion of our earnings that we derive from capital gains. These
capital gains are partly offset by other capital gains that are tax exempt, as well as by a portion of earnings derived from
operations that are tax exempt under the Law of Encouragement of Capital
Investments, 1959. Taxes on income are also attributable to certain of our subsidiaries
that had taxable income.

Companys
Equity in Results of Affiliates, net. Our equity in losses of affiliates, net
were $1.1 million in 2003 compared
to $2.3 million in 2002. Our equity in losses of affiliates, net relates to
affiliates of BluePhoenix.

Minority
Interest, net. Minority interest in profits of subsidiaries in 2003 was $4.1 million
compared to minority interest in losses of subsidiaries of $2.4 million in 2002. This increase in minority interest, net is
attributable to the profits
of our subsidiaries Magic, BluePhoenix and Matrix which was offset by a loss at
Sapiens.

51

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Impact
of Inflation and Currency Fluctuations on Results of Operations

Most
of our revenues from sale of our products and services are in dollars and euros or are
linked to the dollar or the euro, while a substantial portion of our expenses,
principally salaries and related personnel expenses, are in New Israeli
Shekels, or NIS. As a result, we are exposed to any of the
following risks:

| |   |                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------
| |  | that the
  inflation rate in Israel will exceed the NIS devaluation rate against the
  dollar or the euro;
| |   |                                                                                                           
| |  | that the
  devaluation process will lag behind the NIS inflation timing; or                               
| |   |                                                                                                           
| |  | that the
  euro experience devaluation against the dollar.                                                

If
any of these occur, the dollar or euro cost of our operations, as well as our
financial expenses, would increase. We cannot predict any future trends of the
rate of inflation in Israel or the rate of devaluation of the NIS or the euro
against the dollar. An increase in our dollar or euro operational cost will
adversely affect our dollar-measured results of operations. In addition, our
operations could be adversely affected if we are unable to hedge against
currency fluctuations in the future. To date, we have not engaged in
significant hedging transactions. In the future, we may enter into currency
hedging transactions to decrease the risk of financial exposure from
fluctuations in the exchange rate of the dollar against the NIS or the euro.
However, we cannot assure you that these measures will adequately protect us
from material adverse effects arising from the impact of inflation in Israel.

Following
is a summary of the most relevant monetary indicators for the reported periods:

| |                                 |  |                            |  |                                        |   |                                         |  |  |      |   |  |  |  |       |   | 
| | ------------------------------- |  | -------------------------- |  | -------------------------------------- | - | --------------------------------------- |  |  | ---- | - |  |  |  | ----- | - | 
| | For the year ended December 31, |  | Inflation
  rate in Israel |  | Devaluation
  of NIS
  against the US$ |   | Devaluation
  of euro
  against the US$ | 
| |                                 |  | %                          |  | %                                      |   | %                                       | 
| | 2002                            |  |                            |  | 6.5                                    |   |                                         |  |  | 7.3  |   |  |  |  | (15.7 | ) | 
| | 2003                            |  |                            |  | (1.9                                   | ) |                                         |  |  | (7.6 | ) |  |  |  | (17.0 | ) | 
| | 2004                            |  |                            |  | 1.2                                    |   |                                         |  |  | (1.6 | ) |  |  |  | (7.4  | ) | 

Political,
Economic and Military Conditions in Israel

Our
headquarters and principal research and development facilities are located in
Israel. Although we generate approximately 53% of our
revenues from international markets, we are, nonetheless, directly influenced by the political, economic
and military conditions affecting Israel. The execution
of Israels plan of unilateral disengagement from the Gaza Strip and some parts
of the West Bank may affect Israels foreign relations and the stability of the
region. Major hostilities involving Israel or the
interruption or curtailment of trade between Israel and its present trading
partners could have a material adverse effect on our business, operating
results and financial condition. Furthermore, several countries restrict
business with Israeli companies. In addition, nonexempt male adult citizens of
Israel, including some of our officers and employees, are obligated to perform
military reserve duty until
the age of 40 or 45 depending on their function in the army, and are subject to being called for active duty under emergency
circumstances. While we have operated effectively under these requirements
since our incorporation, we cannot predict the full impact of such conditions
on us in the future, particularly if emergency circumstances occur. If many of
our employees are called for active duty, our operations in Israel and our
business may be adversely affected.

52

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B.Liquidity and
Capital Resources

Since
inception, we have financed our growth and business primarily through cash
provided by operations and through public debt and equity offerings, as well as
through private and public debt and equity offerings of our subsidiaries. In
addition, we finance our business through short-term and long-term loans and
borrowings available under our credit facilities.

Cash

At
December 31, 2004 we had cash and cash equivalents and short-term investments
of $146.3 million and at December 31, 2003, we had cash and cash equivalents
and short-term investments of $102.2 million. At December 31, 2004, we had indebtedness to banks of $124.8 million, of which $107.0
million was current liabilities and $17.8 million was long-term liabilities. At
December 31, 2003, we had indebtedness to banks and others of $88.4 million, of
which $66.5 million was current liabilities and $21.9 million was long-term
liabilities.

Formula
has entered into credit facilities with several banks, pursuant to which
Formula may borrow from time to time, on a short-term and long-term basis, up
to an aggregate of approximately $43.0 million. Formulas loan agreements
contain a number of conditions and limitations on the way in which Formula can
operate its business, including limitations on its ability to raise debt and
sell assets; and prohibition on distribution of dividends. The banks did not
object to the distribution of the dividend made in June 2005. The loan agreements also contain various covenants which require Formula
to maintain certain financial ratios related to shareholders equity and operating
results. In addition, one of the loan agreements provides that the loan will be
repayable, at the discretion of the bank, in the event that Dan Goldstein or
Gad Goldstein cease to serve in their current positions in Formula.

Some of
Formulas assets are pledged to banks. These assets include certain of our
shareholdings in our subsidiaries consisting of our entire shareholdings in
BluePhoenix and a portion of our shareholdings in Matrix and Magic.

Our
subsidiaries maintain credit facilities with banks in accordance with their
cash requirements. These credit facilities include, inter alia, certain
covenants related to their operations, such as maintaining a minimum level of
shareholders equity and reaching certain operating results targets. Some of
our subsidiaries assets are pledged to the lender banks. If any of our
subsidiaries does not meet the covenants specified in its credit agreement, and
a waiver with respect to the fulfillment of such covenant has not been received
from the lender bank, the lender bank may foreclose
on the pledged assets to satisfy the debt.

Cash
flow provided by operating activities in 2004 was $17.8 million compared to cash flow
provided by operating activities of $9.6 million in 2003.

53

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Financing
activities

Cash
flow provided by financing activities in 2004 was $12.1 million compared to cash flow
used in financing activities of $4.6 million in 2003. This was mainly the
result of the following transactions:

In
April 2000, F.I.D. Holdings Ltd. and Israel Discount Bank Ltd. invested $15
million in eZoneXchange.com, Inc., a subsidiary of Sapiens. This private
placement was accompanied by a put/call agreement, under which the
participating investors were granted the right to require Sapiens to repurchase
their shares in eZone, beginning in May 2004, in exchange for cash and Sapiens
common shares. In February 2001, eZones operations were discontinued and
Sapiens agreed to a partial exercise of the put option, resulting in a payment
to the investors of $4.5 million. In March 2004, Sapiens entered into a new
agreement with the investors which replaced the put/call agreement and extended
the period in which Sapiens may fulfill the terms of the put option. Sapiens
agreed to issue to the investors, in a private placement, 750,000 common shares
and warrants to purchase an additional 350,000 common shares that are
exercisable through December 31, 2007. In addition, Sapiens agreed to pay the
investors by May 1, 2005, in two annual installments, an aggregate of $8.6
million plus interest at an annual rate of 7.5%. In June 2005, Sapiens entered
into a new agreement with the investors which amends the final payment of $4
million which was due on May 1, 2005. Sapiens paid the investors $2 million in
May 2005, and agreed to pay $1 million by April 1, 2006 and an additional $1
million by August 1, 2006. The investors may, at their sole discretion, convert
all or any portion of the $1 million payable by August 1, 2006, into common
shares of Sapiens, at a conversion price per each share of $3.20.

In 2004,
our subsidiaries issued shares to minority shareholders resulting in gross
proceeds of $4.4 million in the aggregate, of which $1.6 million was received
by Sapiens, $1.2 million by Magic and $1.5 million by Matrix.

In
March 2004, BluePhoenix completed a $5 million private placement to
institutional investors. The terms of this transaction were amended on February
18, 2005. Under the terms of this transaction as amended, BluePhoenix issued to
the institutional investors convertible debentures, bearing interest at a rate
of LIBOR calculated on a semi-annual basis. In addition, the institutional
investors were granted warrants to purchase up to 285,714 of BluePhoenixs
ordinary shares at an exercise price of $6.50 per share, subject to (i)
adjustment for stock dividends, stock splits, recapitalization and other
similar events; and (ii) anti-dilution adjustment. The warrants are exercisable
during a period of five years commencing on September 2004. Under certain
circumstances, the institutional investors may increase their investment by an
additional $3 million of debentures convertible into BluePhoenixs ordinary
shares at a price of $4.50 per share, and receive warrants on the same terms as
the initial warrants, exercisable into such number of BluePhoenixs ordinary
shares equal to 30% of the ordinary shares into which the debentures are
convertible.

In June 2003, we repurchased $2.4 million aggregate
principal amount of
debentures issued by us to the public in Israel, in May 2002.

54

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During
2003, we sold 300,000 Formula ordinary shares on the TASE for aggregate
consideration of $4.8 million.

In the
first quarter of 2003, Magic distributed a dividend to its shareholders of 40
cents per share. The aggregate amount distributed by Magic was $11.8 million.

During
2003, Shandol exercised options to purchase 500,000 ordinary shares of Formula
for an aggregate exercise price of $7.9 million.

In December
2003, Sapiens completed an offering in Israel of convertible debentures and
warrants exercisable into common shares of Sapiens, resulting in gross proceeds
to Sapiens of approximately $17.1 million.

Recent
financing activities

In March
2005, we completed a private placement of 2,400,000 Formula shares for an
aggregate consideration of $36 million.

In June
2005, we distributed to our shareholders a cash dividend of approximately $4 per share. The
aggregate amount distributed by Formula was approximately $53 million.

On June 20,
2005, we repaid the outstanding amount of the debentures issued by us to the public in Israel,
in May 2002. The aggregate amount repaid by us to the debentures holders was
$14.9 million.

Investment
activities

Net cash
used in investing activities in 2004 were $17.1
million and in 2003, $4.9 million. These investing
activities were comprised of the following transactions:

In
2004, we sold shares of several of our subsidiaries in the open market, as follows: 379,657 shares of Magic for aggregate
consideration of $2.4 million,
2,600,000 shares of Matrix for aggregate consideration of $6.1 million and
2,000,000 shares of Formula Vision for an aggregate of $2.1 million.

During 2004, we purchased in the open market
579,132 common shares of
Sapiens for aggregate consideration of $1.4 million.

During
2004, our subsidiaries capitalized software development costs in an aggregate
amount of $15.4 million.

In
2004, our subsidiaries purchased marketable securities for aggregate
consideration of $16.4 million (of which $11 million were paid by Sapiens and
$5 million by Magic).

In
2004, Formula Vision invested in and granted loans to, its affiliates in an
aggregate of $6.2 million.

55

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During
2004, we sold certain investments resulting in aggregate proceeds of $4.2
million ($800,000 to Formula, $600,000 to Formula Vision and $2.8 million to
BluePhoenix).

As
a result of the consolidation of Formula Vision in 2004, we increased our
positive net cash by $13.7 million.

During
2003, we purchased shares of several of our subsidiaries in the open
market, as follows:64,600 shares of
BluePhoenix for an aggregate purchase price of $150,539, 776,154 shares of
Magic for an aggregate purchase price of $911,923, 1,401,189 shares of Sapiens
for an aggregate purchase price of $1.2 million and 30,396 shares of Matrix for
an aggregate purchase price of $46,398.

During
the fourth quarter of 2003, we purchased an aggregate of 4,224,956 shares of
Matrix for an aggregate purchase price of $10 million, under put options we
granted in October 2002 to selling shareholders of New Applicom and Sintec.

During
2003, we sold in the open market 346,364 ordinary shares of Magic for aggregate
consideration of $1.4 million, and warrants of Matrix for aggregate
consideration of $350,000.

During
2003, our subsidiaries capitalized software development costs in an aggregate
amount of $10.2 million.

As
a result of the consolidation of Sapiens in 2003, we increased our positive net
cash by $20.5 million.

We believe
that the net cash proceeds we raised by financing activities, together with
cash flows from operating activities, will be sufficient to meet our cash needs
for the next 12 months at the current level of operations. We will consider in
the future additional equity issuances, debt issuances or borrowings from banks
if necessary to meet cash needs for our growth.

Commitments and Contingent Liabilities

We
have pledged some of Formulas assets in favor of banks under our credit facilities
with those banks. These assets include bank accounts, as well as certain of our
shareholdings in the subsidiaries consisting of our entire shareholdings in BluePhoenix
and a portion of our shareholdings in Matrix and Magic.

Some
of our subsidiaries have floating charges in favor of banks and other financial
institutions. In addition, some of our subsidiaries have liens on leased
vehicles, leased equipment and other assets in favor of the leasing companies.

56

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Other Contractual Commitments

In
connection with one of our credit facilities, Formula committed, among other
things, not to distribute
dividends. The bank did not object to the distribution of the dividend made by
Formula in June 2005. In
addition, one of our loan agreements provides that the loan will be repayable,
at the discretion of the lender bank, in the event that Dan Goldstein or Gad
Goldstein cease to serve in their current positions in Formula.

In
connection with the sale of our interest in certain companies to Formula
Vision, Formula Vision assumed all our rights and obligations under the
agreements with each of Shamrock,
FIMI and IDB with respect to the companies transferred to Formula Vision. For
more information, see Item 4.A.  History and Development of the Company  Capital Expenditures and
Divestitures.

Formula
and Matrix committed to banks who provided lines of credit to them not to grant
a security interest in all or substantially all of their respective assets.

We
entered into an undertaking to indemnify our office holders in specified
limited categories of events and in specified amounts, subject to certain
limitations. For more information, see Item 7.B. Related Party
TransactionsIndemnification of Office Holders.

Related
Party Transactions

Transactions
between Us and Formula Vision

In
January 2004, Formula acquired 59.4% of the outstanding share capital of Formula
Vision in exchange for approximately $35 million of the debentures
issued by Formula Vision to Formula in 2001. The price per share was NIS 4.11
($0.93) which reflects the average closing price of Formula Visions shares on
the TASE during the 30 days preceding Formulas resolution approving the
transaction. This transaction is considered a related party transaction since
Dan Goldstein serves as the chairman of the board of directors and the chief
executive officer of Formula and Formula Vision and was at the time of
consummation of the transaction, a controlling shareholder of Formula Vision.
In addition, Gad Goldstein serves as a director of Formula and Formula Vision.
For more information, see Item 7.B. Related Party Transactions Transactions
between Formula and Formula Vision. We believe that the price per Formula Visions
share paid by Formula in this transaction reflects a fair value of the shares. We do not believe that
the impact of this transaction on our results of operations would have been
different if the transaction would have been made with a third party not
affiliated with us.

For more
information about the transaction between Formula and Formula Vision, see Item
4.A. History and Development of the Company  Capital Expenditures and Divestitures  Restructuring of Our Corporate Structure  Transactions with
Formula Vision.

Private
Placement to FIMGold LP

In
February 2005, the general meeting of shareholders approved a private placement
of 2,400,000 ordinary shares issued to FIMGold LP for an aggregate
consideration of $36 million. FIMGold LP is an entity owned in equal shares by
Dan Goldstein, our chief executive officer and chairman of the board, and FIMI
Opportunity Fund. Prior to the approval by our shareholders, the private
placement was approved by our audit committe and board of directors. The
purchase price per share in the transaction was $15, which was the approximate
closing price per Formulas share on the NASDAQ National Market and the TASE on
December 28, 2004, the date on which an agreement in principal was reached. We believe that the
price per Formulas share paid by FIMGold LP in the private placement reflects a fair value of the shares. We do not believe
that the price per share would have been different if the transaction would
have been made with a third party not affiliated with us.

57

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For more
information about the private placement and related transactions, see Item 7.B. Related Party Transactions  Private
Placement to FIMGold LP.

Effective
Corporate Tax Rates in Israel

Certain of
the companies in the Formula Group have
been granted approved enterprise status under the Investment Law. Accordingly,
if these companies comply with certain requirements, they are eligible for
certain tax benefits for the first seven years in which they generate taxable
income. Income derived from these companies approved enterprise programs will
be tax exempt for a period of two years after the companies have taxable
income. They will also be subject to a 25% company tax rate for the following
five years. Under certain circumstances, if the percentage of the share capital
that foreign shareholders hold in subsidiaries and affiliates of these
companies exceeds 25%, future approved enterprises of the
applicable subsidiary or affiliate would qualify for reduced tax rates for an
additional three years, after the seven years mentioned above. We cannot assure
you that these companies will obtain approval for additional approved
enterprises, that the provisions of the Investment Law will not change, or that
the above-mentioned shareholding portion will be reached or maintained for each
subsequent year. In addition, our equity in affiliated companies net income is
not subject to tax in Israel. Gains from changes in holdings in subsidiaries
and affiliated companies resulting from issuances to third parties are also not
taxable in Israel. These exemptions cause our effective tax rate to fluctuate
from period to period.

On
January 1, 2003, Israels tax laws underwent a significant tax reform
(Amendment 132 to the Income Tax Ordinance (New Version)  1961). The reform
legislation broadened the categories of taxable income, and reduced the tax
rates imposed on employment income. Among the key provisions of this reform
legislation were (i) changes which may result in the imposition of taxes on
dividends received by an Israeli company from its foreign subsidiaries; and
(ii) the introduction of the controlled foreign corporation concept according
to which an Israeli company may become subject to Israeli taxes on certain
income of a non-Israeli subsidiary if the subsidiarys primary source of income
is passive income (such as interest, dividends, royalties, rental income or
capital gains). An Israeli company that is subject to Israeli taxes on the
income of its non-Israeli subsidiaries will receive a credit for income taxes
paid by the subsidiary in its country of residence.

C. Research and
Development, Patents and Licenses

In
2004, we spent $25.0 million on research and development activities, in 2003 we
spent $17.4 million and in 2002 we spent $16 million. The increase in the
amount spent on research and development activities in 2004 compared to 2003,
relates primarily to the consolidation of Formula Vision which had research and
development expenditures of $9.7 million in 2004. The increase in the amount
spent on research and development activities in 2003 compared to 2002, relates
primarily to the consolidation of Sapiens. This increase was partially offset
by a decrease in the research and development expenditures of certain of our
subsidiaries as part of a cost restructuring measures taken by these companies.
For a description of our research and development activities, see Item
4.B. Business Overview-Software
Development.

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For
information concerning our intellectual property rights, see Item 4.B.
Business Overview-Intellectual Property Rights.

D. Trend Information

We
have been affected by global economic changes, in particular the sharp decline
in capital spending in the information technology sector and the IT business
slow-down in North America and Europe, as well as in
Israel. Uncertainties in the North American, European and Israeli markets have
influenced the purchasing patterns of leading software developers who delayed
their planned orders and caused developers to reduce the amount of their
planned license commitment. These changes in purchasing patterns in the IT
industry affected directly the operating results of some of our subsidiaries,
which in turn affected our consolidated operating results. Our revenues
decreased from $402.5 million in 2000 to $387.7 million in 2001 and to $283.3
million in 2002. In 2003 and 2004, as a result of a slight recovery of the
market, and the impact of the consolidation of the results of operations of
Sapiens (beginning with 2003) and Formula Vision (beginning with 2004), this
trend changed, and our revenues increased to $366.8 million and $456.6 million,
respectively. We cannot know whether the global market will recover in the
future, or how the economic conditions will continue to affect our business.

As
IT spending is more cautious, we have pursued a strategy aimed at addressing
current market needs through the introduction of cost-effective, new and
enhanced products. We strive to use our best efforts to take advantage of the
current slow-down to prepare our infrastructure to maximize the long-term
growth potential of the software market.

E.       Off-Balance
Sheet Arrangements

We
do not have any off-balance sheet arrangements.

59

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F.       Tabular
Disclosure of Contractual Obligations

The
following table summarizes our contractual obligations and commitments as of
December 31, 2004.

|                                                                             |  |                       |         |                    |  |             |  |             |        |                       |  |           |  |  |       |  |  |       | 
|---------------------------------------------------------------------------- |  | --------------------- | ------- | ------------------ |  | ----------- |  | ----------- | ------ | --------------------- |  | --------- |  |  | ----- |  |  | ----- | 
|                                                                             |  | Payment due by period |        
|                                                                             |  |                       |        
|                                                                             |  | Total                 |         | Less than
  1 year |  | 1-3
  years |  | 3-5
  years |        | More
  than
  5 years |  | Other (1) | 
|                                                                             |  |                       |         |                    |  |             |  |             |        |                       |  |           | 
|                                                                             |  | $ in thousands        |        
|                                                                             |  |                       |        
|                                                                             |  |                       |         |                    |  |             |  |             |        |                       |  |           |  |  |       |  |  |       | 
|Long term debt obligations                                                   |  |                       | 96,598  |                    |  | 51,723      |  |             | 42,663 |                       |  | 1,865     |  |  | 347   |  |  |      | 
|                                                                             |  |                       |         |                    |  |             |  |             |        |                       |  |           |  |  |       |  |  |       | 
|Lease obligations                                                            |  |                       | 35,702  |                    |  | 11,976      |  |             | 15,144 |                       |  | 8,272     |  |  | 310   |  |  |      | 
|                                                                             |  |                       |         |                    |  |             |  |             |        |                       |  |           |  |  |       |  |  |       | 
|Liability in respect of the acquisition of
  activities                      |  |                       | 2,036   |                    |  | 157         |  |             | 314    |                       |  | 314       |  |  | 1,251 |  |  |      | 
|                                                                             |  |                       |         |                    |  |             |  |             |        |                       |  |           |  |  |       |  |  |       | 
|Other long-term liabilities reflected on our
  balance sheet under U.S. GAAP |  |                       | 5,807   |                    |  |            |  |             |       |                       |  |          |  |  |      |  |  | 5,807 | 
|                                                                             |  |                       |         |                    |  |             |  |             |        |                       |  |           |  |  |       |  |  |       | 
|                                                                             |  |                       |         |                    |  |             |  |             |        |                       |  |           |  |  |       |  |  |       | 
|Total                                                                        |  |                       | 140,143 |                    |  | 63,853      |  |             | 58,121 |                       |  | 10,451    |  |  | 1,908 |  |  | 5,807 | 

---

|    |                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------
|(1) | Other
  obligations include unrealized gains and sevarance pay, the due date of which
  is unknown.

|        |                                           
|------- | ------------------------------------------
|ITEM 6. | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A.Directors and
Senior Management

The
following table describes information about our directors and senior management
as of June 20, 2005.

|                          |  |    |     |                                                  |          | 
|------------------------- |  | -- | --- | ------------------------------------------------ | -------- | 
|Name                      |  |    | Age |                                                  | Position | 
|                          |  |    |     |                                                  |          | 
|Dan
  Goldstein           |  | 51 |     | Chairman of
  the Board, Chief Executive Officer
|Gad
  Goldstein           |  | 46 |     | President,
  Director                           
|Shlomo Nass               |  | 45 |     | Director                                        
|Ishay Davidi              |  | 43 |     | Director                                        
|Yarom Oren                |  | 34 |     | Director                                        
|Gil Weizer (1)            |  | 63 |     | Director                                        
|Daphna
  Sharir (1)       |  | 37 |     | Director                                        
|Bruria Gross
  Prushansky |  | 52 |     | Secretary
  and General Counsel                 
|Naamit
  Salomon          |  | 41 |     | Vice
  President, Finance                       

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|    |                                                                                                                                                         
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Outside
  director. See Item 6.C. Board Practices
   Outside Directors; Audit Committee,
  Internal Auditor, Approval of Certain Transactions, below.

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Dan
Goldstein has served as a chairman of our board of directors
and our chief executive officer since January 1985. Mr. Goldstein is also the
chairman of the board of directors of Matrix and Formula
Vision and is a director of BluePhoenix, Magic, Sapiens and of other
privately-held companies within the Formula Group. Mr. Goldstein is also the chairman
and chief executive officer of Formula Vision. Mr. Goldstein
holds a BA degree in mathematics and computer sciences and an MA degree in business
administration, both from Tel Aviv University. Dan Goldstein is the brother of
Gad Goldstein.

Gad Goldstein has served as one of our
directors since January 1985. Mr. Goldstein was our vice president from 1985
through 1995 and was appointed our president in 1995. Mr. Goldstein is chairman
of the board of BluePhoenix and is also a director of other companies within
the Formula Group, including Matrix, Magic, Sapiens and
Formula Vision. Mr. Goldstein holds a BA degree in economics and an MA degree
in business administration, both from Tel Aviv University. Gad Goldstein is the
brother of Dan Goldstein.

Shlomo Nass has served as one of our directors
since April 2003. Mr. Nass is the president and a partner of I.G.B.  Israel
Global Business, an investment group.Mr.
Nass serves as a
director of several public companies. Mr. Nass holds a B.Sc. degree in
economics and accounting, and an LL.B degree, both from the Bar-Ilan University. Mr. Nass is a certified public
accountant, a member of
the Israeli Bar and holds a Ph.D. in law. Mr. Nass
qualifies as an independent director and an audit committee financial expert,
as such terms are defined in the Nasdaq rules and/or in the Sarbanes-Oxley Act
of 2002.

Ishay
Davidi joined our board of
directors in March 2005. Mr. Davidi is the chief executive officer and a senior
partner at First Israel Mezzanine Investors Ltd. and FIMI 2001 Ltd. Mr. Davidi
also serves as chairman of Tadir-Gan (Precision Products) 1993 Ltd. And as a
director of Lipman Electronic Engineering Ltd., Caesarea Creation Industries
Ltd., Medtechinca Ltd., Tedea Development & Automation Ltd. and TAT
Technologies Ltd. From 1993 until 1996, Mr. Davidi served as the chief
executive officer of the Tikvah VC Fund. Mr. Davidi holds a B.Sc in industrial
and management engineering from Tel-Aviv University and an MBA from Bar-Ilan
University.

Yarom
Oren joined our board of directors in March 2005. Mr. Oren is a senior
partner at First Israel Mezzanine Investors Ltd. and FIMI 2001 Ltd. Mr. Oren
also serves as a director of Caesarea Creation Ltd., a textile manufacturer,
Tefron Ltd., a textile manufacturer traded on NYSE, Ginegar Plastic Products
Ltd., a plastic cover films manufacturer, and Mez Op Holdings Ltd., a holding company
wholly controlled by FIMI. Mr. Oren holds a B.Sc in industrial engineering from
Tel Aviv University and an MBA from WBS England.

Gil
Weizer joined our board of directors as
one of our outside directors in February 2005. Mr. Weizer serves as a director
of several public companies including Fundtech Ltd., Optibase Ltd., Tescom
Software Systems Testing Ltd., and ClickSoftware Technologies Ltd. Mr. Weizer
was the acting vice chairman for ORAMA, an international investment banking
group, and a board member of the TASE from 2002 until 2004. From 1995 to 2000,
Mr. Weizer served as chief executive officer of Hewlett Packard (HP), Israel
and CMS Corp. Mr. Weizer is the chairman of the executive board of Haifa
University, and is a member of the Israel High-Tech Association executive
committee. Mr. Weizer holds a B.S. degree in electrical engineering from the
Technion in Haifa, and an M.S. in electronics and computers from the University
of Minnesota.

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Dafna
Sharir joined our board of directors as
one of our outside directors in February 2005. Ms. Sharir is an independent
consultant in the areas of mergers and acquisitions and business development.
From 2002 until 2004, Ms. Sharir served as senior vice president  investments
of AMPAL  American Israel Corporation, a public company traded on the Nasdaq
National Market. From 1999 until 2002, Ms. Sharir served as director of mergers
and acquisitions of AMDOCS Limited, and prior to that, from 1994 to 1996 as an
associate at the tax department at Cravath, Swaine & Moore, in New York.
Ms. Sharir holds BA degrees in economics and law, both from Tel Aviv
University, an LL.M. in Tax Law from the New York University, and an MBA from
the European Institute of Business Administration (INSEAD), in Fontainebleau,
France.

Bruria
Gross Prushansky has served as our secretary
and general counsel since January 1997. From 1994 until the end of 1996, Ms.
Gross Prushansky was in the private practice of law. From 1988 until 1994, Ms.
Gross Prushansky was the general counsel of Elite Industries Ltd., a major
Israeli food company. Ms. Gross Prushansky, who is a member of the Israeli Bar,
holds an LL.B. degree from Tel Aviv University and has an MA degree in business
administration from the Recanati executive MBA program of Tel Aviv University.

Naamit
Salomon has served as our vice president,
finance since August 1997. Ms. Salomon also serves as a director of Magic and
Sapiens. From 1990 through August 1997, Ms. Salomon was a controller of two
large, privately held companies in the Formula Group. Ms. Salomon holds a BA degree in economics
and business administration from Ben Gurion University and an LL.M. degree from
the Bar-Ilan University.

B.Compensation

In 2004, we
paid to our directors and officers (eight persons) aggregate direct
remuneration of approximately $841,450. This amount includes amounts set aside or accrued to provide post-employment benefits.

| |                                               |                                                                                                                                          
| | --------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------
| | This
  amount does not include the following:
| |                                              
| |                                              | amounts
  expended by us for automobiles made available to our officers;                                                                 
| |                                               |                                                                                                                                          
| |                                              | expenses,
  including business travel, professional and business association dues and
  expenses, that we reimburse our officers for; and
| |                                               |                                                                                                                                          
| |                                              | other
  fringe benefits that companies in Israel commonly reimburse or pay to their
  officers.                                          

The amount
also includes payment of directors fees to our outside directors and Mr.
Shlomo Nass. We
compensate our outside directors in accordance with the regulations
promulgated under the Israeli Companies Law, 1999, referred to as the Companies
Law. We compensate Mr. Shlomo Nass in the same amounts we compensate our
outside directors. In February 2005, our shareholders approved the payment of
compensation to our other non-employee directors, in addition to our outside
directors and Mr. Nass, in the same amounts we compensate our outside
directors.

62

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Our employee
directors do not receive fees for their services as directors. In 2004, we paid
an aggregate amount of $52,250 for post-employment benefits for our executive
officers and directors. Under Israeli law, we are not required to disclose, and have not
otherwise disclosed, the compensation of our senior management and directors on
an individual basis.

In November
2000, options to purchase 16,000 ordinary shares were granted to certain of our
officers under the 2000 share option plan. No director has been granted options
under this plan. The exercise price of the options is $30.8 per share, as
indexed to the Israeli CPI. All of these options are currently exercisable. These options expire on the fifth
anniversary of the date of grant.

Effective
January 1, 1999, all of our executive officers entered into written employment
agreements with us pursuant to which, among other things, we pay them a monthly
salary in an agreed amount. The salary is linked to the Israeli CPI. Each party
may terminate the agreement upon a 90-day notice. If we terminate any of these employment
agreements, we will have to pay the usual severance pay required under Israeli
law for all employees. In addition, two of our executive officers are
entitled to bonuses which aggregate approximately 3.5% of our consolidated net
income exceeding $10 million.

C.Board Practices

Pursuant to
our articles of association, directors are elected at the annual general
meeting of shareholders by a vote of the holders of a majority of the voting
power represented at the meeting. Our board is comprised of 7 persons. The
board includes two outside directors mandated under Israeli law and subject to
additional criteria to help ensure their independence. See -Outside Directors
below. Each director, except for the outside directors, holds office until the
next annual general meeting of shareholders. Officers are appointed by our board of directors. For information regarding the
employment agreements
of our officers, see Item 6.B. Compensation.

Outside
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 at least two outside directors. This law provides that a person may not
be appointed as an outside 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 outside director, or had, during the
two years preceding that date, any affiliation with the company or any entity
controlling, controlled by or under common control with the company. 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
may serve as an outside director if the persons position or other business
activities create, or may create, a conflict of interest with the persons
responsibilities as an outside director or may otherwise interfere with the
persons ability to serve as an outside director or if the person is an employee of the Israel
Securities Authority or of an Israeli stock exchange. If, at the time of
election of an outside director, all other directors are of the same gender,
the outside director to be elected must be of the other gender. Outside directors are to be elected by a
majority vote at a shareholders meeting, provided that either:

| |   |                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the
  majority of shares voted at the meeting, including at least one-third of the
  shares of non-controlling shareholders voted at the meeting, vote in favor of
  election of the director; or
| |   |                                                                                                                                                                                                  
| |  | the
  total number of shares of non-controlling shareholders voted against the
  election of the director does not exceed one percent of the aggregate voting
  rights in the company.           

Pursuant
to a recent amendment to the Companies Law, an outside director must have
financial and accounting expertise or professional qualifications, provided
that at least one outside director will have financial and accounting expertise.
The terms financial and accounting expertise and professional
qualifications are to be defined in regulations to be promulgated by the
Israeli Minister of Justice after consultation with the Israel Securities
Authority. These regulations have not yet been promulgated and therefore, the
qualification requirements described above are not yet in effect.

The initial
term of an outside director is three years and may be extended by the general
meeting of shareholders, for an additional three years. In February 2005, Ms.
Daphna Sharir and Mr. Gil Weizer were appointed as our outside directors, each
to hold office until February 2008.

Each
committee of a companys board of directors is required to include at least one
outside director. However, the audit committee shall include all the outside
directors.

An outside
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 outside director.

Qualifications
of Other Directors

Under
a recent amendment to the Companies Law, the board of directors of a publicly
traded company will be required to make a determination as to the minimum
number of directors who must have financial and accounting expertise according
to criteria which will be defined in regulations to be promulgated by the
Israeli Minister of Justice. According to the Companies Law, the determination
of the board will be based, among other things, on the type of the company, its
size, the volume and complexity of its activities and the number of directors.
Our board will be required to make the determination as to the minimum number
of directors with financial and accounting expertise within 90 days of the
effective date of the applicable regulations.

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Audit Committee

The
Companies Law requires public companies to appoint an audit committee,
comprised of at least three directors, including all of the outside directors.
The chairman of the board of directors, any director employed by or otherwise
providing services to the company, and a controlling shareholder or any
relative of a controlling shareholder, may not be a member of the audit
committee.

We
have established an audit committee, consisting of the two outside directors,
Gil Weizer and Daphna Sharir, as well as Shlomo Nass. Each audit committee
member qualifies as an independent director under the applicable
Nasdaq rules and those of the Securities and Exchange Commission. The board has agreed that Shlomo
Nass is an audit committee financial expert as defined by applicable SEC
regulations. See Item 16A. Audit Committee Financial Expert.

Under
the Companies Law, the audit committee is responsible for overseeing the
business management practices of the company in consultation with the companys
internal auditor and the independent auditor, making recommendations to the
board to improve such practices and approving related party transactions as
required by the Companies Law. In accordance with the Sarbanes-Oxley Act and
Nasdaq requirements, our audit committee is directly responsible for the
appointment, compensation, retention and oversight of our independent auditors.
In addition, the audit committee is responsible for assisting the board in
monitoring our financial statements and the effectiveness of our internal
controls. We are in the process of implementing a formal audit committee
charter embodying these responsibilities.

Internal Auditor

Under
the Companies Law, the board of directors must appoint an internal auditor,
nominated by the audit committee. The role of the internal auditor is to
examine, among other matters, whether the companys actions comply with the law
and orderly business procedure. Under the Companies Law, the internal auditor
may be an employee of the company but not an office holder, or an interested
party (i.e., a holder of 5% or
more of the voting rights in the company or of the issued share capital, the
chief executive officer of the company or any of its directors, or a person who
has the authority to appoint the companys chief executive officer or any of
its directors), or a relative of an office holder or of an interested party. In
addition, the companys independent accountant or its representative may not serve
as the companys internal auditor.

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, however, that
such a breach is not related to a distribution of a dividend or any other distribution
by the company.

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Office Holders Insurance. Our articles of
association provide that, subject to the provisions of the Companies Law, we
may enter into a contract for the insurance of the liability of any of our
office holders imposed on the office holder in respect of an act performed in
his or her capacity as an office holder, 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.                                                                                                                  

We
have obtained an insurance policy covering the Formula Groups directors and officers
liability. Our subsidiaries participate in the premium payments of the
insurance, on a proportional basis. The total premium we paid during 2004 was approximately $320,000.

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, in each case relating to an act performed in his
  capacity as an office holder.

Under
the Companies Law, as amended recently, an undertaking by a company to
indemnify an office holder in advance for a financial liability imposed on the
office holder, must be limited to (i) such events which, in the opinion of the
board of directors, are foreseeable in light of the actual activities of the
company at the time the undertaking is provided; and (ii) such amount or
criteria determined to be reasonable by the board. In light of the recent
amendment to the Companies Law, we are considering updating our articles of
association, if required, in order to comply with the current provisions of the
Companies Law.

Limitations on Exemption, Insurance and
Indemnification. The Companies Law provides that a company may not
indemnify an office holder, enter into an insurance contract which would
provide coverage for any monetary liability, or exempt an office holder from
liability, with respect to 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, except for a breach that was made in negligence;                                 
| |   |                                                                                                                                                                                            
| |  | any act or
  omission done with the intent to derive an illegal personal benefit; or                                                                                                       
| |   |                                                                                                                                                                                            
| |  | any fine
  levied against the office holder.                                                                                                                                               

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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.

In
February 2002, we granted to each of our office holders an indemnification
letter, pursuant to which we undertook to indemnify
each office holder in respect of certain obligations and expenses. We are
considering updating the indemnification letters granted to our office holders,
if required, in light of the recent amendment to the Companies Law adopted in
March 2005. For information concerning the indemnification arrangement with our
office holders, see Item 7.B.
Related Party Transactions-Indemnification of Office
Holders.

Approval of Certain Transactions under the Companies
Law

The
Companies Law codifies the fiduciary duties that office holders, including
directors and executive officers, owe to a company. An office holders
fiduciary duties consist of a duty of care and a duty of loyalty. The duty of
loyalty includes (i) avoiding any conflict of interest between the office
holders position in the company and his personal affairs, (ii) avoiding any
competition with the company, (iii) avoiding exploiting any business
opportunity of the company in order to receive personal advantage for himself
or others, and (iv) revealing to the company any information or documents relating
to the companys affairs which the office holder has received due to his
position as an office holder. Each person listed in the table under Directors
and Senior Management above is an office holder. Under the Companies Law,
arrangements regarding the compensation of directors require the approval of
the audit committee, the board of directors and shareholder approval.

The
Companies Law requires that an office holder of a company promptly disclose 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. In addition, if the transaction is an extraordinary transaction
as defined under the Companies Law, the office holder must also disclose any
personal interest held by the office holders spouse, siblings, parents,
grandparents, descendants, spouses descendants and the spouses of any of the
foregoing. In addition, the office holder must also disclose any interest held
by any corporation in which the office holder owns 5% or more of the share
capital, is a director or general manager or in which he or she has the right
to appoint at least one director or the general manager. An extraordinary
transaction is defined as a transaction other than in the ordinary course of
business, otherwise than on market terms, or that is likely to have a material
impact on the companys profitability, assets or liabilities.

Under
the Companies Law, after the office holder complies with the disclosure
requirements described above, only board approval is required for any
transaction which is not an extraordinary transaction, unless the articles of
association of the company provide otherwise, and provided the transaction is
not adverse to the companys interest. If the transaction is an extraordinary
transaction, the company must receive any approval stipulated by the articles
of association, the approval of the companys audit committee and the approval
of the board of directors, as well as, under certain circumstances, approval by
a meeting of the shareholders of the company. An office holder 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 unless the majority of the board members or members of the audit
committee, as applicable, have a personal interest in such matter and in such
case, the matter should also be approved by the shareholders of the company.

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The
Companies Law applies the same disclosure requirements to a controlling
shareholder of a public company, which includes a shareholder that holds 25% or
more of the voting rights in the company if no other shareholder owns more than
50% of the voting rights in the company. Extraordinary transactions with a
controlling shareholder or in which a controlling shareholder has a personal
interest, and the terms of compensation of a controlling shareholder or its
relative who is an office holder or an employee of the company, require the
approval of the audit committee, the board of directors and the shareholders of
the company. The shareholder approval must include at least one-third of the
shareholders who have no personal interest in the transaction and are voting on
the subject matter or, alternatively, the total shareholdings of those who have
no personal interest in the transaction who vote against the transaction must
not represent more than one percent of the voting rights in the company. In
certain cases provided in regulations promulgated under the Companies Law,
shareholder approval is not required.

The
approvals of the board of directors and shareholders is required for a private
placement of securities (or a series of related private placements during a
12-month period or that are part of one continuous transaction or transactions
conditioned upon each other) in which:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the
  securities issued represent at least 20% of the companys actual voting power prior to
  the issuance of such securities, and such issuance increases the relative
  holdings of a 5% shareholder or causes any person to become a 5% shareholder,
  and the consideration in the transaction (or a portion thereof) is not in
  cash or in securities listed on a recognized stock exchange, or is not at a
  fair market value; or
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | a person would become, as a result of such transaction, a controlling
  shareholder of the company.                                                                                                                                                                                                                                                                                                                                       

D.Employees

We
have approximately 5,300 full-time employees, of whom approximately 4,650 are
software professionals. In 2003, we had approximately 3,500 full-time employees, of whom approximately 3,100 were software
professionals. In 2002, we had the
same approximate number
of employees as in 2003.  The increase in the number of employees
in 2004 compared to 2003 relates primarily to the consolidation of Formula
Vision and its affiliates, which employ in the aggregate approximately 1,000
employees. The increase also stems from an increase in the number of employees
of other members of the group as a result of the growth in their activities, in
particular Matrix and nextSource. The number of our employees in 2002 and 2003
remained relatively the same as a result of an increase in the number of
employees of Matrix and nextSource in 2003 that was offset by a decrease in the
number of employees of Magic and Sapiens due to restructuring measures taken by
these subsidiaries including closing of branches and business lines.

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With
respect to our employees in Israel, we are subject to various Israeli labor
laws and labor practices, and to administrative orders extending certain
provisions of collective bargaining agreements between the Histadrut (Israels
General Federation of Labor) and the Coordinating Bureau of Economic Organizations
(the Israeli federation of employers organizations) to all private sector
employees. For example, mandatory cost of living adjustments, which compensate
Israeli employees for a portion of the increase in the Israeli consumer price
index, are determined on a nationwide basis. Israeli law also requires the
payment of severance benefits upon the termination, retirement or death of an
employee. We meet this requirement by contributing on an ongoing basis towards
managers insurance funds that combine pension, insurance and, if applicable,
severance pay benefits. In addition, Israeli employers and employees are
required to pay specified percentages of wages to the National Insurance
Institute, which is similar to the United States Social Security Administration.
Other provisions of Israeli law or regulation govern matters such as the length
of the workday, minimum wages, other terms of employment and restrictions on
discrimination. We are also subject to the labor laws and regulations of other
jurisdictions in the world where we have employees.

E.Share Ownership

The
following table presents information regarding the ownership of our ordinary
shares by the persons listed in the table under Directors and Senior
Management, as of June 20, 2005.

|                                                        |      |        |           |                                                     |  |                                        |      |   |  |  |  |        |     |  |  | 
|------------------------------------------------------- | ---- | ------ | --------- | --------------------------------------------------- |  | -------------------------------------- | ---- | - |  |  |  | ------ | --- |  |  | 
|                                                        | Name |        |           | Shares beneficially owned                           |  | Options to purchase 
  ordinary shares |     
|                                                        |      |        |           |                                                     |  |                                        |     
|                                                        |      | Number |           | Percentage of 
  outstanding 
  ordinary shares (1) |  |                                        |     
|                                                        |      |        |           |                                                     |  |                                        |     
|Dan Goldstein (2)                                       |      |        | 4,400,000 |                                                     |  |                                        | 33.3 | % |  |  |  |        |     | 
|Gad
  Goldstein                                         |      |        | 325,000   |                                                     |  |                                        | 2.5  | % |  |  |  |        |     | 
|All
  directors and officers as a group (8 persons) (3) |      |        | 4,725,000 |                                                     |  |                                        | 35.8 | % |  |  |  | 16,000 | (4) | 



---

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Percentages in the above
  table are based on 13,200,000 ordinary shares outstanding as of June 20, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|(2) | Dan Goldstein holds a 50%
  interest in FIMGold Limited Partnership, which owns approximately 33.3% of
  Formulas outstanding ordinary shares. Dan Goldstein may be deemed to
  beneficially own all such shares by virtue of shared voting and dispositive
  power pursuant to a shareholders agreement entered between Dan Goldstein,
  through his wholly owned company, Ildani Holdings Ltd., and FIMI Opportunity
  Fund, with respect to FIMGold Ltd., the general partner of FIMGold LP.
  However, Mr. Goldstein disclaims beneficial ownership from one half of such
  shares. For more information about the shareholders agreement, see Item 7.A.
  Major Shareholders.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|(3) | Each
  of the directors and executive officers not separately identified in the
  above table beneficially owns less than one percent of our outstanding
  ordinary shares (including options held by each of these persons) and have
  therefore not been separately disclosed.                                                                                                                                                                                                                                                                                                                                                                                                     
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|(4) | All
  of these options are currently exercisable at an
  exercise price of $30.8 per share, as indexed to the Israeli CPI. These options expire in November 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

Arrangements
Involving the Issue or Grant of Options to Purchase Shares

The 2000 Share Option Plan

In
November 2000, we adopted a share option plan under which we may grant options
to purchase up to an aggregate of 300,000 ordinary shares to employees and
members of our management. Of these options, we granted in November 2000,
options to purchase 64,500 ordinary shares to certain of our employees,
including options to purchase 16,000 shares granted to certain of our officers
and directors. The exercise price of these options is $30.8 per share, as
indexed to the Israeli CPI. The options vested over a three-year period from
the date of grant. The options expire on the fifth anniversary of the date of grant.  As of June 20, 2005, none of these options
has been exercised.

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Option Plans of Our Subsidiaries

Our
operating subsidiaries generally have share option plans pursuant to which
qualified directors, employees and consultants may be granted options for the
purchase of securities in these subsidiaries.
In addition, these subsidiaries may from time to time grant options to
third parties as part of a business transaction.

|        |                                                  
|------- | -------------------------------------------------
|ITEM 7. | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A.Major Shareholders

The
following table presents information regarding the ownership of our ordinary
shares at June 20, 2005 by each person known to us to be the beneficial owner
of more than 5% of our ordinary shares based on information provided to us by
the holders or disclosed in public filings with the Securities and Exchange
Commission.  None of the holders of the
ordinary shares listed in this table have voting rights different from other
holders of our ordinary shares.Except
where we indicated otherwise, we believe, based on information furnished by
these owners, that the beneficial owners of our shares listed below have sole
investment and voting power with respect to the shares.

|                                  |  |                     |  |            |  |  |  |  |      |   | 
|--------------------------------- |  | ------------------- |  | ---------- |  |  |  |  | ---- | - | 
|                                  |  |                     |  |            |  |  | 
|                                  |  |                     |  | Percent of | 
|                                  |  | Shares Beneficially |  |            | 
|Name and Address                  |  | Owned               |  | Class (1)  | 
|                                  |  |                     |  |            | 
|FIMGold
  Limited Partnership (2) |  |                     |  | 4,400,000  |  |  |  |  | 33.3 | % | 
|Bank
  Leumi LeIsrael B.M. (3)   |  |                     |  | 964,127    |  |  |  |  | 7.3  | % | 



---

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Ordinary
  shares deemed beneficially owned by virtue of the right of any person or
  group to acquire these ordinary shares within 60 days of June 20, 2005, are treated as outstanding only for the purposes of
determining the
  percent owned by this person or group. Percentages in the above table are based on 13,200,000 ordinary shares
  outstanding as of June 20, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(2) | In
  March 2005, FIMGold LP purchased from Formula in a private placement
  2,400,000 ordinary shares. FIMGold LP is owned in equal shares by Dan
  Goldstein, our chief executive officer and chairman of the board, and FIMI
  Opportunity Fund. Concurrently with the closing of the private placement, Dan Goldstein sold to
  FIMGold LP his entire shareholdings in Formula, constituting 2,000,000
  ordinary shares. Following these transactions, FIMGold LP owns 4,400,000 of
  our ordinary shares, representing approximately 33.3% of our outstanding
  share capital. In connection
  with the acquisition by FIMGold LP of Formulas shares, Dan Goldstein,
  through his wholly owned company, Ildani Holdings Ltd., and FIMI Opportunity
  Fund, entered into a shareholders agreement with respect to FIMGold Ltd., the
  general partner of FIMGold LP, pursuant to which each party has the right to
  designate one-half of the members of the board of directors of FIMGold Ltd.
  and each resolution of the board of directors requires the approval of at
  least one member designated by each party, including resolutions relating to
  selling, acquiring and voting Formulas shares held by FIMGold LP.
  Notwithstanding the foregoing, the shareholders agreement provides that each
  party has the right to cause the sale of up to an aggregate of 20% of the
  amount of Formulas shares held by FIMGold LP without the consent of the
  other party. Pursuant to the shareholders agreement, Formulas shares held by
  FIMGold LP will be voted for the election of two nominees of each party to
  our board of directors. In addition, we granted registration rights to
  FIMGold LP in respect of Formulas shares held by it, on customary terms and
  conditions.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(3) | Bank
  Leumi LeIsrael B.M. is publicly traded on the TASE. The major shareholder of
  Bank Leumi is the Government of Israel
  (28.3%). Shlomo Eliahu Holdings Ltd. holds a 10% interest in Bank
  Leumi, Otzar Hityashvut Hayehudim holds a 4.9% interest and Bank Hapoalim
  holds 5.2%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

70

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As
of June 20, 2005, 13,200,000 ordinary shares were issued and outstanding,
excluding 24,780 ordinary shares that we purchased during 2002. At that date,
we had approximately 15 shareholders of record. All
of our ordinary shares have equal voting rights. However, under applicable
Israeli law, the shares we hold have no voting rights and, therefore, are
excluded from the number of our outstanding shares.

As
of June 20, 2005, 462,338 ADSs were issued and outstanding pursuant to a
depositary agreement with The Bank of New York, representing 462,338 of our
ordinary shares. As of that date, there were 18 registered holders of ADSs in
the United States.

B.Related Party
Transactions

Private Placement to FIMGold LP

In
February 2005, the general meeting of shareholders approved a private placement
of 2,400,000 ordinary shares issued to FIMGold LP for an aggregate
consideration of $36 million. FIMGold LP is an entity owned in equal shares by
Dan Goldstein, our chief executive officer and chairman of the board, and FIMI
Opportunity Fund. Prior to the approval by our shareholders, the private
placement was approved by our audit committe and board of directors. The
purchase price per share in the transaction was $15, which was the approximate
closing price per Formulas share on the NASDAQ National Market and the TASE on
December 28, 2004, the date on which an agreement in principal was reached.
Concurrently with the closing of the private placement, Dan Goldstein sold to
FIMGold LP his entire shareholdings in Formula, constituting 2,000,000 ordinary
shares, for an aggregate purchase price of $30 million. Following these
transactions, FIMGold LP owns 4,400,000 of our ordinary shares, representing
approximately 33.3% of our outstanding share capital. In addition, Dan Goldstein
concurrently sold to FIMGold LP all of his 15,500,000 ordinary shares in
Formula Vision for an aggregate purchase price of $17 million.

In
connection with the acquisition by FIMGold LP of Formulas shares, Dan
Goldstein, through his wholly owned company, Ildani Holdings Ltd., and FIMI
Opportunity Fund, entered into a shareholders agreement with respect to FIMGold
Ltd., the general partner of FIMGold LP, pursuant to which each party has the
right to designate one-half of the members of the board of directors of FIMGold
Ltd. and each resolution of the board of directors requires the approval of at
least one member designated by each party, including resolutions relating to
selling, acquiring and voting Formulas shares held by FIMGold LP. Notwithstanding
the foregoing, the shareholders agreement provides that each party has the
right to cause the sale of up to an aggregate of 20% of Formulas shares held
by FIMGold LP without the consent of the other party. Pursuant to the
shareholders agreement, Formulas shares held by FIMGold LP will be voted for
the election of two nominees of each party to our board of directors. In
addition, we granted registration rights to FIMGold LP in respect of Formulas
shares held by it, on customary terms and conditions.

71

---

---



Registration Rights Agreements

In
March 2005, in connection with the private placement of 2,400,000 Formulas
shares issued to FIMGold LP, and the purchase by FIMGold LP of 2,000,000
Formulas shares from Dan Goldstein, Formula granted to FIMGold LP registration
rights with respect to the 4,400,000 shares owned by it. Under the registration
rights agreement entered into between Formula and FIMGold LP, Formula has agreed that at the request of
FIMGold LP, and on no more than two occasions, Formula will file a registration
statement under the Securities Act of 1933, as amended, referred to as the
Securities Act, for an offering of the shares with respect to which
registration is requested. In addition, if Formula otherwise proposes to
register its ordinary shares under the Securities Act, FIMGold LP may request
that Formula register its shares as well, subject to certain limitations.
Formula shall bear all fees and expenses in connection with the registration,
except that FIMGold LP will pay all fees and expenses of its own counsel and
all underwriting discounts and commissions relating to its shares.

In
1997, Formula, Dan Goldstein, Gad Goldstein, Aaron Crystal and an
additional shareholder, referred to collectively as the holders, entered into a
registration rights agreement with BluePhoenix. Under this registration rights
agreement, the holders have certain registration rights with respect to their
BluePhoenix shares. BluePhoenix has agreed that, beginning January 31, 1998, at
the request of the holders of a majority of the shares held by the holders, and
on no more than two occasions, BluePhoenix will file a registration statement
under the Securities Act of 1933, as amended, referred to as the Securities
Act, for an offering of the shares with respect to which registration is
requested. In addition, if BluePhoenix otherwise proposes to register its
ordinary shares under the Securities Act, these holders may request that
BluePhoenix register their shares as well, subject to certain limitations.
BluePhoenix shall bear all fees and expenses in connection with the
registration, except that the holders will pay all fees and expenses of their
own counsel and all underwriting discounts and commissions relating to their
shares. In accordance with this agreement, in May 2004, BluePhoenix included
100,000 BluePhoenix shares held by each of Dan Goldstein, Gad Goldstein and
Aaron Crystal, in a registration statement on Form F-3 filed by BluePhoenix
under the Securities Act. Such registration statement was declared effective in
March 2005.

72

---

---



In
October 2002, Formula and other shareholders of Liraz entered into a
registration rights agreement with BluePhoenix as part of a share exchange
agreement with those shareholders. Under this agreement, BluePhoenix agreed that, until October 12, 2005,
at the request of the holders of at least 20% of the shares issued to Liraz
shareholders under the share exchange agreement, and no more than once, BluePhoenix
will, subject to certain limitations, file a registration statement under the
Securities Act for an offering of their shares with respect to which
registration is requested. In addition, if BluePhoenix otherwise proposes to register its
ordinary shares under the Securities Act, these holders may request that BluePhoenix
registers their shares as well, subject to certain limitations. BluePhoenix
shall bear all expenses in connection with the registration, provided that all underwriting commissions shall be paid by the
holders selling shares with respect to their shares sold. In accordance with this agreement, in May
2004, BluePhoenix included 100,000 BluePhoenix shares held by Arie Kilman, in a
registration statement on Form F-3 filed by BluePhoenix under the Securities
Act. Such registration statement was declared effective in March 2005.

Voting Agreement

Messrs.
Dan Goldstein and Gad Goldstein have entered into voting agreements that
require them to vote the ordinary shares of BluePhoenix held by them as
instructed by Formula. The voting agreements may be terminated by either party
upon a prior notice.

Transactions between Formula and Formula
Vision

In
connection with the exercise by Formula Vision in Novemebr 2001 of an option to
purchase from Formula its entire interest in Formulas privately held
companies, Formula Vision issued to Formula, in December 2001, a series of
5-year debentures of $58.9 million in the aggregate, linked to the Israeli CPI
and bearing interest at an annual rate of 5%. On March 31, 2002, we lent to Formula Vision an
additional $19.4 million in consideration for a series of debentures with
similar terms of the debentures issued in December 2001.

As
part of the agreement related to the exercise of the option by Formula Vision
to purchase from Formula its interest in privately held companies, we also
transferred to Formula Vision our rights and obligations with respect to the
transferred companies under our agreements with each of Shamrock, FIMI and IDB. This series of transactions is considered a related
party transaction
since Dan Goldstein serves as the chairman of the board of directors and the
chief executive officer of Formula and Formula Vision and was at that time, a
controlling shareholder of Formula Vision. In addition, Gad Goldstein serves as
a director of Formula and Formula Vision.

In
January 2004, Formula Vision issued to Formula 38,000,000 shares representing
59.4% of Formula Visions outstanding share capital in exchange for $35 million
of the amount of the debentures. The transaction was approved by Formulas
audit committee and by its board of directors. The price per share reflected
the average closing market price of Formula Visions share on the TASE during
the 30 days preceding the date of approval of the transaction by Formulas
board of directors. In connection with this
transaction, following the receipt by Formula Vision of the opinion of the
Israeli Securities Authority, referred to as the ISA, regarding this
transaction, Formula Vision informed its shareholders that it was the
ISAs opinion that the said transaction
requires the approval of Formulas shareholders with the special majority
required under the Israeli law for approval of related party transactions. In
the absence of such approval, if required,
Formula may revoke the transaction, and may also claim damages from
Formula Vision, without revoking the transaction, provided Formula Vision knew
of Messrs. Goldsteins personal interest in the said transaction and knew, or
should have known, about the absence of such approval. The ISAs opinion was
based on the assumption that Messrs. Goldsteins ability to direct Formulas
activity derives mainly from their substantial holdings in Formula, and as
such, their positions as office holders could not be viewed as unrelated to
their shareholdings.

73

---

---



The
Company is of the view, based on its legal counsels opinion, that at the time
of consummation of the transaction, Messrs. Goldstein did not hold a
controlling interest in Formula under the law.

For
more information about the transaction between Formula and Formula Vision, see
Item 4.A. History and Development of the Company  Capital Expenditures and Divestitures-Restructuring of Our Corporate
Structure.

Indemnification of Office Holders

In
February 2002, we granted to each of our office holders an indemnification
letter, pursuant to which we undertook to indemnify
each office holder in respect of an obligation or expense imposed on the office
holder in respect of an act performed in his or her capacity as an office
holder, provided, however, that the undertaking is limited to categories of
events specified in the indemnification letter and subject to the provisions of
any law, as follows:

| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | ---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (i)  | a financial
  obligation imposed on him or her in favor of another person by a court
  judgment, including a compromise judgment or an arbitrators award approved
  by court; and                                                                                                                                                                                                                                                                              
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | (ii) | reasonable
  litigation expenses including attorneys fees, expended by an office holder
  or charged to the office holder by a court, in a proceeding instituted
  against the office holder by the company or on its behalf or by another
  person, or in a criminal charge from which the office holder was acquitted,
  or in a criminal proceeding in which the office holder was convicted of an
  offense that does not require proof of criminal intent.

The
indemnification described above shall also apply to an obligation or expense
imposed on the office holder in respect of an act performed in his or her
capacity as an office holder or an employee of one of our subsidiaries. Our
undertaking for indemnification is limited to up to 25% of our shareholders
equity as it appears in our latest financial statements known at the date of
indemnification.

Our
undertaking for indemnification shall not apply to a liability incurred as a
result of any of the following:

74

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---



| |       |                                                                                                                                                                                                    
| | ----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (i)   | a breach by
  the office holder of his or her 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;
| |       |                                                                                                                                                                                                    
| | (ii)  | a breach by
  the office holder of his or her duty of care if the breach was done
  intentionally or recklessly;                                                                                   
| |       |                                                                                                                                                                                                    
| | (iii) | any act or
  omission done with the intent to derive an illegal personal benefit; or                                                                                                               
| |       |                                                                                                                                                                                                    
| | (iv)  | any fine
  levied against the office holder.                                                                                                                                                       

We
shall not be required to indemnify an office holder, if the office holder, or
anyone on its behalf, already received payment in respect of a liability
subject to indemnification, under an effective insurance coverage or an
effective indemnification arrangement with a third party, provided, however,
that if such payment made to the office holder does not cover the entire
liability subject to the indemnification, we shall indemnify the office holder
in respect of the difference between the amount paid to the office holder and
the liability subject to the indemnification.

In
light of the recent amendment to the Companies Law adopted in March 2005, we
are considering updating the indemnification letters described above, if
required pursuant to the law.

Office Holders Insurance

We
have obtained an insurance policy covering the Formula Groups directors and
officers liability. Our subsidiaries participate in the premium payments of
the insurance, on a proportional basis. The total premium Formula paid during
2003 was approximately $120,000.

Other
Transactions

From
time to time, in our ordinary course of business, we engage in transactions
with our subsidiaries and affiliates. We believe that these agreements are made
on an arms length basis upon terms and conditions no less favorable to us, our
subsidiaries and affiliates, as we could obtain from unaffiliated third
parties. If we engage with our subsidiaries and affiliates in transactions
which are not in the ordinary course of business, we receive the approvals
required under the Companies Law. These approvals include audit committee
approval, board approval and, in certain circumstances, shareholder approval.
See Item 6.C. Board Practices.

C.      Interests
of Experts and Counsel

Not
applicable.

75

---

---



|        |                      
|------- | ---------------------
|ITEM 8. | FINANCIAL INFORMATION

A.      Consolidated
Statements and Other Financial Information

Financial
Statements

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
involved in any proceedings in which any of our directors, members of our
senior management or any of our affiliates is either a party adverse to us or
to our subsidiaries or has a material interest adverse to us or to our
subsidiaries. We are also not involved in any material legal proceedings,
except as described below.

In
July 2003, a former Liraz shareholder filed an application with the Tel Aviv
Jaffa District Court to approve a claim filed by him against BluePhoenix, as a
class action. The claim relates to the acquisition of Liraz shares, which
BluePhoenix completed in March 2003. The shareholder alleges that the share
price BluePhoenix paid to Lirazs shareholders in the tender offer and in a
subsequent mandatory purchase was lower than the fair price of Liraz shares.
The maximum amount of the claim is approximately $5.8 million in the aggregate.
In the lawsuit, the plaintiff has applied for the courts approval to represent
all of the shareholders of Liraz who sold their shareholdings pursuant to the
tender offer and the mandatory acquisition. No hearing has been scheduled for
this lawsuit. Based on BluePhoenixs analysis of the statement of claim,
including an evaluation of the fair value of the Liraz shares, and the price
paid for Liraz in a previous transaction immediately prior to the tender offer,
we believe that the allegations against BluePhoenix in this proceeding are
without merit and intend to vigorously defend the claim and contest the
allegations made therein.

Dividend
policy

In
August 2001, Formula distributed to its shareholders a dividend in kind of
Formula Visions (formerly known as Mashov) shares held by Formula.

In
May 2005, Formula declared a cash dividend in the amount of approximately $4
per ordinary share, or approximately $53 million in the aggregate, which was
distributed to its shareholders on June 1, 2005.

Under
Formulas new dividend policy adopted recently by its board of directors, sums
that are not planned to be used for investments in the near future, will be
distributed to the shareholders as a cash dividend, to the extent that our
performance allows such distribution.

76

---

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B.      Significant
Changes

In
March 2005, we completed a private placement of 2,400,000 Formula shares for
aggregate consideration of $36 million. The shares were issued to FIMGold LP,
an entity owned in equal shares by Dan Goldstein and FIMI Opportunity Fund.

In
June 2005, we distributed to our shareholders a cash dividend of approximately
$4 per share. The aggregate amount distributed by Formula was approximately $53
million.

Except
as described above and disclosed elsewhere in this annual report, there has
been no material change in our financial position since December 31, 2004.

|        |                      
|------- | ---------------------
|ITEM 9. | THE OFFER AND LISTING

A.      Offer
and Listing Details

Price
Range of Ordinary Shares

The
following table shows the high and low closing price for our ordinary shares on
the TASE, for the periods indicated.
The exchange rate reported by the Bank of Israel on June 20, 2005 was
NIS 4.54 = $1.00.

|                       |  |                           |        |    
|---------------------- |  | ------------------------- | ------ | ---
|Calendar Period        |  | Closing
  Price Per Share |       
|                       |  |                           |        |    
|                       |  | in NIS                    |       
|                       |  | High                      |        | Low
|                       |  |                           |        |    
|                       |  |                           |        |    
|2000                   |  |                           | 355.00 |    
|2001                   |  |                           | 151.30 |    
|2002                   |  |                           | 75.80  |    
|2003                   |  |                           | 79.40  |    
|First Quarter          |  |                           | 41.33  |    
|Second Quarter         |  |                           | 63.90  |    
|Third Quarter          |  |                           | 61.40  |    
|Fourth Quarter         |  |                           | 79.40  |    
|2004                   |  |                           |        |    
|First Quarter          |  |                           | 98.40  |    
|Second Quarter         |  |                           | 94.70  |    
|Third Quarter          |  |                           | 91.07  |    
|Fourth Quarter         |  |                           | 74.77  |    
|2005                   |  |                           |        |    
|First Quarter          |  |                           | 89.65  |    
|January                |  |                           | 84.73  |    
|February               |  |                           | 83.04  |    
|March                  |  |                           | 89.65  |    
|April                  |  |                           | 82.36  |    
|May                    |  |                           | 72.04  |    
|June (through June 20) |  |                           | 64.79  |    

77

---

---



Price
Range of American Depositary Shares

The
following table shows, for the periods indicated, the high and low closing sale
prices for the ADSs, as reported by the Nasdaq National Market.

|                       |  |                           |       |    
|---------------------- |  | ------------------------- | ----- | ---
|Calendar Period        |  | Closing
  Price Per Share |      
|                       |  |                           |       |    
|                       |  | in $                      |      
|                       |  | High                      |       | Low
|                       |  |                           |       |    
|                      
|2000                   |  |                           | 92.19 |    
|2001                   |  |                           | 38.00 |    
|2002                   |  |                           | 16.92 |    
|2003                   |  |                           | 18.05 |    
|First Quarter          |  |                           | 8.75  |    
|Second Quarter         |  |                           | 14.35 |    
|Third Quarter          |  |                           | 14.32 |    
|Fourth Quarter         |  |                           | 18.05 |    
|2004                   |  |                           |       |    
|First Quarter          |  |                           | 22.08 |    
|Second Quarter         |  |                           | 20.61 |    
|Third Quarter          |  |                           | 20.00 |    
|Fourth Quarter         |  |                           | 17.57 |    
|2005                   |  |                           |       |    
|First Quarter          |  |                           | 20.44 |    
|January                |  |                           | 19.20 |    
|February               |  |                           | 19.00 |    
|March                  |  |                           | 20.44 |    
|April                  |  |                           | 18.87 |    
|May                    |  |                           | 22.99 |    
|June (through June 20) |  |                           | 14.62 |    

B.      Plan
of Distribution

Not
applicable.

C.      Markets

Since
our initial public offering in 1991, our ordinary shares have been traded in
Israel on the TASE. No U.S. trading market exists for the ordinary shares.
Since October 1997, our ADSs are traded on the NASDAQ National Market, under
the symbol FORTY.

D.      Selling
Shareholders

Not applicable.

E.      Dilution

Not
applicable.

78

---

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F.      Expenses
of the Issue

Not
applicable.

|         |                       
|-------- | ----------------------
|ITEM 10. | ADDITIONAL INFORMATION

A.      Share
Capital

Not
applicable.

B.      Memorandum
and Articles of Association

We
are registered with the Israeli Companies Register under the number
52-003669-0. Our objects are specified in our memorandum of association. These
objects include:

| |   |                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------
| |  | operating
  within the field of informational and computer systems;                                                                          
| |   |                                                                                                                                              
| |  | providing
  management, consulting and sale services for computers, computer equipment,
  software for computers and for information systems;
| |   |                                                                                                                                              
| |  | the business
  of systems analysis, systems programming and computer programming; and                                                        
| |   |                                                                                                                                              
| |  | establishing
  facilities for instruction and training for computers and digital systems.                                                    

Description
of Our Share Capital

Our
company share capital consists of ordinary shares. Our articles of association
do not 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.

Dividend
and Liquidation Rights

We
may declare a dividend to be paid to the holders of ordinary shares according
to their rights and interests in our profits. We may invest or use for our own
benefit all unclaimed dividends. If dividends remain unclaimed for seven years
from the date we declared the dividend they lapse and revert back to us. Our
board of directors can cause us to pay the dividend to a holder who would have
been entitled if the dividend had not reverted back to us. In case of
liquidation, after satisfying liabilities to creditors, our assets will be
distributed to the holders of ordinary shares in proportion to their holdings.
This right may be affected by the grant of a preferential dividend or
distribution rights to the holders of a class of shares with preferential
rights that may be authorized in the future. Under the Companies Law, the
declaration of a dividend does not require the approval of the shareholders of
the company, unless the companys articles of association require otherwise.
Our articles of association provide that our board of directors may declare and
pay dividends without any further action of our shareholders.

79

---

---



Redemption
provisions

In
accordance with our articles of association, we may issue redeemable shares and
accordingly redeem those shares.

Voting,
Shareholder Meetings and Resolutions

Holders
of our ordinary shares have one vote for each ordinary share held on all
matters submitted to the 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.

We
must hold an annual general meeting once a year with a maximum period of
fifteen months between the meetings. All other meetings of shareholders other
than annual general meetings are considered special general meetings. Our board
of directors may call a special general meeting whenever it decides it is
appropriate. In addition, shareholders representing 5% of the outstanding share
capital may require the board of directors to call a special general meeting.
The quorum required for a general meeting of shareholders consists of two or
more holders present in person or by proxy who hold or represent at least 25%
of the voting power. A meeting adjourned for a 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 meeting may decide with the consent
of the holders of a majority of the voting power represented at the meeting in
person or by proxy and voting on the question of adjournment. At the reconvened
meeting, if a quorum is not present within half an hour from the time appointed
for holding the meeting, the required quorum will consist of two shareholders
present in person or by proxy.

Under
the Companies Law, unless otherwise provided in the articles of association or
applicable law, all resolutions of the shareholders require a simple majority,
except in certain circumstances provided for under the Israeli law, which
require a majority of at least 75% of the shares present at the meeting.

Under
the Companies Law, a shareholder has a duty to act in good faith towards the
company in which he holds shares and towards other shareholders and to refrain
from abusing his power in the company including voting in the general meeting
of shareholders on:

| |   |                                                                                    
| | - | -----------------------------------------------------------------------------------
| |  | any
  amendment to the articles of association                                     
| |   |                                                                                    
| |  | an increase
  of the companys authorized share capital                            
| |   |                                                                                    
| |  | a merger; or                                                                       
| |   |                                                                                    
| |  | approval of
  some of the acts and transactions which require shareholder approval.

A
shareholder has the general duty to refrain from depriving rights of other
shareholders. Any controlling shareholder, any shareholder who knows that it
possesses the power to determine the outcome of a shareholder vote and any
shareholder that, under the provisions of the articles of association, has the
power to appoint an office holder in the company, is under a duty to act in
fairness towards the company. The Companies Law does not describe the substance
of this duty.

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Transfer
of Shares

Fully
paid ordinary shares are issued in registered form and may be freely
transferred under our articles of association unless the transfer is restricted
or prohibited by another instrument.

Modification
of Class Rights

Under
our articles of association, the rights attached to any class unless otherwise
provided by the terms of the class including voting, rights to dividends and
the like, may be varied by adoption of the necessary amendment to the articles
of association, provided that the affected shareholders approve the change by a
class meeting in which a simple majority of the voting power of the class
represented at the meeting and voting on the matter approves the change.

Election
of Directors

Our
ordinary shares do not have cumulative voting rights in the election of
directors. As a result, the holders of ordinary shares that represent more than
50% of the voting power represented at a shareholders meeting have the power to
elect all of our directors, other than the outside directors which are
appointed by a special majority of shareholders. For a summary of those
provisions in our articles of association with respect to the directors, see
Item 6. Directors, Senior Management and Employees.

Anti-Takeover
Provisions; Mergers and Acquisitions under Israeli Law

Mergers

The
Companies Law permits merger transactions if approved by each partys board of
directors and shareholders. In determining whether the required majority has
approved the merger in the event of cross ownership between the merging
companies, namely, if the merging companys shares are held by the other party
to the merger, or by any person holding at least 25% of the means of control of
the other party to the merger, then a vote against the merger by holders of the
majority of the shares present and voting, excluding shares held by the other
party to the merger or by such person, or anyone acting on behalf of either of
them, including any of their affiliates, is sufficient to reject the merger
transaction. In the event that the merger transaction has not been approved by
the special majority described above, the holders of at least 25% of the voting
rights of such company may apply to the court for approval of the merger. The
court may approve the merger if it is found that the merger is fair and
reasonable, taking into account the value of the parties to the merger and the
consideration offered to the shareholders. Upon the request of a creditor of
either party to the proposed merger, the court may delay or prevent the merger.
A merger may not be consummated unless at least 50 days have passed from the
time that a proposal for approval of the merger has been filed with the Israeli
Registrar of Companies and 30 days have passed from the date of the approval of
the shareholders of the merging companies.

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The
Companies Law further provides that the foregoing approval requirements will
not apply to shareholders of a wholly-owned subsidiary in a rollup merger
transaction, or to the shareholders of the acquirer if:

| |   |                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the transaction
  does not involve an amendment to the acquirers memorandum or articles of
  association;                                                                                 
| |   |                                                                                                                                                                                            
| |  | the
  transaction does not contemplate the issuance of more than 25% of the voting
  rights of the acquirer which would result in any shareholder becoming a
  controlling shareholder; and
| |   |                                                                                                                                                                                            
| |  | there is no
  cross ownership of shares of the merging companies, as described above.                                                                                                    

Tender
Offers

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 holder of 25% or more of the voting rights in the
company.  This rule does not apply if
there is already another holder of 25% or more of the voting rights in the
company.  Similarly, the Companies Law
provides that an acquisition of shares in a public company must be made by means
of a tender offer if as a result of the acquisition the purchaser would become
a holder of more than 45% of the voting rights of the company, if there is no
other holder of more than 45% of the voting rights of the company.

The
foregoing provisions do not apply to:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a private placement
  in which the companys shareholders approved such holder owning 25% or more
  of the voting rights in the company (if there is no other shareholder that
  holds 25% or more of the voting rights in the company); or more than 45% of
  the voting rights in the company (if there is no other shareholder that holds
  45% or more of the voting rights in the company); or  
| |   |                                                                                                                                                                                                                                                                                                                                                                                                      
| |  | a purchase
  from an existing holder of 25% or more of the voting rights in the company
  that results in another person becoming a holder of 25% or more of the voting
  rights in the company or a purchase from an existing holder of more than 45%
  of the voting rights in the company that results in another person becoming a
  holder of more than 45% of the voting rights in 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 law in the country in which the shares are traded,
including the rules and regulations of the stock exchange on which the shares
are traded, there is either a limitation on acquisition of any level of control
of the company, or the acquisition of any level of control requires the
purchaser to do so by means of a tender offer to the public.

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The
Companies Law also provides that if following any acquisition of shares, the
acquirer holds 90% or more of the companys shares or of a class of shares, the
acquisition must be made by means of a tender offer for all the target
companys shares or all the shares of the class, as applicable. An acquirer who
wishes to eliminate all minority shareholders must do so by way of a tender
offer and acquire 95% of all shares not held by or for the benefit of the
acquirer before the acquisition. If, however, the tender offer to acquire 95%
is not successful, the acquirer may not acquire shares tendered if by doing so
the acquirer would own more than 90% of the shares of the target company.

C.
      Material Contracts

We
consider the private placement completed in March 2005, and the transactions
with Formula Vision as material contracts. For a summary of the terms of these
contracts, see Item 4.A. Information on the Company  Capital Expenditures and Divestitures.

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 transferred in
non-Israeli currencies at the rate of exchange prevailing at the time of
conversion. We expect therefore, that dividends, if any, that we pay to holders
of ADSs, will be paid in dollars, net of conversion expenses of the depositary,
the Bank of New York and Israeli income taxes. 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. See Item 3.D.
Risk Factors.

Non-residents
of Israel may freely hold and trade our ADSs or ordinary shares pursuant to the
general permit issued under the Israeli Currency Control Law, 1978.  Neither our articles 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.

E.
      Taxation

Israeli
Taxation

The
following is information regarding Israeli tax laws to which U.S. and other
non-Israeli shareholders may be subject.
The information below does not apply to specified persons or cover
specified situations. Therefore, you are advised to consult your own tax
advisor as to particular tax consequences unique to you related to an
investment in our ordinary shares or ADSs, including the effects of applicable
Israeli or foreign or other tax laws and possible changes in the tax laws.

To
the extent that the discussion is based on legislation yet to be judicially or
administratively interpreted, we cannot assure you that the views we express
herein will accord
with any such
interpretation in the future.

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Under
current Israeli law, individual or corporate shareholders (which are not
subject to the provisions of the Inflationary Adjustments Law), selling our
ordinary shares are subject to a 15% tax rate on any capital gain accrued after
January 1, 2003 when certain conditions are met. However, foreign residents are
exempt from capital gains tax on the sale of traded securities of Israeli
companies.  The foregoing does not apply
to companies or individuals which are subject to Chapter II of the Income Tax
(Inflationary Adjustments) Law, 1985. In general, Chapter II of the
Inflationary Adjustments Law applies to all Israeli companies and individuals,
except for those companies which comply with all of the following: (i) they do
not generate any business income; (ii) they do not apply for a deduction of
financing expenses; and (iii) they are held only by individuals.
Notwithstanding the foregoing, dealers in securities in Israel are taxed at
regular tax rates applicable to business income. We obtained a ruling from the
Israeli income tax authorities confirming that capital gains received upon sale
of ADSs will be subject to the same treatment as capital gains received upon
sale of our ordinary shares.

Pursuant
to the convention between the Government of the United States of America and
the Government of Israel with respect to taxes on income (the U.S.-Israel tax
treaty), the sale, exchange or disposition of our ADSs or 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, if apply, 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 in accordance with tax treaties.

Non-residents
of Israel are subject to income tax on passive income accrued or derived from
sources in Israel like dividends, royalties and interest, as well as
non-passive income from services rendered in Israel. On distributions of
dividends other than bonus shares (stock dividends) we should generally
withhold at source income tax at a rate of 25%, unless a different rate applies
under a treaty between Israel and the shareholders country of residence. Under
the U.S.-Israel tax treaty, the maximum tax on dividends paid to a holder of
our ADSs or ordinary shares who is a resident of the United States will be 25%
or 12.5% if certain conditions are met including, interalia, that the holder is
a corporation which holds, directly or indirectly, shares representing 10% or more
of the voting power in our company during the relevant period preceding the
date of payment of the dividend.
However, under the Law for the Encouragement of Capital Investments,
1959 (the Investments Law), dividends generated by an approved enterprise are
taxed at the rate of 15%.

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United
States Federal Income Tax Considerations

Subject
to the limitations described herein, this discussion summarizes the material
United States federal income tax consequences of the purchase, ownership and
disposition of our ordinary shares or ADSs to a United States holder.  A United States holder is a holder of our
ordinary shares or ADSs who is:

| |   |                                                                                                                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an
  individual citizen or resident of the United States;                                                                                                                                                                                                                                                                                                                
| |   |                                                                                                                                                                                                                                                                                                                                                                          
| |  | a
  corporation (or another entity taxable as a corporation for United States
  federal income tax purposes) created or organized under the laws of the
  United States or any political subdivision thereof;                                                                                                                                                            
| |   |                                                                                                                                                                                                                                                                                                                                                                          
| |  | an estate,
  the income of which is subject to United States federal income tax regardless
  of its source; or                                                                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                          
| |  | a trust (i)
  if, in general, a United States court is able to exercise primary supervision
  over its administration and one or more United States persons have the
  authority to control all of its substantial decisions or (ii) that has in
  effect a valid election under applicable United States Treasury regulations
  to be treated as a United States person.

Unless
otherwise specifically indicated, this discussion does not consider the United
States tax consequences to a person that is not a United States holder and
considers only United States holders that will own the ordinary shares or ADSs
as capital assets.

This
discussion is based on current provisions of the Internal Revenue Code of 1986,
as amended, referred to as the Code, current and proposed Treasury regulations
promulgated under the Code and administrative and judicial interpretations of
the Code, all as currently in effect and all of which are subject to change,
possibly with a retroactive effect. This discussion does not address all
aspects of United States federal income taxation that may be relevant to any
particular United States holder based on the United States holders individual
circumstances.  In particular, this
discussion does not address the United States federal income tax consequences
to United States holders who are broker-dealers or who own, directly,
indirectly or constructively, 10% or more of our outstanding voting shares,
United States holders holding the ordinary shares or ADSs as part of a hedging,
straddle or conversion transaction, United States holders whose functional
currency is not the United States dollar, insurance companies, tax-exempt
organizations, financial institutions, persons who acquired their shares upon
the exercise of employees stock options or otherwise as compensation, and
persons subject to the alternative minimum tax, who may be subject to special
rules not discussed below. Additionally, the tax treatment of persons who are,
or hold the ordinary shares or ADSs through, a partnership or other
pass-through entity is not considered, nor is the possible application of
United States federal estate or gift taxes or any aspect of state, local or
non- United States tax laws.

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You
are advised to consult your tax advisor with respect to the specific United
States federal, state, local and foreign income tax consequences to you of
purchasing, holding or disposing of our ordinary shares or ADSs.

Taxation on Distributions on the Ordinary
Shares or ADSs

In
August 2001, Formula distributed to its shareholders a dividend in kind of
Formula Visions shares held by Formula, which was distributed in the form of
cash to holders of our ADRs. In June 2005, Formula distributed a cash dividend
to its shareholders.  If Formula makes
distributions in the future, the amount of the distribution with respect to the
ordinary shares or ADSs will equal the amount of cash and the fair market value
of any property distributed and will also include the amount of any Israeli
taxes withheld, as described above under Israeli Taxation. Subject to the
discussion below under Tax Consequences if We are a Passive Foreign Investment
Company, a distribution paid by us with respect to the ordinary shares or ADSs
to a United States holder will be treated as dividend income to the extent that
the distribution does not exceed our current and accumulated earnings and
profits, as determined for United States federal income tax purposes.  Dividends that are received by United States
holders that are individuals, estates or trusts will be taxed at the rate
applicable to long-term capital gains (a maximum rate of 15%), provided that
such dividends meet the requirements of qualified dividend income. Dividends that fail to meet such
requirements, and dividends received by corporate United States holders, are
taxed at ordinary income rates.  No
dividend received by a United States holder will be a qualified dividend (1) if
the United States holder held the ordinary share or ADS with respect to which
the dividend was paid for less than 61 days during the 121-day period beginning
on the date that is 60 days before the ex-dividend date with respect to such
dividend, excluding for this purpose, under the rules of Code section 246(c),
any period during which the United States holder has an option to sell, is
under a contractual obligation to sell, has made and not closed a short sale
of, is the grantor of a deep-in-the-money or otherwise nonqualified option to
buy, or has otherwise diminished its risk of loss by holding other positions
with respect to, such ordinary share or ADS (or substantially identical
securities); or (2) to the extent that the United States holder is under an
obligation (pursuant to a short sale or otherwise) to make related payments
with respect to positions in property substantially similar or related to the
ordinary share or ADS with respect to which the dividend is paid.  If we were to be a passive foreign
investment company, a foreign personal holding company or a foreign
investment company (as such terms are defined in the Code) for any year,
dividends paid on our ordinary shares or ADSs in such year or in the following
year would not be qualified dividends.
In addition, a non-corporate United States holder will be able to take a
qualified dividend into account in determining its deductible investment
interest (which is generally limited to its net investment income) only if it
elects to do; in such case the dividend will be taxed at ordinary income rates.

The
amount of any distribution which exceeds the amount treated as a dividend will
be treated first as a non-taxable return of capital, reducing the United States
holders tax basis in its ordinary shares or ADSs to the extent thereof, and
then as capital gain from the deemed disposition of the ordinary shares or
ADSs. Corporate holders will not be allowed a deduction for dividends received
in respect of the ordinary shares or ADSs.

Dividends
paid by us in NIS will be included in the income of United States holders at
the dollar amount of the dividend (including any Israeli taxes withheld
therefrom), based upon the spot rate of exchange in effect on the date of the
distribution. United States holders will have a tax basis in NIS for United
States federal income tax purposes equal to that dollar value. Any subsequent
gain or loss in respect of NIS arising from exchange rate fluctuations will
generally be taxable as United States source ordinary income or loss.

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Subject
to the limitations set forth in the Code and the Treasury regulations
thereunder, United States holders may elect to claim as a foreign tax credit
against their United States federal income tax liability the Israeli income tax
withheld from dividends received in respect of the ordinary shares or ADSs. The
limitations on claiming a foreign tax credit include, among others, computation
rules under which foreign tax credits allowable with respect to specific
classes of income cannot exceed the United States federal income taxes
otherwise payable with respect to each such class of income. In this regard,
dividends paid by us will be foreign source passive income for U.S. foreign
tax credit purposes or, in the case of a financial services entity, financial
services income. United States holders that do not elect to claim a foreign
tax credit may instead claim a deduction for the Israeli income tax withheld if
they itemize deductions. The rules relating to foreign tax credits are complex,
and you should consult your tax advisor to determine whether and to what extent
you would be entitled to this credit.  A
United States holder will be denied a foreign tax credit for Israeli income tax
withheld from a dividend received on the ordinary shares or ADSs (i) if the United
States holder has not held the ordinary shares or ADSs for at least 16 days of
the 30-day period beginning on the date which is 15 days before the ex-dividend
date with respect to such dividend or (ii) to the extent the United States
holder is under an obligation to make related payments with respect to
positions in substantially similar or related property.  Any days during which a United States holder
has substantially diminished its risk of loss on the ordinary shares or ADSs
are not counted toward meeting the required 16-day holding period.

Taxation on Disposition of the Ordinary
Shares or ADSs

Subject
to the discussion below under Tax Consequences if We are a Passive Foreign
Investment Company, upon the sale, exchange or other disposition of our
ordinary shares or ADSs, a United States holder will recognize capital gain or
loss in an amount equal to the difference between the amount realized on the
disposition and the United States holders tax basis in the ordinary shares or
ADSs. The gain or loss recognized on the disposition will be long-term capital
gain or loss if the United States holder held the ordinary shares or ADSs for
more than one year at the time of the disposition.  Gain or loss recognized by a United States holder on a sale,
exchange or other disposition of ordinary shares or ADSs will be treated as
U.S. source income or loss for United States foreign tax credit purposes.

A
United States holder that uses the cash method of accounting calculates the
dollar value of the proceeds received on the sale as of the date that the sale
settles. However, a United States
holder that uses the accrual method of accounting is required to calculate the
value of the proceeds of the sale as of the trade date and may therefore
realize foreign currency gain or loss.
A United States holder may avoid realizing foreign currency gain or loss
by electing to use the settlement date to determine the proceeds of sale for
purposes of calculating the foreign currency gain or loss.  In addition, a United States holder that
receives foreign currency upon disposition of ordinary shares or ADSs and
converts the foreign currency into dollars after the settlement date or trade
date (whichever date the United States holder is required to use to calculate
the value of the proceeds of sale) will have foreign exchange gain or loss
based on any appreciation or depreciation in the value of the foreign currency
against the dollar, which will generally be United States source ordinary
income or loss.

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Tax Consequences if We are a Passive Foreign
Investment Company

We
will be a passive foreign investment company, or PFIC, for a taxable year if
either (1) 75% or more of our gross income in the taxable year is passive
income; or (2) 50% or more of the value, determined on the basis of a quarterly
average, of our assets in the taxable year produce, or are held for the
production of, passive income. If we own (directly or indirectly) at least 25%
by value of the stock of another corporation, we will be treated for purposes
of the foregoing tests as owning our proportionate share of the other
corporations assets and as directly earning our proportionate share of the
other corporations income. If we are a PFIC, a United States holder must determine
under which of three alternative taxing regimes it wishes to be taxed:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The QEF
  regime applies if the United States holder elects to treat us as a qualified electing fund (QEF) for
the
  first taxable year in which the United States holder owns our ordinary shares
  or ADSs or in which we are a PFIC, whichever is later, and if we comply with
  certain reporting requirements.  If
  the QEF regime applies, then each year that we are a PFIC such United States
  holder will include in its gross income a proportionate share of the our
  ordinary earnings (which is taxed as ordinary income) and net capital gain
  (which is taxed as long-term capital gain), subject to a separate election to
  defer payment of taxes, which deferral is subject to an interest charge.  These amounts would be included in income
  by an electing United States holder for its taxable year in which our taxable
  year ends, whether or not such amounts are actually distributed to the United
  States holder.  A United States
  holders basis in our ordinary shares or ADSs for which a QEF election has
  been made would be increased to reflect the amount of any taxed but
  undistributed income.  Generally, a
  QEF election allows an electing United States holder to treat any gain
  realized on the disposition of his ordinary shares or ADSs as capital gain.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |   | Once made,
  the QEF election applies to all subsequent taxable years of the United States
  holder in which it holds our ordinary shares or ADSs and for which we are a
  PFIC, and can be revoked only with the consent of the Internal Revenue
  Service.  The QEF election is made by
  attaching a completed Internal Revenue Service Form 8621, including the PFIC
  annual information statement, to a timely filed United States federal income
  tax return.  Even if a QEF election is
  not made, a U.S. person who is a shareholder in a PFIC must file a completed
  Internal Revenue Service Form 8621 every year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |   | If a QEF
  election is made after the first taxable year in which a United States holder
  holds our ordinary shares or ADSs and we are a PFIC, then special rules would
  apply.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | A second
  regime, the mark-to-market regime, may be elected so long as our ordinary
  shares or ADSs are publicly traded.
  Pursuant to this regime, an electing United States holders ordinary
  shares or ADSs are marked-to-market each year and the United States holder
  recognizes as ordinary income or loss an amount equal to the difference as of
  the close of the taxable year between the fair market value of our ordinary
  shares or ADSs and the United States holders adjusted tax basis
  therein.  Losses are allowed only to
  the extent of net mark-to-market gain previously included by the United
  States holder under the election for prior taxable years.  An electing United States holders
  adjusted basis in
  our ordinary
  shares or ADSs is increased by income recognized under the mark-to-market
  election and decreased by the deductions allowed under the election.                                                                                                                                                                                                                                                                                                                                                                                                    

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| |  
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |   | Under the
  mark-to-market election, gain on the sale of our ordinary shares or ADSs is
  treated as ordinary income, and loss on the sale of our ordinary shares or
  ADSs, to the extent the amount of loss does not exceed the net mark-to-market
  gain previously included, is treated as ordinary loss.  The mark-to-market election applies to the
  tax year for which the election is made and all later tax years, unless the
  ordinary shares or ADSs cease to be marketable or the Internal Revenue
  Service consents to the revocation of the election.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |   | If the
  mark-to-market election is made after the first taxable year in which a
  United States holder holds our ordinary shares or ADSs and we are a PFIC,
  then special rules would apply.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | A United
  States holder making neither the QEF election nor the mark-to-market election
  is subject to the excess distribution regime.  Under this regime, excess distributions are subject to
  special tax rules.  An excess
  distribution is either (1) a distribution with respect to ordinary shares or
  ADSs that is greater than 125% of the average distributions received by the
  United States holder from us over the shorter of either the preceding three
  years or such United States holders holding period for our ordinary shares
  or ADSs, or (2) 100% of the gain from the disposition of our ordinary shares
  or ADSs (including gain deemed recognized if the ordinary shares or ADSs are
  used as security for a loan).                                                                                                                                                                                                                                                                                                                
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |   | Excess
  distributions must be allocated ratably to each day that a United States
  holder has held our ordinary shares or ADSs.
  A United States holder must include amounts allocated to the current
  taxable year and to any period prior to the first day of the first taxable
  year for which we are a PFIC in its gross income as ordinary income for the
  current taxable year.  All amounts
  allocated to other years of the United States holder would be taxed at the
  highest tax rate for each such prior year applicable to ordinary income.  The United States holder also would be
  liable for interest on the deferred tax liability for each such other year
  calculated as if such liability had been due with respect to each such other
  year.  A United States holder that is
  an individual is not allowed a deduction for interest on the deferred tax
  liability.  The portions of
  distributions that are not characterized as excess distributions are
  subject to tax in the current year under the normal tax rules of the Code.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |   | A United
  States person who inherits shares or ADSs in a foreign corporation that was a
  PFIC in the hands of the decedent (who was not a non resident alien and did
  not make either of the elections described above), is denied the otherwise
  available step-up in the tax basis of such shares or ADSs to fair market
  value at the date of death.  The U.S.
  person steps into the shoes of the decedent and will be subject to the rules
  described above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

89

---

---



We
believe that in 2004 we were not a PFIC and currently we expect that we will
not be a PFIC in 2005.  However, PFIC
status is determined as of the end of the taxable year and is dependent on a
number of factors, including the value of our assets and the amount and type of

our gross
income.  Therefore, there can be no
assurance that we will not become a PFIC for the current fiscal year ending
December 31, 2005 or in a future year.
We will notify United States holders in the event we conclude that we
will be treated as a PFIC for any taxable year to enable United States holders
to consider whether or not to elect to treat us as a QEF for United States
federal income tax purposes or to mark to market the ordinary shares or ADSs
or to become subject to the excess distribution regime.

United
States holders are urged to consult their tax advisors regarding the
application of the PFIC rules, including eligibility for and the manner and
advisability of making, the QEF election or the mark-to-market election.

Information Reporting and Backup
Withholding

A
United States holder generally is subject to information reporting and may be
subject to backup withholding at rate of up to 28% with respect to dividend
payments and receipt of the proceeds from the disposition of the ordinary
shares or ADSs. Backup withholding will not apply with respect to payments made
to exempt recipients, including corporations and tax-exempt organizations, or
if a United States holder provides a correct taxpayer identification number (or
certifies that he has applied for a taxpayer identification number), certifies
that such holder is not subject to backup withholding or otherwise establishes
an exemption. Backup withholding is not an additional tax and may be claimed as
a credit against the United States federal income tax liability of a United
States holder, or alternatively, the United States holder may be eligible for a
refund of any excess amounts withheld under the backup withholding rules, in
either case, provided that the required information is furnished to the
Internal Revenue Service.

Non-United States holders of Ordinary Shares
or ADSs

Except
as provided below, a non-United States holder of ordinary shares or ADSs
(except certain former United States citizens and long-term residents of the
United States) will not be subject to United States federal income or
withholding tax on the receipt of dividends on, and the proceeds from the
disposition of, an ordinary share or ADS, unless that item is effectively
connected with the conduct by the non-United States holder of a trade or
business in the United States and, in the case of a resident of a country which
has an income tax treaty with the United States, that item is attributable to a
permanent establishment in the United States or, in the case of an individual,
a fixed place of business in the United States. In addition, gain recognized by
an individual non-United States holder will be subject to tax in the United
States if the non-United States holder is present in the United States for 183
days or more in the taxable year of the sale and other conditions are met.

Non-United
States holders will not be subject to information reporting or backup withholding
with respect to the payment of dividends on ordinary shares or ADSs unless the
payment is made through a paying agent, or an office of a paying agent, in the
United States. Non-United States holders will be subject to information
reporting and backup withholding at a rate of up to 28% with respect to the
payment within the United States of dividends on the ordinary shares or ADSs
unless the holder provides its taxpayer identification number, certifies to its
foreign status, or otherwise establishes an exemption.

90

---

---



Non-United
States holders will be subject to information reporting and backup withholding
at a rate of up to 28% on the receipt of the proceeds from the disposition of
the ordinary shares or ADSs to, or through, the United States office of a
broker, whether domestic or foreign, unless the holder provides a taxpayer
identification number, certifies to its foreign status or otherwise establishes
an exemption. Non-United States holders will not be subject to information reporting
or backup withholding with respect to the receipt of proceeds from the
disposition of the ordinary shares or ADSs by a foreign office of a broker;
provided, however, that if the broker is a U.S. person or a U.S. related
person, information reporting (but not backup withholding) will apply unless
the broker has documentary evidence in its records of the non-United States
holders foreign status or the non-United States holder certifies to its
foreign status under penalties of perjury or otherwise establishes an
exemption. For this purpose, a U.S. related person is a broker or other
intermediary that maintains one or more enumerated U.S. relationships. Backup
withholding is not an additional tax and may be claimed as a credit against the
United States federal income tax liability of a non-United States holder, or
alternatively, the non-United States holder may be eligible for a refund of any
excess amounts withheld under the backup withholding rules, in either case,
provided that the required information is furnished to the Internal Revenue
Service.

F.
      Dividend and Paying Agents

Not
applicable.

G.     Statement by Experts

Not
applicable.

H.     Documents On Display

Formula
files annual and submits special reports and other information with the SEC.
You may inspect and copy such material at the public reference facilities
maintained by the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549. You may
also obtain copies of such material from the SEC at prescribed rates by writing
to the Public Reference Section of the SEC, 450 Fifth Street, N.W., Washington,
D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on
the public reference room.

The
SEC maintains an Internet website at http://www.sec.gov that contains reports
and other material that are filed through the SECs Electronic Data Gathering,
Analysis and Retrieval (EDGAR) system. Formula began filing through the EDGAR
system beginning in October 2002.

Formulas
ADSs are quoted on the NASDAQ National Market. You may inspect reports and
other information concerning Formula at the offices of the National Association
of Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006.

91

---

---



Information
about Formula is also available on its website at
http://www.formulasystems.com. Such information on our website is not part of
this annual report.

As
a foreign private issuer, Formula is exempt from the rules under the Exchange
Act prescribing the furnishing and content of proxy statements, and Formulas
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, Formula is 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.

I.        Subsidiary
Information

Not
applicable.

|         |                                                            
|-------- | -----------------------------------------------------------
|ITEM 11. | QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISKS

Currency Exchange Rate Fluctuations and
Impact of Inflation

In
light of the nature of Formulas activities, Formula invests its cash and cash
equivalents in short term deposits. As of December 31, 2004, Formula invested
substantially all of the cash it held in dollar accounts bearing interest based
on LIBOR and in NIS accounts bearing interest based on the Israeli prime rate.
In addition, Formula has outstanding short-term and long-term loans in NIS. In
May 2002, Formula issued debentures to the public. We repaid these debentures
in accordance with their terms, on June 20, 2005. Principal and interest on
those debentures were linked to the Israeli CPI.

An
increase in value of the NIS against the dollar (after taking into account the
rate of inflation or deflation in Israel) may have a negative impact on our
operating results and financial condition. In particular, our finance expenses
may increase. Depending upon the circumstances, we will consider entering into
currency hedging transactions to decrease the risk of financial exposure from
fluctuations in the exchange rate of the dollar against the NIS. There can be
no assurance that these activities, or others that we may use from time to
time, will eliminate the negative financial impact of currency fluctuations and
inflation.

We
do not engage in currency speculation. Generally, we do not hold nor have we
issued, to any material extent, any derivatives or other financial instruments
for trading purposes.

Fluctuations in Market Price of Securities We
Hold

We
hold securities of several publicly traded companies on the Nasdaq National Market
and the TASE. These companies include Magic, BluePhoenix, Matrix, Sapiens and
Formula Vision. We consider these holdings as long-term holdings. We are
exposed to the risk of fluctuation of the price of these companies securities.
All of these publicly traded companies have experienced significant historical
volatility in their stock prices. Fluctuations in the market price of our
holdings in these companies may result in the fluctuation of the value of our
assets. We typically do not attempt to reduce or eliminate our market exposure
on these securities.

92

---

---



|         |                                                        
|-------- | -------------------------------------------------------
|ITEM 12. | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.

Not
applicable.

P A R T II

|         |                                                 
|-------- | ------------------------------------------------
|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

(a)
Disclosure Controls and Procedures.
We have carried out an evaluation, as of the end of our fiscal year, under the
supervision and with the participation of our management, including our chief
executive officer and chief financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based upon that
evaluation, the chief executive officer and chief financial officer concluded
that our disclosure controls and procedures are effective as of our fiscal year
end to ensure that information required to be disclosed by us in reports that
we file or submit under the Securities Exchange Act of 1934 was recorded,
processed, summarized and reported within the time periods specified in the
Securities Exchange Commission rules and forms.

(b)
Not applicable.

(c)
Not applicable.

(d)
Changes in Internal Control Over Financial
Reporting. There have been no significant changes in our internal
controls over financial reporting that occured during the the year ended
December 31, 2004, that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.

|         |           
|-------- | ----------
|ITEM 16. | [RESERVED]

93

---

---



|          |                                 
|--------- | --------------------------------
|ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT

Our
board of directors has agreed that Mr. Shlomo Nass, a member of our audit
committee and an independent member of our board of directors pursuant to the
Nasdaq requirements, is an audit committee financial expert, as defined by
applicable SEC regulations.

|          |               
|--------- | --------------
|ITEM 16B. | CODE OF ETHICS

Formula
has adopted a code of business conduct and ethics applicable to its executive
officers, directors and all other employees. A copy of the code is available to
all Formulas employees, investors and others upon request to the following
address: Formula Systems (1985) Ltd., 3 Abba Eban Boulevard, Herzliya 46725,
Israel, Attn: General Counsel. Any waiver of this code for executive officers
or directors will be disclosed through the filing of a Form 6-K.

|          |                                       
|--------- | --------------------------------------
|ITEM 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES

Policy on
Pre-Approval of Audit and Non-Audit Services of Independent Auditors

Our
audit committee is responsible for the oversight of our independent auditors
work. The audit committees policy is to pre-approve all audit and non-audit
services provided by Ziv Haft certified public accountants (Isr.) BDO member
firm. These services may include audit services, audit-related services, tax
services and other services, as further described below. The audit committee
sets forth the basis for its pre-approval in detail, listing the particular
services or categories of services which are pre-approved, and setting forth a
specific budget for such services. Additional services may be pre-approved by
the audit committee on an individual basis. Once services have been
pre-approved, Ziv Haft certified public accountants (Isr.) BDO member firm and
our management then report to the audit committee on a periodic basis regarding
the extent of services actually provided in accordance with the applicable
pre-approval, and regarding the fees for the services performed.

Principal Accountant
Fees and Services

The Company
paid the following fees for professional services rendered by Ziv Haft
certified public accountants (Isr.) BDO member firm, for the years ended
December 31:

| |                    |  |                    |     |      |  |     | 
| | ------------------ |  | ------------------ | --- | ---- |  | --- | 
| |                    |  | 2004               |     | 2003 | 
| |                    |  |                    |     |      | 
| |                    |  | ($ in
  thousands) |    
| | Audit Fees         |  |                    | 723 |      |  | 825 | 
| | Audit-Related Fees |  |                    | 120 |      |  | 88  | 
| | Tax Fees           |  |                    | 92  |      |  | 79  | 
| | All Other Fees     |  |                    |    |      |  |    | 
| |                    |  |                    |     |      |  |     | 
| | Total              |  |                    | 935 |      |  | 972 | 

The
audit fees for the years ended December 31, 2004 and 2003 were for professional
services rendered for the audits of our annual consolidated financial
statements, review of our consolidated quarterly financial statements,
statutory audits of Formula and certain subsidiaries, issuance of comfort letters,
consents and assistance with review of documents filed with the SEC.

94

---

---



The
audit-related fees for the years ended December 31, 2004 and 2003 were incurred
by one of our subsidiaries for assurance and related services related to
accounting consultations and audits in connection with acquisitions, issuance
of convertible debentures and related warrants and review of a registration
statement by the SEC.

Tax
fees for the years ended December 31, 2004 and 2003 were for services related
to tax compliance, including the preparation of tax returns and claims for
refund, and tax advice.

|          |                                                           
|--------- | ----------------------------------------------------------
|ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

Not
applicable.

|          |                                                                       
|--------- | ----------------------------------------------------------------------
|ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

Not
applicable.

95

---

---



P A R T III

|         |                     
|-------- | --------------------
|ITEM 17. | FINANCIAL STATEMENTS

We
have responded to Item 18 in lieu of this item.

|         |                     
|-------- | --------------------
|ITEM 18. | FINANCIAL STATEMENTS

The
financial statements required by this item are found at the end of this annual
report, beginning on page F1.

|         |         
|-------- | --------
|ITEM 19. | EXHIBITS

|              |  |                                                                                                                                                                      | 
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
|Exhibit
  No. |  |                                                                                                                                                                     
|              |  |                                                                                                                                                                      | 
|1.1           |  | Memorandum of Association*                                                                                                                                          
|              |  |                                                                                                                                                                     
|1.2           |  | Articles of Association as amended on January 7, 2001**                                                                                                             
|              |  |                                                                                                                                                                     
|2             |  | The description of terms of debentures issued by the Registrant
in May
  2002, contained in Section 2.3 of the prospectus of the Registrant dated May
  23, 2002 ***
|              |  |                                                                                                                                                                     
|4.1           |  | Agreement dated October 1, 1999 between the Registrant and
Shamrock
  Holdings of California Inc.****                                                               
|              |  |                                                                                                                                                                     
|4.2           |  | Agreement dated January 24, 2001 among the Registrant, Sapiens
  International Corporation N.V. and Yarnfield International Limited**                               
|              |  |                                                                                                                                                                     
|4.3           |  | Amendment to the agreement among the Registrant, Sapiens
  International Corporation N.V. and Yarnfield International Limited, dated
  October 20, 2002*****        
|              |  |                                                                                                                                                                     
|4.4           |  | Agreement dated December 30, 2001 between the Registrant and
Formula
  Vision Technologies (F.V.T.) Ltd. (English summary accompanied by Hebrew
  original)******   
|              |  |                                                                                                                                                                     
|4.5           |  | Agreement dated December 15, 2003 between the Registrant and
Formula
  Vision Technologies (F.V.T.) Ltd. *****                                                      
|              |  |                                                                                                                                                                     
|4.6           |  | Share Purchase Agreement dated February 16, 2005 between the
  Registrant and FIMGold LP                                                                            
|              |  |                                                                                                                                                                     
|4.7           |  | Registration Rights Agreement dated March 3, 2005 between the
  Registrant and FIMGold LP                                                                           
|              |  |                                                                                                                                                                     
|4.8           |  | Form of the 1997 Share Option Plan (English translation from
Hebrew
  original)*                                                                                    
|              |  |                                                                                                                                                                     
|4.9           |  | Form of the 2000 Share Option Plan (English translation from
Hebrew
  original)**                                                                                   
|              |  |                                                                                                                                                                     
|4.10          |  | Letter of Indemnification, dated February 14, 2002******                                                                                                            
|              |  |                                                                                                                                                                     
|8             |  | List of Subsidiaries                                                                                                                                                
|              |  |                                                                                                                                                                     
|12.1          |  | Certification of the Chief Executive Officer pursuant to
§302 of the
  Sarbanes-Oxley Act                                                                           
|              |  |                                                                                                                                                                     
|12.2          |  | Certification of the Principal Financial Officer pursuant to
§302 of
  the Sarbanes-Oxley Act                                                                       
|              |  |                                                                                                                                                                     
|13.1          |  | Certification of the Chief Executive Officer pursuant to 18 U.S.C.
  sec. 1350, as adopted pursuant to sec. 906 of the Sarbanes-Oxley Act                           
|              |  |                                                                                                                                                                     
|13.2          |  | Certification of the Principal Financial Officer pursuant to 18
  U.S.C. sec. 1350, as adopted pursuant to sec. 906 of the Sarbanes-Oxley Act                       

|                                                                                                                                        
|----------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                        
|* Incorporated by reference
  to the Registration Statement on Form F-1 (File No. 333- 8858).                                           
|** Incorporated by reference to the Annual Report on Form 20-F
filed
  with the Securities and Exchange Commission on June 29, 2001.    
|*** Incorporated by reference to the Form 6-K filed with the
  Securities and Exchange Commission on June 14, 2002.                     
|**** Incorporated by reference to the Annual Report on Form 20-F
  filed with the Securities and Exchange Commission on June 21, 2000.  
|***** Incorporated by reference to the Annual Report on Form 20-F
  filed with the Securities and Exchange Commission on June 30, 2004. 
|****** Incorporated by reference to the Annual Report on Form 20-F
  filed with the Securities and Exchange Commission on June 28, 2002.

96

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli corporation)

2004 Annual Report

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

2004 CONSOLIDATED FINANCIAL STATEMENTS

TABLE OF CONTENTS

|                                                         |     
|-------------------------------------------------------- | ----
|                                                         | Page
|                                                         |     
|REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM: | F1 
|                                                         |     
|CONSOLIDATED
  FINANCIAL STATEMENTS:                     |     
|                                                         |     
|Balance Sheets                                           | F2 
|                                                         |     
|Statements of
Operations                                 | F4 
|                                                         |     
|Statements of Changes in
Shareholders
  Equity          | F5 
|                                                         |     
|Statements of Cash
Flows                                 | F6 
|                                                         |     
|Notes to Financial
Statements                            | F10

The amounts are stated in U.S. dollars ($).

---

---



Report of Independent Registered Public
Accounting Firm
To the Shareholders and Board of Directors ofFORMULA SYSTEMS (1985) LTD.

We have
audited the consolidated balance sheets of Formula Systems (1985) Ltd. and its
subsidiaries (the Company) as of December 31, 2004 and 2003 and the
consolidated statements of operations, changes in shareholders equity and cash
flows for each of the three years in the period ended December 31, 2004. These
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We did not
audit the financial statements of certain subsidiaries, whose consolidated
assets constitute approximately 26.86% and 28.44% of total consolidated assets
as of December 31, 2004 and 2003, respectively, and whose consolidated revenues
constitute approximately 28.58%, 31.82% and 21.82% of total consolidated
revenues for the years ended December 31, 2004, 2003 and 2002, respectively. We
did not audit the financial statements of certain affiliated companies, the
Companys investment in which, as reflected in the balance sheets of December
31, 2004 is $18.4 million, and the Companys share in losses of which is
$1.4 million. The financial statements
of those subsidiaries were audited by other auditors, whose reports have been
furnished to us, and our opinion, insofar as it relates to the amounts included
in respect of those subsidiaries is based solely on the reports of the other
auditors.

We conducted
our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting.

Our audits
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Companys internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

In our
opinion, based on our audits and the reports of other auditors, the
consolidated financial statements present fairly, in all material respects, the
consolidated financial position of the Company as of December 31, 2004 and
2003, and the related consolidated results of operations and cash flows for
each of the three years in the period ended December 31, 2004, in conformity
with generally accepted accounting principles as applied in the United States
of America.

Tel-Aviv,
Israel
June 28, 2005

| |                                    
| | -----------------------------------
| | Ziv Haft                           
| | Certified Public Accountants (Isr.)
| | BDO member firm                    

F1

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED BALANCE SHEETS

|                                                                                                                               |  |                         |         |      |  |         |  
|------------------------------------------------------------------------------------------------------------------------------ |  | ----------------------- | ------- | ---- |  | ------- | -
|                                                                                                                               |  | December
  31,          |        
|                                                                                                                               |  |                         |        
|                                                                                                                               |  | 2004                    |         | 2003 | 
|                                                                                                                               |  |                         |         |      | 
|                                                                                                                               |  | (U.S. $ in
  thousands) |        
|                                                                                                                               |  |                         |        
|                                                                                                                              
|ASSETS                                                                                                                         |  |                         |         |      |  |         |  
|CURRENT ASSETS:                                                                                                                |  |                         |         |      |  |         |  
|Cash and cash equivalents                                                                                                      |  |                         | 107,174 |      |  | 93,456  |  
|Short-term investments (Note 3)                                                                                                |  |                         | 39,073  |      |  | 8,773   |  
|Trade receivables (net of allowances for
doubtful debts of $5,988 and
  $5,365 as of December 31, 2004 and 2003, respectively) |  |                         | 114,533 |      |  | 93,298  |  
|Other current assets (Note 17A)                                                                                                |  |                         | 26,105  |      |  | 18,846  |  
|Inventories                                                                                                                    |  |                         | 4,668   |      |  | 2,635   |  
|                                                                                                                               |  |                         |         |      |  |         |  
|                                                                                                                               |  |                         | 291,553 |      |  | 217,008 |  
|                                                                                                                               |  |                         |         |      |  |         |  
|                                                                                                                               |  |                         |         |      |  |         |  
|LONG-TERM
  INVESTMENTS, LOANS AND RECEIVABLES:                                                                                |  |                         |         |      |  |         |  
|Loans and other investments (Note 4)                                                                                           |  |                         | 5,247   |      |  | 3,092   | *
|Investments in affiliates (Note 5)                                                                                             |  |                         | 24,389  |      |  | 3,373   |  
|                                                                                                                               |  |                         |         |      |  |         |  
|                                                                                                                               |  |                         | 29,636  |      |  | 6,465   |  
|                                                                                                                               |  |                         |         |      |  |         |  
|                                                                                                                               |  |                         |         |      |  |         |  
|DEBENTURES (Note 2B)                                                                                                           |  |                         |        |      |  | 80,246  |  
|                                                                                                                               |  |                         |         |      |  |         |  
|                                                                                                                               |  |                         |         |      |  |         |  
|SEVERANCE
  PAY FUND                                                                                                           |  |                         | 31,943  |      |  | 26,226  | *
|                                                                                                                               |  |                         |         |      |  |         |  
|                                                                                                                               |  |                         |         |      |  |         |  
|PROPERTY
  AND EQUIPMENT, NET (Note 6)                                                                                         |  |                         | 26,529  |      |  | 25,756  |  
|                                                                                                                               |  |                         |         |      |  |         |  
|                                                                                                                               |  |                         |         |      |  |         |  
|GOODWILL (Note 1J and Note 7)                                                                                                  |  |                         | 196,921 |      |  | 142,214 | *
|                                                                                                                               |  |                         |         |      |  |         |  
|                                                                                                                               |  |                         |         |      |  |         |  
|                                                                                                                               |  |                         |         |      |  |         |  
|OTHER
  ASSETS, NET (Note 8)                                                                                                   |  |                         | 64,438  |      |  | 46,113  | *
|                                                                                                                               |  |                         |         |      |  |         |  
|                                                                                                                               |  |                         |         |      |  |         |  
|                                                                                                                               |  |                         |         |      |  |         |  
|                                                                                                                               |  |                         | 641,020 |      |  | 544,028 |  
|                                                                                                                               |  |                         |         |      |  |         |  

F2

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)

|                                                                                                                                                                           |  |                         |         |      |  |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ------- | -
|                                                                                                                                                                           |  | December
  31,          |        
|                                                                                                                                                                           |  |                         |        
|                                                                                                                                                                           |  | 2004                    |         | 2003 | 
|                                                                                                                                                                           |  |                         |         |      | 
|                                                                                                                                                                           |  | (U.S. $ in
  thousands) |        
|                                                                                                                                                                           |  |                         |        
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                       |  |                         |         |      |  |         |  
|CURRENT LIABILITIES:                                                                                                                                                       |  |                         |         |      |  |         |  
|Liabilities to banks and others (Notes 10 and
17B)                                                                                                                         |  |                         | 104,975 |      |  | 66,543  | *
|Trade payables                                                                                                                                                             |  |                         | 41,605  |      |  | 31,327  |  
|Other accounts payable (Note 17C)                                                                                                                                          |  |                         | 81,105  |      |  | 71,092  |  
|Debentures (Note 9)                                                                                                                                                        |  |                         | 32,374  |      |  | 15,340  | *
|Customer advances, net of work in
progress                                                                                                                                 |  |                         | 6,900   |      |  |        |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|                                                                                                                                                                           |  |                         | 266,959 |      |  | 184,302 |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|LONG-TERM
  LIABILITIES:                                                                                                                                                   |  |                         |         |      |  |         |  
|Debentures (Note 11)                                                                                                                                                       |  |                         | 27,086  |      |  | 50,983  |  
|Provision for losses in formerly owned
investee                                                                                                                            |  |                         | 1,971   |      |  | 1,971   |  
|Deferred taxes                                                                                                                                                             |  |                         | 958     |      |  | 942     |  
|Customer advances                                                                                                                                                          |  |                         | 1,114   |      |  | 2,312   |  
|Liabilities to banks and others (Note
10)                                                                                                                                  |  |                         | 19,789  |      |  | 21,900  |  
|Liability in respect of the acquisition of
activities                                                                                                                      |  |                         | 2,036   |      |  | 2,149   |  
|Accrued severance pay                                                                                                                                                      |  |                         | 37,750  |      |  | 30,755  | *
|Unrealized gains (Note 13)                                                                                                                                                 |  |                         |        |      |  | 4,459   |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|                                                                                                                                                                           |  |                         | 90,704  |      |  | 115,471 |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|MINORITY
  INTEREST                                                                                                                                                        |  |                         | 96,579  |      |  | 68,251  |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|COMMITMENTS
  AND CONTINGENCIES (Note 14)                                                                                                                                  |  |                         |         |      |  |         |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|SHAREHOLDERS
  EQUITY (Note 15):                                                                                                                                          |  |                         |         |      |  |         |  
|Share capital  ordinary shares of NIS 1 par
value (authorized  December 31, 2004 and 2003  25,000,000 shares; issued: December 31, 2004 and
  2003  10,824,780 shares) |  |                         | 3,215   |      |  | 3,215   |  
|Additional paid-in capital                                                                                                                                                 |  |                         | 99,535  |      |  | 99,275  |  
|Retained earnings                                                                                                                                                          |  |                         | 99,166  |      |  | 91,067  |  
|Accumulated other comprehensive loss                                                                                                                                       |  |                         | (14,879 | )    |  | (17,294 | )
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|                                                                                                                                                                           |  |                         | 187,037 |      |  | 176,263 |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|Cost of 24,780 treasury shares                                                                                                                                             |  |                         | (259    | )    |  | (259    | )
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|Total shareholders equity                                                                                                                                                 |  |                         | 186,778 |      |  | 176,004 |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  
|                                                                                                                                                                           |  |                         | 641,020 |      |  | 544,028 |  
|                                                                                                                                                                           |  |                         |         |      |  |         |  

*
Reclassified.

The accompanying notes form an integral part
of the financial statements.

F3

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|------------------------------------------------------------- |  | ------------------------------------------------- | ------- | ---- |  | ------- | - |  | ------- | -
|                                                              |  | Year ended
  December 31,                         |        
|                                                              |  |                                                   |        
|                                                              |  | 2004                                              |         | 2003 |  | 2002    |  
|                                                              |  |                                                   |         |      |  |         |  
|                                                              |  | (U.S. $ in
  thousands, except per share amounts) |        
|                                                              |  |                                                   |        
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|Revenues
  (Note 17I(2))                                      |  |                                                   | 456,610 |      |  | 366,830 |   |  | 283,310 |  
|Cost of
  revenues                                            |  |                                                   | 284,961 |      |  | 230,500 |   |  | 186,908 |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|Gross profit                                                  |  |                                                   | 171,649 |      |  | 136,330 |   |  | 96,402  |  
|Research and
  development costs, net                         |  |                                                   | 25,036  |      |  | 17,368  |   |  | 15,967  |  
|Selling,
  general and administrative expenses                |  |                                                   | 128,537 |      |  | 107,103 |   |  | 85,292  |  
|Restructuring
  and non-recurring costs (Note 17D)            |  |                                                   |        |      |  |        |   |  | 1,829   |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|Operating income (loss)                                       |  |                                                   | 18,076  |      |  | 11,859  |   |  | (6,686  | )
|Financial
  (expenses) income, net (Note 17E)                 |  |                                                   | (8,904  | )    |  | (3,676  | ) |  | 3,605   |  
|Gain on
  realization of shareholdings, net (Note 17G)        |  |                                                   | 8,893   |      |  | 2,756   |   |  | 4,668   |  
|Other
  expenses, net (Note 17F)                              |  |                                                   | (332    | )    |  | (90     | ) |  | (2,100  | )
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|Income (loss) before taxes on income                          |  |                                                   | 17,733  |      |  | 10,849  |   |  | (513    | )
|Taxes on
  income (Note 16)                                   |  |                                                   | 4,631   |      |  | 2,540   |   |  | 2,014   |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|                                                              |  |                                                   | 13,102  |      |  | 8,309   |   |  | (2,527  | )
|Equity in
  losses of affiliated companies, net               |  |                                                   | (2,523  | )    |  | (1,071  | ) |  | (2,327  | )
|Minority
  interest in losses (earnings) of subsidiaries, net |  |                                                   | (2,480  | )    |  | (4,118  | ) |  | 2,448   |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|Net income (loss)                                             |  |                                                   | 8,099   |      |  | 3,120   |   |  | (2,406  | )
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|Earnings (loss) per share (Note 17J):                         |  |                                                   |         |      |  |         |   |  |         |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|Basic                                                         |  |                                                   | 0.73    |      |  | 0.29    |   |  | (0.24   | )
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|Diluted                                                       |  |                                                   | 0.65    |      |  | 0.24    |   |  | (0.24   | )
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|Weighted average number of shares outstanding (Note 17J):     |  |                                                   |         |      |  |         |   |  |         |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|Basic                                                         |  |                                                   | 10,800  |      |  | 10,037  |   |  | 10,171  |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  
|Diluted                                                       |  |                                                   | 10,800  |      |  | 10,285  |   |  | 10,171  |  
|                                                              |  |                                                   |         |      |  |         |   |  |         |  

The accompanying notes form an integral part
of the financial statements.

F4

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS EQUITY

|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|------------------------------------------------------------------------------------------ |  | -------------------------------- | ---------- | ---------- |  | -------------- |  | ------------------- | ------ | -------------------- |  | ----------------- | - | ----- | ------- | - |  | ------ | - |  | ------- | -
|                                                                                           |  | Share Capital                    |            |            |  |                |  | Accumulated         |        |                      |  |                   |  
|                                                                                           |  |                                  |            | Additional |  |                |  | other               |        | Cost of              |  |                   |  
|                                                                                           |  | Number of
  Shares               |            | Amount     |  | paid-inCapital |  | Retained
  Earnings |        | comprehensive
  loss |  | Treasury
  Shares |   | Total |        
|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |        
|                                                                                           |  | (U.S.
  $ in  t h o u s a n d s) |           
|                                                                                           |  |                                  |           
|Balance as of January 1, 2002                                                              |  |                                  | 10,324,780 |            |  | 3,101          |  |                     | 89,930 |                      |  | 90,353            |   |       | (16,963 | ) |  |       |   |  | 166,421 |  
|Changes during 2002:                                                                       |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Net loss                                                                                   |  |                                  |           |            |  |               |  |                     |       |                      |  | (2,406            | ) |       |        |   |  |       |   |  | (2,406  | )
|Currency translation adjustments                                                           |  |                                  |           |            |  |               |  |                     |       |                      |  |                  |   |       | (6,734  | ) |  |       |   |  | (6,734  | )
|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Total comprehensive loss                                                                   |  |                                  |           |            |  |               |  |                     |       |                      |  |                  |   |       |        |   |  |       |   |  | (9,140  | )
|Issuance of options in connection with debenture                                           |  |                                  |           |            |  |               |  |                     | 1,056  |                      |  |                  |   |       |        |   |  |       |   |  | 1,056   |  
|Deferred compensation                                                                      |  |                                  |           |            |  |               |  |                     | 214    |                      |  |                  |   |       |        |   |  |       |   |  | 214     |  
|Purchase of treasury stock                                                                 |  |                                  | (324,780   | )          |  |               |  |                     |       |                      |  |                  |   |       |        |   |  | (3,398 | ) |  | (3,398  | )
|Elimination of tax benefit resulting from issuance expenses                                |  |                                  |           |            |  |               |  |                     | (1,804 | )                    |  |                  |   |       |        |   |  |       |   |  | (1,804  | )
|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Balance
  as of December 31, 2002                                                          |  |                                  | 10,000,000 |            |  | 3,101          |  |                     | 89,396 |                      |  | 87,947            |   |       | (23,697 | ) |  | (3,398 | ) |  | 153,349 |  
|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Changes during 2003:                                                                       |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Net Income                                                                                 |  |                                  |           |            |  |               |  |                     |       |                      |  | 3,120             |   |       |        |   |  |       |   |  | 3,120   |  
|Currency translation adjustments                                                           |  |                                  |           |            |  |               |  |                     |       |                      |  |                  |   |       | 6,403   |   |  |       |   |  | 6,403   |  
|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Total comprehensive income                                                                 |  |                                  |           |            |  |               |  |                     |       |                      |  |                  |   |       |        |   |  |       |   |  | 9,523   |  
|Deferred compensation                                                                      |  |                                  |           |            |  |               |  |                     | 406    |                      |  |                  |   |       |        |   |  |       |   |  | 406     |  
|Proceeds from sale of treasury stock                                                       |  |                                  | 300,000    |            |  |               |  |                     | 1,657  |                      |  |                  |   |       |        |   |  | 3,139  |   |  | 4,796   |  
|Exercise of share options                                                                  |  |                                  | 500,000    |            |  | 114            |  |                     | 7,816  |                      |  |                  |   |       |        |   |  |       |   |  | 7,930   |  
|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Balance
  as of December 31, 2003                                                          |  |                                  | 10,800,000 |            |  | 3,215          |  |                     | 99,275 |                      |  | 91,067            |   |       | (17,294 | ) |  | (259   | ) |  | 176,004 |  
|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Changes during 2004:                                                                       |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Net Income                                                                                 |  |                                  |           |            |  |               |  |                     |       |                      |  | 8,099             |   |       |        |   |  |       |   |  | 8,099   |  
|Unrealized gains from available-for-sale securities, net                                   |  |                                  |           |            |  |               |  |                     |       |                      |  |                  |   |       | (50     | ) |  |       |   |  | (50     | )
|Currency translation adjustments                                                           |  |                                  |           |            |  |               |  |                     |       |                      |  |                  |   |       | 2,465   |   |  |       |   |  | 2,465   |  
|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Total comprehensive income                                                                 |  |                                  |           |            |  |               |  |                     |       |                      |  |                  |   |       |        |   |  |       |   |  | 10,514  |  
|Beneficial conversion features                                                             |  |                                  |           |            |  |               |  |                     | 106    |                      |  |                  |   |       |        |   |  |       |   |  | 106     |  
|Deferred compensation                                                                      |  |                                  |           |            |  |               |  |                     | 101    |                      |  |                  |   |       |        |   |  |       |   |  | 101     |  
|Capital fund arising from elimination of gain on realization of
  development stage entity |  |                                  |           |            |  |               |  |                     | 53     |                      |  |                  |   |       |        |   |  |       |   |  | 53      |  
|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Balance
  as of December 31, 2004                                                          |  |                                  | 10,800,000 |            |  | 3,215          |  |                     | 99,535 |                      |  | 99,166            |   |       | (14,879 | ) |  | (259   | ) |  | 186,778 |  
|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Accumulated unrealized gain from available-for-sale securities                             |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       | (50     | ) |  |        |   |  |         |  
|Accumulated currency translation
  adjustments                                             |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       | (14,829 | ) |  |        |   |  |         |  
|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  
|Accumulated other comprehensive loss                                                       |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       | (14,879 | ) |  |        |   |  |         |  
|                                                                                           |  |                                  |            |            |  |                |  |                     |        |                      |  |                   |   |       |         |   |  |        |   |  |         |  

The accompanying notes form an integral part
of the financial statements.

F5

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                                           |  |                         |        |      |  |         |    |  |        |   
|------------------------------------------------------------------------------------------ |  | ----------------------- | ------ | ---- |  | ------- | -- |  | ------ | --
|                                                                                           |  | Year ended December 31, |       
|                                                                                           |  |                         |       
|                                                                                           |  | 2004                    |        | 2003 |  | 2002    |   
|                                                                                           |  |                         |        |      |  |         |   
|                                                                                           |  | (U.S. $ in thousands)   |       
|                                                                                           |  |                         |       
|CASH
  FLOWS FROM OPERATING ACTIVITIES:                                                    |  |                         |        |      |  |         |    |  |        |   
|Net income (loss)                                                                          |  |                         | 8,099  |      |  | 3,120   |    |  | (2,406 | ) 
|Adjustments to reconcile net income (loss) to net cash provided by
  operating activities: |  |                         |        |      |  |         |    |  |        |   
|Impairment and write down of investments in investees and
loans                            |  |                         | 471    |      |  | 915     |    |  | 1,656  |   
|Minority interest in earnings (losses) of consolidated
subsidiaries                        |  |                         | 2,480  |      |  | 4,118   |    |  | (2,448 | ) 
|Equity in losses of affiliated companies, net                                              |  |                         | 2,523  |      |  | 1,071   |    |  | 2,472  |   
|Depreciation and amortization                                                              |  |                         | 20,597 |      |  | 18,547  |    |  | 12,906 |   
|Impairment of software development costs                                                   |  |                         | 901    |      |  |        |    |  |       |   
|Increase (decrease) in accrued severance pay, net                                          |  |                         | 287    |      |  | (620    | )  |  | 219    |   
|Loss (gain) from sale of property and equipment                                            |  |                         | (60    | )    |  | (26     | )  |  | 176    |   
|Gain on realization of shareholdings                                                       |  |                         | (8,893 | )    |  | (2,756  | )  |  | (4,668 | ) 
|Amortization of deferred option compensation                                               |  |                         | 194    |      |  | 456     |    |  | 430    |   
|Erosion, change in accrued interest and capital loss on
debentures                         |  |                         | 3,471  |      |  | 3,583   |    |  | (2,945 | ) 
|Erosion (appreciation) in
  value of long term loans and deposits, net                     |  |                         | 715    |      |  | (1,659  | )  |  | 108    |   
|Deferred taxes                                                                             |  |                         | (1,101 | )    |  | 827     |    |  | (410   | ) 
|Accrued interest on redeemable shares in a subsidiary                                      |  |                         | 64     |      |  | 320     |    |  |       |   
|Gain (loss) on payment of convertible subordinated notes                                   |  |                         | 50     |      |  | (61     | )  |  |       |   
|Sale of trading marketable securities, net                                                 |  |                         | (3,533 | )    |  | (2,665  | )* |  | (1,857 | )*
|Increase (decrease) in trade marketable securities                                         |  |                         | (26    | )    |  | (991    | )  |  | 435    |   
|Capital gain on sale of available for sale marketable
securities                           |  |                         | (64    | )    |  |        |    |  |       |   
|Changes in operating assets and liabilities:                                               |  |                         |        |      |  |         |    |  |        |   
|Decrease (increase) in inventories                                                         |  |                         | (1,850 | )    |  | (265    | )  |  | 1,159  |   
|Decrease (increase) in trade receivables                                                   |  |                         | (8,044 | )    |  | (12,649 | )  |  | 14,153 |   
|Decrease (increase) in other accounts receivable                                           |  |                         | (2,146 | )    |  | 7,913   |    |  | 1,827  |   
|Increase (decrease) in trade payables                                                      |  |                         | 3,033  |      |  | 2,927   |    |  | (9,483 | ) 
|Increase (decrease) in other accounts payable and restructuring
  accrual                  |  |                         | (4,641 | )    |  | (12,475 | )  |  | (8,212 | ) 
|Increase (decrease) in customer advances, net of work in
progress                          |  |                         | 5,279  |      |  |        |    |  |       |   
|                                                                                           |  |                         |        |      |  |         |    |  |        |   
|Net cash
  provided by operating activities                                                |  |                         | 17,806 |      |  | 9,630   |    |  | 3,112  |   
|                                                                                           |  |                         |        |      |  |         |    |  |        |   

* Reclassified.

The accompanying notes form an integral part
of the financial statements.

F6

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|---------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ------- | - |  | ------- | -
|                                                                                               |  | Year ended December 31, |        
|                                                                                               |  |                         |        
|                                                                                               |  | 2004                    |         | 2003 |  | 2002    |  
|                                                                                               |  |                         |         |      |  |         |  
|                                                                                               |  | (U.S. $ in thousands)   |        
|                                                                                               |  |                         |        
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                          |  |                         |         |      |  |         |   |  |         |  
|Acquisition of newly-consolidated subsidiaries (Appendix C)                                    |  |                         | 13,724  |      |  | 20,481  |   |  | (1,774  | )
|Proceeds from realization of investment in previously-consolidated
  subsidiaries (Appendix D) |  |                         | (353    | )    |  | 12      |   |  | (9      | )
|Investment in debentures                                                                       |  |                         |        |      |  |        |   |  | (19,422 | )
|Proceeds from repayment of debentures                                                          |  |                         |        |      |  | 301     |   |  | 2,919   |  
|Loans to employees                                                                             |  |                         | (235    | )    |  |        |   |  |        |  
|Restricted short term deposit, net                                                             |  |                         | (600    | )    |  |        |   |  |        |  
|Restricted long term deposit, net                                                              |  |                         | 2,554   |      |  |        |   |  |        |  
|Purchase of property and equipment                                                             |  |                         | (5,718  | )    |  | (4,887  | ) |  | (3,382  | )
|Purchase of available for sale marketable securities, net                                      |  |                         | (16,413 | )    |  |        |   |  |        |  
|Proceeds from sale of property and equipment                                                   |  |                         | 1,827   |      |  | 1,246   |   |  | 1,160   |  
|Investment in and loans to affiliated and other companies                                      |  |                         | (6,162  | )    |  | (1,685  | ) |  | (17,488 | )
|Proceeds from sale of investments in and loans to affiliated
  companies                       |  |                         | 4,160   |      |  | 1,581   |   |  | 2,128   |  
|Purchase of an activity by a consolidated company                                              |  |                         |        |      |  | (429    | ) |  | (1,330  | )
|Purchase of intangible assets by consolidated companies                                        |  |                         | (449    | )    |  |        |   |  | (353    | )
|Investment in long term bank deposits, net                                                     |  |                         | (639    | )    |  | 18      |   |  | (180    | )
|Capitalization of software development and other costs                                         |  |                         | (15,367 | )    |  | (10,172 | ) |  | (4,424  | )
|Purchase of minority interest in subsidiaries                                                  |  |                         | (5,710  | )    |  | (23,599 | ) |  | (16,231 | )
|Proceeds from realization of investment in subsidiaries                                        |  |                         | 11,025  |      |  | 2,846   |   |  |        |  
|Proceeds from investments in short term bank deposits, net                                     |  |                         | 1,245   |      |  | 9,400   |   |  |        |  
|Dividends received from affiliated companies                                                   |  |                         |        |      |  |        |   |  | 31      |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|Net cash
  used in investing activities                                                        |  |                         | (17,111 | )    |  | (4,887  | ) |  | (58,355 | )
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                          |  |                         |         |      |  |         |   |  |         |  
|Proceeds from sale of subsidiary call warrants                                                 |  |                         |        |      |  | 1,386   |   |  | 2,174   |  
|Issuance of convertible debt                                                                   |  |                         | 4,357   |      |  | 20,977  |   |  | 29,453  |  
|Purchase of treasury stock                                                                     |  |                         |        |      |  |        |   |  | (3,398  | )
|Issuance of treasury stock                                                                     |  |                         |        |      |  | 4,796   |   |  |        |  
|Exercise of share options                                                                      |  |                         |        |      |  | 7,930   |   |  |        |  
|Dividend to minority shareholders in subsidiaries                                              |  |                         | (88     | )    |  | (4,831  | ) |  | (128    | )
|Short-term bank credit, net                                                                    |  |                         | 20,410  |      |  | (41,344 | ) |  | 37,061  |  
|Repayment of long-term loans                                                                   |  |                         | (29,521 | )    |  | (5,061  | ) |  | (5,045  | )
|Receipt of long-term loans                                                                     |  |                         | 12,681  |      |  | 19,581  |   |  | 4,841   |  
|Issuance in a subsidiary to minority shareholders, net                                         |  |                         | 4,405   |      |  | 479     |   |  | 356     |  
|Convertible debt issuance expenses in a subsidiary                                             |  |                         | (32     | )    |  | (1,496  | ) |  |        |  
|Payment of convertible subordinated notes in a subsidiary                                      |  |                         |        |      |  | (4,144  | ) |  |        |  
|Payment of issuance expenses in a subsidiary                                                   |  |                         | (20     | )    |  | (361    | ) |  |        |  
|Debenture redemption                                                                           |  |                         |        |      |  | (2,484  | ) |  |        |  
|Purchase of treasury stock in a subsidiary by a subsidiary
thereof                             |  |                         | (102    | )    |  |        |   |  | (482    | )
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|Net cash
  used in financing activities                                                        |  |                         | 12,090  |      |  | (4,572  | ) |  | 64,832  |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|Effect of exchange rate changes on cash and
  cash equivalents                                 |  |                         | 933     |      |  | 2,724   |   |  | (2,575  | )
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|NET
  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                         |  |                         | 13,718  |      |  | 2,895   |   |  | 7,014   |  
|CASH AND
  CASH EQUIVALENTS AT BEGINNING OF YEAR                                               |  |                         | 93,456  |      |  | 90,561  |   |  | 83,547  |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|CASH AND
  CASH EQUIVALENTS AT END OF YEAR                                                     |  |                         | 107,174 |      |  | 93,456  |   |  | 90,561  |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  

The accompanying notes form an integral part
of the financial statements.

F7

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS

Appendix A  Supplemental cash flow
information:

|                                         |  |                         |       |      |  |       |  |  |       | 
|---------------------------------------- |  | ----------------------- | ----- | ---- |  | ----- |  |  | ----- | 
|                                         |  | Year ended December 31, |      
|                                         |  |                         |      
|                                         |  | 2004                    |       | 2003 |  | 2002  | 
|                                         |  |                         |       |      |  |       | 
|                                         |  | (U.S. $ in thousands)   |      
|                                         |  |                         |      
|                                         |  |                         |       |      |  |       |  |  |       | 
|Cash paid during the year in respect of: |  |                         |       |      |  |       |  |  |       | 
|Interest                                 |  |                         | 7,066 |      |  | 6,547 |  |  | 5,616 | 
|                                         |  |                         |       |      |  |       |  |  |       | 
|                                         |  |                         |       |      |  |       |  |  |       | 
|Income tax                               |  |                         | 6,357 |      |  | 4,652 |  |  | 5,940 | 
|                                         |  |                         |       |      |  |       |  |  |       | 

Appendix B  Non-cash activities:

|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|--------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ----- | ---- |  | ----- |  |  | ----- | 
|                                                                                                                            |  | Year ended December 31, |      
|                                                                                                                            |  |                         |      
|                                                                                                                            |  | 2004                    |       | 2003 |  | 2002  | 
|                                                                                                                            |  |                         |       |      |  |       | 
|                                                                                                                            |  | (U.S. $ in thousands)   |      
|                                                                                                                            |  |                         |      
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Purchase of fixed assets against trade
  payables                                                                           |  |                         | 39    |      |  | 80    |  |  |      | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Investment in a consolidated company
  against issuance of share capital to minority shareholders of consolidated
  company |  |                         |      |      |  | 5,101 |  |  | 9,358 | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Purchase of activity against long term
  liability                                                                          |  |                         |      |      |  |      |  |  | 2,503 | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Investment in affiliates and other
  companies, recorded against accounts payable                                           |  |                         |      |      |  | 807   |  |  |      | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Purchase of shares from minority
  shareholders of subsidiary, against accounts payable                                     |  |                         |      |      |  |      |  |  | 262   | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Realization of convertible debenture in a
  subsidiary                                                                      |  |                         |      |      |  | 229   |  |  | 242   | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Purchase of shares from minority
  shareholders of subsidiary against debentures                                            |  |                         |      |      |  |      |  |  | 1,310 | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Realization of investment in an exchange
  shares transaction                                                               |  |                         |      |      |  |      |  |  | 6,422 | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Purchase of technology from affiliated
  company against loan                                                               |  |                         | 1,695 |      |  | 1,917 |  |  |      | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Purchase of intellectual property rights
  against settlement of loan                                                       |  |                         |      |      |  | 642   |  |  |      | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Warrants issued as consideration for
  purchase of activity                                                                 |  |                         |      |      |  | 121   |  |  |      | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 

The accompanying notes form an integral part
of the financial statements.

F8

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS

Appendix C  Acquisition of
newly-consolidated subsidiaries:

|                                                                              |  |                         |         |      |  |         |   |  |        |  
|----------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ------- | - |  | ------ | -
|                                                                              |  | Year ended December 31, |        
|                                                                              |  |                         |        
|                                                                              |  | 2004                    |         | 2003 |  | 2002    |  
|                                                                              |  |                         |         |      |  |         |  
|                                                                              |  | (U.S. $ in thousands)   |        
|                                                                              |  |                         |        
|Assets and liabilities of subsidiaries
  consolidated as of acquisition date: |  |                         |         |      |  |         |   |  |        |  
|Working capital (other than cash and cash
  equivalents)                      |  |                         | 11,670  |      |  | 12,726  |   |  | (1,019 | )
|Liabilities arising from purchase of an
  activity                            |  |                         |        |      |  |        |   |  | 743    |  
|Investment in affiliates and others
  including loans                         |  |                         | (27,436 | )    |  | 19,014  |   |  | 6,232  |  
|Property and equipment                                                        |  |                         | (4,671  | )    |  | (4,074  | ) |  | (480   | )
|Other assets and deferred expenses                                            |  |                         | (13,085 | )    |  | (23,748 | ) |  | (413   | )
|Goodwill arising upon acquisition                                             |  |                         | (60,524 | )    |  | (14,379 | ) |  | (6,654 | )
|Long-term liabilities                                                         |  |                         | 18,507  |      |  | 8,887   |   |  | 77     |  
|Debentures                                                                    |  |                         | 45,336  |      |  | 12,099  |   |  |       |  
|Unrealized gain                                                               |  |                         | (1,508  | )    |  |        |   |  |       |  
|Minority interest at acquisition date                                         |  |                         | 9,182   |      |  | 9,956   |   |  | (260   | )
|Exchange of debentures against shares                                         |  |                         | 36,253  |      |  |        |   |  |       |  
|                                                                              |  |                         |         |      |  |         |   |  |        |  
|Total                                                                         |  |                         | 13,724  |      |  | 20,481  |   |  | (1,774 | )
|                                                                              |  |                         |         |      |  |         |   |  |        |  

Appendix D  Proceeds from realization of
investments in previously-consolidated subsidiaries:

|                                                                                |  |                         |         |      |  |        |   |  |      |  
|------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ------ | - |  | ---- | -
|                                                                                |  | Year ended December 31, |        
|                                                                                |  |                         |        
|                                                                                |  | 2004                    |         | 2003 |  | 2002   |  
|                                                                                |  |                         |         |      |  |        |  
|                                                                                |  | (U.S. $ in thousands)   |        
|                                                                                |  |                         |        
|Assets and liabilities of consolidated subsidiaries as of date of
  realization |  |                         |         |      |  |        |   |  |      |  
|Working capital (other than cash and cash
  equivalents)                        |  |                         | (14,204 | )    |  | 330    |   |  | (289 | )
|Investment in affiliate (including loans)                                       |  |                         | 1,139   |      |  | (2,613 | ) |  | 221  |  
|Property and equipment                                                          |  |                         | 2,081   |      |  | 360    |   |  |     |  
|Other assets and deferred expenses                                              |  |                         |        |      |  | 67     |   |  | (31  | )
|Goodwill                                                                        |  |                         | 7,756   |      |  | 2,133  |   |  | 76   |  
|Long-term liabilities                                                           |  |                         | (392    | )    |  | (201   | ) |  | 14   |  
|Loss (gain) from realization of investments
  in subsidiaries                   |  |                         |        |      |  | 27     |   |  |     |  
|Minority interest                                                               |  |                         | 3,267   |      |  | (91    | ) |  |     |  
|                                                                                |  |                         |         |      |  |        |   |  |      |  
|Total                                                                           |  |                         | (353    | )    |  | 12     |   |  | (9   | )
|                                                                                |  |                         |         |      |  |        |   |  |      |  

The accompanying notes form an integral part
of the financial statements.

F9

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant Accounting
Policies:

|   |                                                                                                                                                                                                                                                                                                                                                                                 
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | General:                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                 
|   | Formula
  Systems (1985) Ltd. (Formula) was incorporated in Israel in 1985. Since 1991,
  the Companys shares have been traded on the Tel Aviv Stock Exchange (the
  TASE) and since 1997, through American Depositary Shares (ADS) under the
  symbol FORTY on the NASDAQ National Market in the United States. Each ADS
  represents one ordinary share of the Company.
|   |                                                                                                                                                                                                                                                                                                                                                                                 
|   | Formula, through its subsidiaries (collectively, the Company
  or the Group) is engaged in
  the
  development, production and marketing
  of information technology (IT) solutions and services. The Group operates in two principal business segments,
  IT Services and Proprietary Software Solutions. For a description of the
  segments  see Note 17H.            
|   |                                                                                                                                                                                                                                                                                                                                                                                 
|   | The following table presents certain information regarding the
  control and ownership of Formulas significant subsidiaries and material investments,
  as of the dates indicated:                                                                                                                                                                                             

| |                                                                                           |  |                                     |  |                     |  |  |  |  |       |  | 
| | ----------------------------------------------------------------------------------------- |  | ----------------------------------- |  | ------------------- |  |  |  |  | ----- |  | 
| |                                                                                           |  | Percentage of ownership and control | 
| |                                                                                           |  |                                     | 
| |                                                                                           |  | December 31,
  2004                 |  | December 31,
  2003 | 
| |                                                                                           |  |                                     |  |                     | 
| | Name of subsidiary:                                                                       |  | %                                   | 
| |                                                                                           |  |                                     | 
| |                                                                                           |  |                                     |  |                     |  |  | 
| | Matrix IT Ltd.  (Matrix)                                                                |  |                                     |  | 58.63               |  |  |  |  | 72.15 |  | 
| | BluePhoenix Solutions Ltd. (BluePhoenix)  (formerly
 Crystal Systems Solutions Ltd.) |  |                                     |  | 58.66               |  |  |  |  | 58.8  |  | 
| | Magic Software Enterprises Ltd. (Magic)                                                 |  |                                     |  | 50.1                |  |  |  |  | 52.9  |  | 
| | NextSource Inc.                                                                           |  |                                     |  | 100                 |  |  |  |  | 100   |  | 
| | Sapiens International Corporation N.V.
(Sapiens)                                        |  |                                     |  | 52.37               |  |  |  |  | 50.69 |  | 
| | Formula Vision Technologies (F.V.T.) Ltd.  (Formula
Vision)                             |  |                                     |  | 56.2                |  |  |  |  |      |  | 

| |                                                                                        
| | ---------------------------------------------------------------------------------------
| | The above list consists only of
  active companies that
  are held directly by Formula.

F10

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant Accounting
Policies (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | General (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | Accounting Principles                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | The
  consolidated financial statements have been prepared in accordance with
  generally accepted accounting principles (GAAP) as applied in the United
  States.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | Functional and Reporting Currency                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | The currency
  of the primary economic environment in which the operations of Formula and
  most of its subsidiaries are conducted is the New Israeli Shekel (NIS). The
  functional currency of the remaining subsidiaries is the United States dollar
  (dollar). Formula has elected to use the dollar as its reporting currency.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | The
  financial statements of Formula and most of its subsidiaries whose functional
  currency is the NIS have been translated into dollars under the principles
  described in Financial Accounting Standards Board Statement No. 52, Foreign
  Currency Translation. Assets and liabilities have been translated at
  period-end exchange rates.  The
  results of operations have been translated at the exchange rates on the dates
  on which the transactions occurred or at average exchange rates. Differences
  resulting from translation are presented under shareholders equity, in the
  item accumulated other comprehensive loss. Accordingly, the financial
  statements of subsidiaries whose functional currency is the dollar are
  presented in the consolidated financial statements in their original amounts.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | Use of Estimates and Assumptions in the
  Preparation of the Financial Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | 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, the disclosure of
  contingent assets and liabilities as of the dates of the financial statements
  and the reported amounts of revenues and expenses during the reporting
  periods.                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | The actual
  results may differ from these estimates.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|B. | Principles of Consolidation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | The
  consolidated financial statements include Formulas financial statements as
  well as those of its subsidiaries in which it has a controlling interest, and
  a certain variable interest entity that the Company is required to
  consolidate pursuant to Financial Accounting Standards Board Interpretation
  No. 46, Consolidation of Variable Interest Entities as revised in December
  2003 (FIN 46). Acquisition of subsidiaries is accounted for under the
  purchase method. All inter-company balances and transactions have been
  eliminated upon consolidation.                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|C. | Cash and Cash Equivalents:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | Cash
  equivalents are considered by the Company to be highly-liquid investments,
  including, inter-alia, short-term deposits with banks, the maturity of which
  did not exceed three months at the time of acquisition and which are
  unrestricted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

F11

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant Accounting
Policies (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|D. | Investments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Investments
  in non-marketable securities of companies in which the Company does not have
  the ability to exercise significant influence over operating and financial
  policy are recorded at cost. The Company accounts for investments in
  marketable equity securities and debt securities in accordance with SFAS No.
  115, Accounting for Certain Investments in Debt and Equity Securities (SFAS
  No. 115). Management determines the appropriate classification of its
  investments in marketable equity securities and debt securities at the time
  of purchase and reevaluates such determinations at each balance sheet date.
  Marketable equity securities and debt securities that are classified as
  trading or as available-for-sale are reported at fair value.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Unrealized
  gains and losses from marketable securities classified as available for
  sale are excluded from earnings and are reported as a component of
  accumulated other comprehensive income (loss) in shareholders equity.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Unrealized
  gains and losses from marketable securities classified as trading are
  reported in the statement of income.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Investments
  are periodically reviewed to determine whether an impairment in value has
  occurred that is of a non-temporary nature, in which case the investment is
  written down to its fair value.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|E. | Provision for Doubtful Accounts:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | The provision for doubtful
  accounts was calculated on the basis of specific receivables, where, in the
  opinion of Group management, doubt exists as to their collectability.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|F. | Inventory:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Inventory is comprised of hardware and software.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Inventory is valued at the lower of cost or market value. Cost is
  determined on the first in  first out basis.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|G. | Debentures:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Debentures
  from sale of investments relates to the transaction carried out on December
  31, 2001. The debentures were issued by Formula Vision, in connection with
  the sale of non-public companies held by Formula to Formula Vision.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Formula
  evaluated periodically (until December 31, 2003), the financial strength of
  Formula Vision and its ability to meet the repayment schedule of the loan
  (see Note 2B).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

F12

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant Accounting
Policies (cont.):

|   |                                                                                                                                                                                                                                                    
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|H. | Investments in Affiliates:                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                    
|   | Affiliates are companies over which significant influence is
  exercised, but which are not consolidated subsidiaries, and are accounted for
  by the equity method, net of write-down for decrease in value, which is not
  of a temporary nature.
|   |                                                                                                                                                                                                                                                    
|I. | Property and Equipment, net:                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                    
|   | Property and
  equipment are stated at cost, net of accumulated depreciation. Depreciation
  is calculated by the straight-line method over their estimated useful
  lives.  The following are the annual
  depreciation rates:                    

| |                           |                    
| | ------------------------- | -------------------
| |                           | %                  
| |                           |                    
| | Computers
  and equipment | 6  33 (mainly 33) 
| | Motor
  vehicles          | 15  33 (mainly 15)
| | Buildings                 | 4                  
| | Leasehold
  improvements  | 10  20 (mainly 20)

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|J. | Goodwill:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | Goodwill reflects the excess of the purchase price of subsidiaries
  acquired over the fair value of net assets acquired. Until December 31, 2001,
  goodwill was amortized in equal annual installments, over a period of 10
  years. In the event it was determined that goodwill was not recoverable, its
  book value was written off and charged to the statement of operations as goodwill
  impairment.                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | In July 2001, the Financial Accounting
  Standards Board (FASB) issued Statement of Financial Accounting Standards
  No. 142, Goodwill and Other Intangible Assets (SFAS 142). SFAS 142
  requires goodwill to be tested for impairment on an annual basis and more
  frequently in certain circumstances, and written down when impaired rather
  than being amortized as required by previous accounting standards.
  Furthermore, SFAS 142 requires purchased intangible assets other than
  goodwill to be amortized over their useful lives unless those lives are
  determined to be indefinite.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | SFAS 142 was effective for fiscal years
  beginning after December 15, 2001. In accordance with SFAS 142, the Company
  ceased amortizing goodwill totaling $105 million as of the beginning of 2002.During
  2002 the Company completed its transitional impairment review of goodwill.
  Based on the impairment tests performed, there was no impairment of goodwill
  as of January 1, 2002. The Company has selected December 31st as
  the date on which it will perform its annual goodwill impairment test.                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | As of December 31, 2004, 2003 and 2002, no
  impairment was required. There can be no assurance that future goodwill
  impairment tests will not result in a charge to net income.                                                                                                                                                                                                                                                                                                                                                                                                                          

F13

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant Accounting
Policies (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|K. | Software Development Costs:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | Development
  costs of software, which is intended for sale that are incurred after the
  establishment of technological feasibility of the relevant product, and are
  capitalized. Technological feasibility is determined when detailed program
  design is completed and verified in accordance with the provisions of SFAS
  No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or
  Otherwise Marketed of the FASB.                                                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | Software
  development costs incurred before technological feasibility has been
  established are charged to the statement of income as incurred, net of
  participation of the Office of the Chief Scientist of the Israeli Ministry of
  Industry and Trade (the OCS).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | Amortization
  of capitalized software development costs begins when the product is
  available for general release to customers. Annual amortization is calculated
  according to the higher of the straight-line method over the remaining useful
  life of the product or based on the ratio of current gross revenues to
  current and anticipated future gross revenues. At present, amortization is
  computed under the straight-line method, mainly over a period of 3 years.
  During the year ended December 31, 2004, consolidated subsidiaries capitalized
  software development costs aggregating $15.4 million (2003  $10.2 million,
  2002  $4.4 million) and amortized capitalized software development costs
  aggregating $10.1 million (2003  $8.1 million, 2002  $5.1 million).
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | As of
  December 31, 2004, the unamortized capitalization of a subsidiarys software
  development costs exceeded the net realizable value of this intangible asset
  in the amount of $901,000 and therefore a subsidiary included an impairment
  of capitalized software development costs in the amount of $901,000 which is
  presented in cost of revenues.                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | Management
  estimates that the total capitalized costs do not exceed the net realizable
  value of the software product. In the event that unamortized software
  development costs exceed the net realizable value of the product, they are
  written down to net realizable value.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|L. | Other Intangible Assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | Other intangible assets are comprised of related intangible assets of
  customers and acquired technology and are amortized over their useful lives
  using a method of amortization that reflects the pattern in which the
  economic benefits of the intangible assets are consumed or otherwise used up.
  Related intangible assets of customerand acquired technology are amortized
  over a period of 8 and 510 years, respectively.                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | The Company reviews the useful life of its intangible assets
  annually.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

F14

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant Accounting
Policies (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|M. | Impairment in Value of Long-Lived Assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The Companys long-lived assets are reviewed for impairment in accordance
  with Statement of Financial Accounting Standard No. 144, Accounting for the
  Impairment or Disposal of Long-lived Assets (SFAS No. 144), whenever
  events or changes in circumstances indicate that the carrying amount of an
  asset may not be recoverable. The recoverability of assets held and used is
  measured by a comparison of the carrying amount of the assets to the future
  undiscounted cash flows expected to be generated by the assets. If such
  assets are considered to be impaired, the impairment to be recognized is
  measured by the amount by which the carrying amount of the assets exceeds the
  fair value of the assets. For the years ended December 31, 2004, 2003 and
  2002, no impairment losses have been identified.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|N. | Severance Pay:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The Companys
  liability for severance pay to its employees pursuant to Israeli law and
  employment agreements is covered in part by managers insurance policies, for
  which the Company makes monthly payments. The value of these polices is
  recorded as an asset in the Companys balance sheet. The Company may only
  make withdrawals from the managers insurance policies for the purpose of
  paying severance pay. The severance pay liability is calculated on the basis
  of one months salary for each year of service, based on the most recent
  salary of each employee.                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | Pursuant to
  Section 14 of the Severance Compensation Act, 1963 (Section 14), certain
  employees of the Company who elected to be included under this section, are
  entitled only to monthly deposits, at a rate of 8.33% of their monthly
  salary, made in their name with insurance companies. Payments in accordance
  with Section 14 release the Company from any future severance payments in
  respect of those employees. Deposits under Section 14 are not recorded as an
  asset in the Companys balance sheet.                                                                                                                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The expenses in respect of severance pay for the years ended December
  31, 2004, 2003 and 2002 were $5,121 thousand, $5,216 thousand and $2,917
  thousand, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|O. | Revenue Recognition:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | Revenues
  derived from direct software license agreements are recognized in accordance
  with Statement of Position (SOP) 97-2 Software Revenue Recognition (as
  amended by SOP 98-4 and SOP 98-9), upon delivery of the software when
  collection is probable, where the license fee is otherwise fixed or determinable,
  and when there is persuasive evidence that an arrangement exists.                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | When a
  project involves significant modification of software, revenue is generally
  recognized according to the percentage of completion method. Under this
  method, estimated revenue is generally accrued based on costs incurred to
  date as a percentage of the total updated estimated costs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

F15

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant Accounting
Policies (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|O. | Revenue Recognition (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | The
  arrangements, which include multiple elements, are usually arrangements where
  the Company sells software products and Post Contract Support (PCS).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | In addition
  there are certain arrangements where the Company sells software and
  consulting services. Consulting service fees are based on time invested.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | For these
  multiple elements, SOP 97-2 requires that the fair value of each component in
  a multiple element arrangement will be determined based on the vendors
  specific objective evidence (VSOE) for that element, and revenue is allocated
  to each component based on its fair value. SOP 98-9 requires that revenue be
  recognized under the residual method when VSOE does not exist for all the
  delivered elements, VSOE of fair value exists for all undelivered elements,
  and all other SOP 97-2 critera are met. Under the residual method, any
  discount in the arrangement is allocated to the delivered elements. The
  specific objective evidence for the PCS is established by the price charged
  on separate PCS renewal contracts. The VSOE for the consulting services is
  established by the price charged on other time based consulting service
  contracts where no sale of other elements is involved, considering, among
  other things, the territory where the service is performed, the size of the
  customer, the quantity of the purchased services and the professional
  expertise of the consultants. The revenue associated with the delivered
  elements is recognized using the residual method discussed above.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | The Company
  recognizes revenues from consulting fees with respect to projects billed on a
  time and material basis, based on the number of hours performed.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | In some of
  the agreements with the Companys customers, the customers have the right to
  receive unspecified upgrades on an if-and-when available basis (the Company
  does not provide specific upgrades). These upgrades are considered PCS.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | Revenue
  allocated to the PCS is recognized ratably over the term of the PCS.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | The Company
  recognizes revenues from projects as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | (i)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Revenue from
  projects billed on a time and material basis is recognized in accordance with
  SOP 81-1 Accounting for Performance of Construction  Type and Certain
  Production  Type Contracts, using contract accounting on a percentage of
  completion method, on the basis of the relationship between actual costs
  incurred and the total costs that are expected to be incurred over the
  duration of the contract. Provision is made for estimated losses and
  uncompleted contracts, in the amount of the estimated losses on the entire
  contract in the period in which such losses first become evident. As of
  December 31, 2004, no such estimated losses were identified.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   | (ii)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | Revenue from
  fixed fee
  contracts is also recognized in accordance with the percentage of
  completion method. The Company recognizes contract losses, if any, in the
  period in which they first become evident.                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

F16

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant Accounting
Policies (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|O. | Revenue Recognition (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | Revenues
  from consulting services, consisting of billable hours for services provided,
  are recognized as the services are rendered.                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | Revenues
  from maintenance and training contracts are recognized relatively over the
  contract period.                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | Revenues
  from sale of hardware are recognized when the merchandise is delivered to the
  customer, provided no significant vendor obligations remain.                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | Some of the
  Companys contracts include client acceptance clauses. In these contracts,
  the Company follows the guidance of TPA 5100.67 and SAB 104. In determining
  whether revenue can be recognized, when an acceptance clause exists, the
  Company considers, among other things, its history with similar arrangements,
  the customers involvement in the progress, and the existence of other
  service providers and the payment terms.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | There are no
  rights of return, price protection or similar contingencies in the Companys
  contracts.                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | Revenues
  from sales of hardware are recognized when the merchandise is delivered to
  the customer, provided no significant vendor obligations remains.                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | Management
  believes that the Companys revenue recognition policies are in accordance
  with the Securities and Exchange Commission Staff Accounting Bulletin
  No. 101 and SAB 104, Revenue Recognition in Financial Statements.                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|P. | Government Grants:                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | Royalty-bearing grants from the Government of Israel for the funding
  of research and development projects are recognized at the time that the
  Company is entitled to such grants on the basis of the related costs
  incurred, and are recorded as a deduction from research and development
  costs.                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | The Company also received non-royalty-bearing grants from the Fund
  for the Encouragement of Marketing Activity. These grants are recognized at
  the time the Company is entitled to such grants, on the basis of the costs
  incurred, and included as a deduction from selling, marketing, general and
  administrative expenses.                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|Q. | Provision for Warranty:                                                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | In light of the past experience, Formula and the
  majority of its subsidiaries do not record any provision for warranties in
  respect of their products and services.                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|R. | Advertising Costs:                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | The Company
  records advertising expenses as incurred.                                                                                                                                                                                                                                                                                                                                                                                              

F17

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant Accounting
Policies (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|S. | Gain on Realization of Shareholdings:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | Gain on
  realization of shareholdings includes the results of realization of the
  Companys shareholdings in investees arising either on the sale of such shareholdings
  or from the issuance of stock by the investees to third parties, which is
  recognized in accordance with the provisions of Staff Accounting Bulletin
  (SAB) No. 51 issued by the Securities and Exchange Commission. The Company
  charges to the statement of operations such results, provided that the
  conditions stipulated by SAB 51 for such recognition have been met.                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|T. | Deferred Income Taxes:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | Formula and
  its subsidiaries account for income taxes in accordance with Statement of
  Financial Accounting Standard No. 109, Accounting for Income Taxes (SFAS
  No. 109). This Statement prescribes the use of the liability method whereby
  deferred tax assets and liability account balances are determined based on
  the differences between the financial reporting and tax bases of assets and
  liabilities and are measured using the enacted tax rates and laws that will
  be in effect when the differences are expected to reverse. Formula and its
  subsidiaries provide a valuation allowance, where necessary, in order to
  reduce deferred tax assets to an amount that is more likely than not to be
  realized.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|U. | Earnings (Loss) Per Share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | Earnings
  (loss) per share (EPS) are calculated in accordance with the provisions of
  SFAS No. 128 of the FASB (SFAS 128). SFAS 128, Earnings per Share
  requires the presentation of both basic and diluted EPS.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | Basic net
  earnings (loss) per share are calculated on the basis of the weighted average
  number of common shares outstanding during each year. The diluted earnings
  (loss) per share are calculated on the basis of the weighted average number
  of common shares outstanding during each year, plus the dilutive potential
  common shares considered outstanding during the year.                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|V. | Treasury Shares Held by the Company:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | Shares of the Company that are held by the Company (treasury shares)
  are presented as a reduction of shareholders equity, at their cost to the
  Company. Gains and losses upon the sale of these shares, net of related
  income taxes, are carried to additional paid-in capital and to retained
  earnings, respectively.                                                                                                                                                                                                                                                                                                                                                                                                               

F18

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant Accounting
Policies (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|W. | Concentration of Credit Risks  Allowance for Doubtful Accounts:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Most of the Groups cash and cash equivalents and short-term
  investments as of December 31, 2004 and 2003 were deposited with Israeli,
  U.S. and European banks. The Company is of the opinion that the credit risk
  in respect of these balances is remote.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Most of the Groups sales are made in Israel, North America and
  Europe, to a large number of customers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | The Groups trade receivables are derived from sales to large, solid
  organizations located mainly in Europe, North America and Israel. The Group
  performs ongoing credit evaluations of its customers and has established an
  allowance for doubtful accounts based upon factors relating to the credit
  risk of specific customers and other information. In certain circumstances,
  the Company may require letters of credit, other collateral or additional
  guarantees. From time to time, the Company sells certain of its accounts receivable
  to financial institutions, within the normal course of business. Where
  receivables are sold without recourse to the Company, the relevant receivable
  is de-recognized and cash recorded. Where receivables are sold with full or
  partial recourse to the Company, the receivable is not de-recognized and a
  liability reflecting the obligation to the financial institution is recorded
  within financial debts until the Companys liability is discharged through
  the financial institution receiving payment from the customer.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Formula and its subsidiaries had no
  off-balance-sheet concentration of credit risk such as foreign exchange
  contracts, options contracts or other foreign hedging arrangements as of
  December 31, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | The provision for doubtful accounts charged to general and
  administrative expenses amounted to $1.2 million, $14,000 and $2.8 million in
  the years 2004, 2003 and 2002, respectively, and was determined for specific
  debts where doubt existed as to their collectability.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|X. | Options Granted to Employees:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | The Company
  accounts for its Employee Stock Option Plans using the treatment prescribed
  by Accounting Principles Board Opinion No. 25, Accounting for Stock
  Issued to Employees (APB 25) and FASB issued Interpretation No. 44,
  Accounting for Certain Transactions Involving Stock Compensation (FIN
  44).  Under APB 25, the cost of
  compensation for employee stock option plans is measured using the intrinsic
  value based method of accounting.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

F19

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant
Accounting Policies (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|X. | Options Granted to Employees (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | In October
  1995, the FASB issued Statement No. 123, Accounting for Stock-Based
  Compensation (SFAS 123).  This
  Statement, effective as of the 1997 financial statements, established a fair
  value based method of accounting for employee stock options or similar equity
  instruments, and encourages the adoption of that method for stock
  compensation plans. SFAS 148 Accounting for Stock Based Compensation
  amended SFAS 123 to provide alternative methods of transition for a voluntary
  change to the fair value based method of accounting for such plans.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | However, it
  also allows companies to account for those plans, with respect to options
  granted to employees, using the accounting treatment prescribed by APB 25.                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | The Company
  has elected to account for share option plans according to APB 25 and FIN 44
  and has accordingly complied with the disclosure requirements set forth in
  SFAS 123 for companies electing to apply APB 25.                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | Compensation
  costs in respect of such plans in the net amounts of $65 thousand, $193
  thousand and $239 thousand, respectively, were charged to income in 2004,
  2003 and 2002. Had the compensation costs in respect of the Companys plans
  been determined based on the fair value at the grant date, consistent with
  the method of SFAS 123 as amended by SFAS 148, the Companys net income and
  earnings per share would have been decreased to the pro-forma amounts
  indicated below:                                                                                 

| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| | -------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------- | ------ | ---- |  | ------ | - |  | ------ | -
| |                                                                                                                                                    |  | Year Ended
  December 31                            |       
| |                                                                                                                                                    |  |                                                     |       
| |                                                                                                                                                    |  | 2004                                                |        | 2003 |  | 2002   |  
| |                                                                                                                                                    |  |                                                     |        |      |  |        |  
| |                                                                                                                                                    |  | (U.S. $ in
  thousands except per share 
  amounts) |       
| |                                                                                                                                                    |  |                                                     |       
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| | Net income
  (loss), as reported                                                                                                                   |  |                                                     | 8,099  |      |  | 3,120  |   |  | (2,406 | )
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| | Add: Stock-based employee compensation
  expenses included in reported net income, net of related tax effects                                      |  |                                                     | 65     |      |  | 193    |   |  | 239    |  
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| | Less: Total stock-based employee
  compensation expenses determined under the fair value based method for all
  awards, net of related tax effects |  |                                                     | (1,615 | )    |  | (1,832 | ) |  | (1,421 | )
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| | Pro-forma net income (loss)                                                                                                                        |  |                                                     | 6,549  |      |  | 1,481  |   |  | (3,588 | )
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| | Earnings
  (loss) per share:                                                                                                                       |  |                                                     |        |      |  |        |   |  |        |  
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| | Basic  as reported                                                                                                                                |  |                                                     | 0.73   |      |  | 0.29   |   |  | (0.24  | )
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| | Basic  pro forma                                                                                                                                  |  |                                                     | 0.58   |      |  | 0.12   |   |  | (0.35  | )
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| | Diluted  as reported                                                                                                                              |  |                                                     | 0.65   |      |  | 0.24   |   |  | (0.24  | )
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  
| | Diluted  pro forma                                                                                                                                |  |                                                     | 0.51   |      |  | 0.09   |   |  | (0.35  | )
| |                                                                                                                                                    |  |                                                     |        |      |  |        |   |  |        |  

F20

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant
Accounting Policies (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Y. | Derivatives and Hedging:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The Company
  accounts for derivatives and hedging based on Financial Accounting Standards
  Board Statement No. 133, Accounting for Derivative Instruments and Hedging
  Activities as amended (SFAS No. 133). SFAS 133 requires companies to
  recognize all of its derivative instruments on the balance sheet at fair
  value. The accounting for changes in the fair value of a derivative
  instrument depends on whether it has been designated and qualifies as part of
  a hedging relationship and further, on the type of hedging relationship.                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | Some
  subsidiaries enter into forward exchange contracts to hedge certain
  transactions denominated in foreign currencies. The purpose of Companys
  foreign currency hedging activities is to protect the subsidiaries from risk
  that the eventual dollar cash flow from international activities will be
  adversely affected by changes in the exchange rates. The subsidiaries
  forward contracts did not qualify as hedging instruments under SFAS No. 133.
  Changes in the fair value of forward contracts are reflected in the
  consolidated statements of operations as financial income or expense.                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|Z. | Fair Value of Financial Instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The
  estimated fair value of financial instruments has been determined by the
  Company using available market information and valuation methodologies.
  Considerable judgment is required in estimating fair values. Accordingly, the
  estimates may not be indicative of the amounts the Company could realize in a
  current market exchange. The carrying amounts of cash and cash equivalents,
  trade receivables, short-term bank credit and trade payables approximate
  their fair values due to the short-term maturity of such instruments. The
  fair value for marketable securities is based on quoted market prices and do
  not significantly differ from a carrying amount.

F21

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant
Accounting Policies (cont.):

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                            
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Z.  | Fair Value of Financial Instruments (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|    | The carrying
  amounts of the Companys long-term borrowing arrangements approximate their
  fair value. Fair values were estimated using discounted cash flow analyses,
  based on prevailing market borrowing rates.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|    | The fair
  value of the debentures with a carrying value in the amount of $50,107
  thousand as of December 31, 2004 according to the quoted price in the TASE is
  $53,370 thousand. The fair value of the traded warrants does not
  significantly differ from their carrying amount.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|AA. | Reclassification:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|    | Certain
  comparative figures for previous years have been reclassified to conform to
  the presentation of the current year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|AB. | Recently Issued Accounting Pronouncement:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|    | In December
  2004, the Financial Accounting Standards Board (FASB)  issued FASB Statement No. 123 (revised
  2004), Share-Based Payment, (SFAS 123(R)) which is a revision of FASB
  Statement No. 123, Accounting for Stock-Based Compensation (SFAS 123).
  SFAS 123(R) supersedes APB Opinion No. 25, Accounting for Stock issued to
  Employees, and amends FASB Statement No. 95, Statement of Cash Flows.
  Generally, the approach in SFAS 123(R) is similar to the approach described
  in SFAS 123. However, SFAS 123(R) requires all share-based payments to
  employees, including grants of employee stock options, to be recognized in
  the income statement of operations based on their fair values. Pro forma
  disclosure is no longer an alternative.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|    | SFAS 123(R)
  permits public companies to adopt its requirements using one of two methods:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                            
|    | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | A modified
  prospective method in which compensation cost is recognized beginning with
  the effective date (a) based on the requirements of SFAS 123(R) for all
  share-based payments granted  after
  the effective date and (b) based on the requirements of SFAS 123 for all
  awards granted to employees prior to the effective date of SFAS 123(R) that
  remain unvested on the effective date.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                            
|    | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | A modified
  retrospective method which includes the requirements of the modified
  prospective method described above, but also permits entities to restate
  based on the amounts previously recognized under SFAS 123 for purposes of pro
  forma disclosures either (a) all prior periods presented or (b) prior interim
  periods of the year of adoption.                                          

F22

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant
Accounting Policies (cont.):

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
|AB. | Recently Issued Accounting Pronouncement (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    | In April
  2005, the Securities and Exchange Commission postponed the required adoption
  date of SFAS 123(R) from no later than July 1, 2005 to no later than January
  1, 2006. Early adoption will be permitted in periods in which financial
  statements have not yet been issued. The Company expects to adopt SFAS 123(R)
  on January 1, 2006. The Company plans to adopt SFAS 123(R) using the
  modified-prospective method.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    | In December
  2004, the FASB issued SFAS No. 153, Exchange of Non-monetary Assets  An
  Amendment of APB Opinion No. 29, Accounting for Non-monetary Transactions.
  (SFAS No. 153). SFAS No. 153 eliminates the exception from fair value
  measurement for non-monetary exchange of similar productive assets in
  paragraph 21(b) of APB Opinion No. 29, Accounting for non-monetary
  Transactions, and replaces it with an exception for exchanges that do not
  have commercial substance. SFAS No. 153 specifies that a Non-monetary
  exchange has commercial substance if the future cash flows of the entity are
  expected to change significantly as a result of the exchange. SFAS No. 153 is
  effective for the fiscal periods beginning after June 15, 2005. The adoption
  of SFAS No. 153 is not expected to have a material impact on the Company
  financial statements or its results of operations.                                                                                             
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    | In March
  2004, the FASB approved the consensus reached on the Emerging Issue Task
  Force (EITF) Issue No. 03-1. The meaning of Other-Than-Temporary Impairment
  and Its Application to Certain Investments. The issues objective is to
  provide guidance for identifying other-than-temporarily impaired investments.
  EITF 03-1 also provides new disclosure requirements for investments that are
  deemed to be temporarily impaired. In September 2004, the FASB issued a FASB
  Staff Position (FSP) EITF 03-1-1 that delays the effective date of the measurement
  and recognition guidance in EITF 03-1 until further notice. The disclosure
  requirements of EITF 03-1 are effective with this annual report for fiscal
  2004. Once the FASB reaches a final decision on the measurement and
  recognition provisions, the Company will evaluate the impact of the adoption
  of the accounting provisions of EITF 03-1.                                                                                 
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    | In November
  2004, the FASB issued FAS No. 151, Inventory Costs  an amendment of ARB 43,
  Chapter 4, (FAS 151). This statement amends the guidance in ARB No. 32,
  Chapter 4, Inventory Pricing, to clarify the accounting for abnormal
  amounts of idle facility expense, freight, handling costs, and wasted
  material. This statement requires that those items be recognized as
  current-period charges, In addition, this Statement requires that allocation
  of fixed production overheads to the costs of conversion be based on the
  normal capacity of the production facilities. This statement will be
  effective for inventory costs incurred during fiscal years beginning after
  June 15, 2005 (January 1, 2006 for the Company). Earlier application of FAS
  151 is permitted. The provisions of this statement shall be applied
  prospectively. The Company does not expect this statement to have a material
  effect on the Companys financial statements or its results of operations.

F23

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1    Summary of Significant
Accounting Policies (cont.):

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|AB. | Recently Issued Accounting Pronouncement (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|    | In July
  2004, the FASB issued EITF Issue No. 02-14, Whether an Investor Should Apply
  the Equity Method of Accounting to Investments Other Than Common Stock. EITF
  Issue No. 02-14 addresses whether the equity method of accounting applies
  when an investor does not have an investment in voting common stock of an
  investee but exercises significant influence through other means. EITF Issue
  No. 02-14 states that an investor should only apply the equity method of
  accounting when it has investments in either common stock or in substance
  common stock of the investee, provided that the investor has the ability to
  exercise significant influence over the operating and financial policies of
  the investee. The provisions in EITF Issue No. 02-14 are effective for reporting
  periods beginning after September 15, 2004 (October 1, 2004 for the Company).
  The adoption of EITF 02-14 by the Company did not have any effect on the
  Companys financial statements or its results of operations.

Note 2    Certain Transactions:

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | In August
  2001, Formula entered into an agreement with Matrix, formerly Romtec
  Electronics Ltd. and its former controlling shareholders. According to the
  agreement, Matrix allotted to Formula 23,788,151 ordinary shares of Matrix,
  representing 85% of Matrixs outstanding share capital, in consideration for
  13,045,870 ordinary shares of ForSoft. It was agreed, inter-alia, that at the
  date of the closing of the transaction, Matrixs shareholders equity will be
  $8,000 thousand  consisting of liquid
  assets, and that Matrix will be devoid of any activity and/or assets, except
  for those mentioned above.In connection with this transaction, Formula
  agreed to guarantee a loan in the amount of $8.34 million extended by a
  commercial bank to the principal shareholders of Matrix. In addition, the
  borrowers pledged to the bank the shares they hold in Matrix. During the
  three-year loan period, the borrowers are prohibited from selling Matrixs
  shares to their affiliated parties. Formula undertook to pay to the bank at
  the termination of the loan period, the difference, if any, between the loan
  amount and the sale proceeds of the pledged Matrix shares. An unrealized gain
  in the amount of $3,078 thousand was created and it was realized at the
  earlier of a decrease in Formulas guarantee or the end of 3 years from the
  time of the transaction.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | In December
  2004, the bank released Formula of the above guarantee, and Formula
  recognized the unrealized gain.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

F24

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2    Certain Transactions
(cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|B. | In November
  2001, Formula Vision exercised the option granted by Formula in July 2001, to
  acquire the entire interest held by Formula in privately held companies.
  Under this transaction, Formula transferred to Formula Vision its entire
  interest, including related obligations, in the following companies: 51%
  interest in F.I.S. Software Ltd., 78.0% interest in Formula Retail Solutions
  Ltd., 50.1% interest in F.T.S.  Formula Telecom Solutions Ltd., 72.0%
  interest in N.I.P. Nikuv International Projects Ltd., 36.0% interest in
  Enformia Software Ltd., 1.0% interest in Babylon Ltd., 0.85% interest in
  Demantra Ltd., 100.0% interest in Forsoft Export (1999) Ltd., 80.3% interest
  in Airport Systems Technologies Ltd., 68.0% interest in Transtech, 50.0%
  interest in ESI, 34.0% interest in GeoSim System Ltd., 100.0% interest in
  Shandol, its interest in the first and second venture capital funds, Formula
  Ventures and its 100.0% interest in the funds management company and in
  Formula Ventures Ltd.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | The
  aggregate consideration paid by Formula Vision was $58.9 million, reflecting
  the book value of the transferred companies as of June 30, 2001, plus amounts
  invested by Formula prior to the closing of the transaction.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | Under the
  terms of the agreement with Formula Vision, Formula Vision issued to Formula,
  in December 2001, a series of debentures of $58.9 million in the aggregate,
  linked to the Israeli Consumer Price Index (CPI) and bearing an interest at
  an annual rate of 5%. Formula Vision is required to repay the debentures in
  five annual installments, subject to adjustments, based on the income of
  Formula Vision during each of the five years. The payments on account of the
  debentures plus linkage differences will be no less than 30% and no more than
  70% of the income arising from the sale of the transferred companies in any
  calendar year.                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | Income for
  these purposes is defined as the amounts received by Formula Vision, if any,
  in consideration for a sale of any of the transferred companies in any given
  calendar year, less selling expenses, as well as amounts received by Formula
  Vision from distributions to be made by any of the transferred companies in
  any given calendar year. Payments to be made on account of the debentures, in
  any given calendar year, shall be no less than 20% of the annual profit as
  recorded in the financial statements of Formula Vision. Any amounts which
  remain outstanding will be payable at the end of the 5-year period. In
  connection with this transaction, Formula lent to Formula Vision on March 31,
  2002 an additional $19.4 million and Formula Vision issued to Formula an
  additional series of debentures in that amount, with similar terms to the
  debentures issued in December 2001.                                                                                                                           

F25

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2    Certain Transactions
(cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|B. | (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|  
|   | During 2002,
  Formula Vision repaid $2.9 million as principal and $8.1 million as interest
  and linkage differences on the debentures.                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | During 2003,
  Formula Vision repaid $0.3 million as principal and $2.5 million as interest
  and linkage differences on the debentures.In the event that during the term
  of the indebtedness, Formula
  Vision issues to a third party convertible debentures, Formula is entitled to
  convert the indebtedness into the same class of convertible debentures,
  having the same terms as the convertible debentures issued to the third party.                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | As part of
  the agreement between Formula and Formula Vision, Formula transferred to
  Formula Vision its rights and obligations with respect to the transferred
  companies under its agreement with each of Shamrock, FIMI and IDB. If either
  of Shamrock, FIMI or IDB exercises the option to exchange the securities in
  the transferred companies for Formulas shares and to the extent exercised,
  Formula Vision assumed all the rights and undertakings in connection with the
  exercise of the option.       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | In January
  2004, Formula exchanged approximately $35 million of the aggregate amount of
  the debentures for 38,000,000 shares of Formula Vision issued to Formula and
  constituting 59.4% of the outstanding share capital of Formula Vision. The
  price per share was NIS 4.11 ($0.93) which reflects the average closing price
  of Formula Visions shares on the TASE during the 30 days preceding Formulas
  resolution approving the transaction, which was relative closed to the
  average of the market price.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | All
  unrealized gains which were resulted out of the original transaction in 2001,
  were eliminated during the 2004 transaction.                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Formula
  Vision is a managing and holding company, guiding a group of privately held
  IT companies with innovative, proprietary technologies and solutions targeting
  international markets. Formula Vision holds a controlling interest in some of
  these privately held companies and a minority interest in the other members
  of the group.                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | The results
  of operations of Formula Vision are included in the results of operations of
  the Company for all of 2004.                                                                                                                                                                                                                                                                                                                                                                                                    

F26

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2    Certain Transactions
(cont.):

|   |                                                                                                                                                           
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|B. | (cont.):                                                                                                                                                  
|   |                                                                                                                                                           
|   | Following
  are the amounts assigned to major components of 2004 acquisitions balance
  sheets in the aggregate as of the date of purchase (in thousands):

| |                                                 |  |                          |         | 
| | ----------------------------------------------- |  | ------------------------ | ------- | 
| |                                                 |  | (U.S. $ in 
  thousands) |        
| |                                                 |  |                          |        
| |                                                 |  |                          |         | 
| | Current
  assets                                |  |                          | 35,883  | 
| | Investment
  and other assets                   |  |                          | 30,666  | 
| | Property and
  Equipment                        |  |                          | 3,893   | 
| |                                                 |  |                          |         | 
| | Total
  tangible assets acquired                |  |                          | 70,442  | 
| | Goodwill                                        |  |                          | 57,144  | 
| | Customer
  related intangible asset (1)         |  |                          | 967     | 
| |                                                 |  |                          |         | 
| | Technology (2)                                  |  |                          | 5,579   | 
| |                                                 |  |                          |         | 
| | Total
  tangible and intangible assets acquired |  |                          | 134,132 | 
| | Current
  liabilities                           |  |                          | 29,523  | 
| | Debenture                                       |  |                          | 45,336  | 
| | Other long
  term liabilities                   |  |                          | 13,888  | 
| |                                                 |  |                          |         | 
| | Total
  liabilities                             |  |                          | 88,747  | 
| | Minority
  interest                             |  |                          | 9,131   | 
| |                                                 |  |                          |         | 
| | Net assets
  acquired                           |  |                          | 36,254  | 
| |                                                 |  |                          |         | 

|    |                                                                                      
|--- | -------------------------------------------------------------------------------------
|(1) | The value
  assigned to customer related intangibles is being amortized over 8 years.
|   
|(2) | The value
  assigned to technology is being amortized over 5-10 years.               

F27

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2    Certain Transactions
(cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|B. | (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | The following
  unaudited pro forma summary presents information as if the acquisitions had
  occurred as of January 1, 2003. The pro forma information, which is provided
  for informational purposes only, is based on historical information and does
  not necessarily reflect the results that would have occurred, nor is it
  necessarily indicative of future results of operations of the consolidated
  entity. None of the goodwill is tax deductible. All goodwill was allocated to
  the proprietary software products segment.

| |                            |  |                                                               |         |  
| | -------------------------- |  | ------------------------------------------------------------- | ------- | -
| |                            |  | Year ended
  December 31, 2003                                |        
| |                            |  |                                                               |        
| |                            |  | (U.S.$ in
  thousands,
  except per share data)
  (unaudited) |        
| |                            |  |                                                               |        
| |                            |  |                                                               |         |  
| | Revenues                   |  |                                                               | 378,873 |  
| | Net loss                   |  |                                                               | (4,763  | )
| | Loss per
  share  basic   |  |                                                               | (1.54   | )
| | Loss per
  share  diluted |  |                                                               | (1.57   | )

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|C. | On May 30,
  2002, Formula consummated a public offering in Israel of $14.8 million of
  debentures. Options to purchase an aggregate of 2,000,000  ordinary shares of Formula were attached
  to the debentures. The proceeds from the public offering were $14.9 million
  of which $13.8 million were allocated to the debentures and $1.1 million were
  allocated to the options. The allocation was made on the basis of the average
  market price of the options in the first 3 trading days.            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | The
  debentures are repayable in a lump sum in three years, but can be redeemed
  earlier by the holders at a predetermined redemption price. The nominal
  interest rate for each year of the three-years is approximately 5.77%,
  payable only after 3 years. Principal and interest on the debentures are
  linked to  the CPI. In June 2003,
  Formula repurchased $2.4 million aggregate principal amount of the debenture,
  leaving $14.50 million aggregate principal amount of debentures outstanding.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | The
  associated options were for a term of one year and were exercisable at a
  price of $15.8 per ordinary share. The exercise price of the options was also
  linked to the CPI. The options expired on May 30, 2003.(see Note 19(3))                                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|D. | On July 30,
  2002, Matrix consummated a public offering in Israel of $21 million
  debentures linked to the CPI and bearing interest at an annual rate of 4.95%,
  to be repaid on August 5, 2005.                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | The
  debentures are convertible into ordinary shares of Matrix at any time until
  July 17, 2005.                                                                                                                                                                                                                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | Matrix
  received a request for 96,194 packages in the aggregate amount of $19.6
  million of which 30,000 packages were requested by Matrix I.T. Systems Ltd.
  (a subsidiary of Matrix).                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | Options to
  purchase an aggregate of 10,000,000 ordinary shares of Matrix, were attached
  to the debentures.                                                                                                                                                                                                                                                                                                                                                                                                   

F28

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2    Certain Transactions
(cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|D. | (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The
  associated options have a term of 3 years and are exercisable at a price of
  $1.69 (linked to the CPI) per Matrix ordinary share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The proceeds
  from the public offering were $13.4 million, of which $12.3 million were
  allocated to the debentures and $1.1 million were allocated to the options.
  The allocation was done on the basis of the average market price of the
  option in the first 3 trading days.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The
  debentures were issued at a discount, which is being amortized over the life
  of the debentures.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | During 2003,
  Matrix IT Systems Ltd. sold all of Matrixs convertible debentures held by it
  for an aggregate consideration of $4.5 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|E. | In December
  2003, Sapiens completed an offering of securities in Israel, resulting in
  gross proceeds to Sapiens of approximately $17.1 million. In this offering,
  Sapiens sold 100,000 units of securities, each unit consisting of 800
  unsecured convertible debentures (Series A), two options (Series A)
  exercisable into debentures (Series A) and six warrants (Series 1)
  exercisable into common shares of Sapiens. The debentures are linked to the
  dollar and bear interest at an annual rate of 6%. The debentures are
  convertible into Sapiens common shares until November 21, 2009. Each NIS 27
  (currently approximately $5.90) amount of debentures may be converted into
  one common share of Sapiens, subject to adjustments. Each warrant (Series 1)
  is exercisable into one common share of Sapiens at an exercise price of
  approximately $6.14. The warrants are exercisable  until November 21, 2007.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|F. | In April
  2000, Sapiens completed a private placement of 600,000 shares of Common stock
  (investors shares) in its wholly owned subsidiary, eZoneXchange.com, Inc.
  (eZoneXchange), for $15 million. The investors also received a warrant to
  purchase an additional 2.25% of the Common Stock of eZoneXchange at the same
  private placement share price of $25 per share. As part of the transaction,
  the subsidiary entered into a Put/Call Agreement pursuant to which the
  investors were granted the right (exercisable in whole or in part) to cause
  the subsidiary during the put option exercise period (May 4, 2004 through May
  3, 2005) to repurchase the investors shares at the principal amount of the
  investors investment plus 5% annual interest accrued thereon from May 4,
  2000.                                                                                                                    

F29

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2    Certain Transactions
(cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                               
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|F. | (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | The Put/Call
  Agreement provides that 50% of the consideration from the investors shares
  will be paid in cash and 50% in the Subsidiarys Common shares to be valued
  according to the average closing market price of the Subsidiarys Common
  share over the 14-day trading period preceding the date of issuance of the
  put consideration. The agreement also included a call option which grants the
  subsidiary the option to purchase the investors shares at a price of $30 in
  the first two years after the investment date, $37.5 in the third year, and
  $45 in the fourth year. The purchase price will be multiplied by the
  percentage of shares purchased. The exercise period will last until the
  earlier of the fifth anniversary of the investment date, an acquisition of
  eZoneXchange, or an IPO by eZoneXchange.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | During
  February 2001, the subsidiary decided to close the operations of
  eZoneXchange, and repurchased 173,100 of the investors shares with a cash
  repayment of $4.5 million for principal and interest, according to an
  amendment to the Put/Call Agreement. As a result, the amount of the principal
  portion of the redeemable shares in a subsidiary to be repaid in cash was
  decreased by $4.2 million, net of expenses.                                                                                                                                                                                                                                                                                                                                                                                                              
|  
|   | In addition,
  in accordance with the amendment, if the market price of the subsidiary
  Common share reaches $10 per share, the investors will have the right to put
  192,333 shares of its eZoneXchange stocks in return for the subsidiarys
  363,776 Common shares at a price of $13.75 per share. No interest is accrued
  for the amended portion of the investment. The remaining portion of the
  investment to be repaid in shares (approximately $2.5 million) will continue
  to be subject to the original terms of the Put/Call Agreement. The amendment
  terminated the subsidiarys call option.                                                                                                                                                                                                                                    
|  
|   | As of March
  16, 2004, the balance of the Redeemable Shares in eZoneXchange totaled
  approximately $11.6 million, including interest accrued through that date.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | On March 16,
  2004, the subsidiary and the investors signed an agreement according to
  which, among other terms specified in the agreement, the subsidiary would
  redeem the remaining eZoneXchange Common
  shares and eZoneXchange warrants held by the investors by three means:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                               
|   | a.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | Issuance of
  shares: a subsidiary issued to the investors an aggregate of 750,000 of the
  subsidiarys Common shares on March 26, 2004.                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | In addition,
  the investors were granted a right to demand the registration of the shares,
  such right to be effective no earlier than March 31, 2005.      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | The Common
  shares issued were valued at approximately $2.7 million, based on the
  subsidiarys stock market price on the date of issuance (March 26, 2004).



F30

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 2    Certain Transactions
(cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                        
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|F. | (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | b.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | Loan
  payable: the subsidiary agreed to pay an amount of $8.6 million to the
  investors, bearing annual interest of 7.5% compounded annually on the
  outstanding principal from January 1, 2004 to be paid semi-annually, with
  principal payments of $4.6 million by no later than May 1, 2004, and $4.0
  million by no later than May 1, 2005. The May 1, 2004 payment was made by the
  subsidiary on schedule.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | The 7.5%
  interest rate is considered the market interest rate for debt with similar
  risk, and accordingly, the fair value of the loan payable was determined to
  be its carrying value.                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | c.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | Warrants:
  the subsidiary issued to the investors warrants to purchase 350,000 shares of
  Common Stock of the subsidiary at an exercise price of $4.00 per common share
  of the subsidiary, exercisable at any time and from time to time during the
  period from issuance to December 31, 2007.                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | The warrants
  were valued at $560,000 using the Black-Scholes pricing model with the
  following assumptions: exercise price $4, fair value of the underlying shares
  $3.65, interest rate 2.5%, dividend yield  0% and volatility of 60%.                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | The
  difference between the fair value of the new debt, equal to $11,868,000, and
  the carrying amount of the liability before the modification of $11,569,000,
  in the amount of $299,000, was recorded as a settlement of redeemable shares
  in a subsidiary and deemed to be a dividend in the 2004 consolidated
  statements of operations.                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | Pursuant to
  an evaluation of the terms of the agreement under the provisions of EITF
  00-19, Accounting for Derivative Financial Instruments Indexed to, and
  potentially settled in, a Companys own Stock, the Company has classified
  all of the above derivative financial instruments issued in connection with
  the private placement as liabilities.                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | On May 29,
  2005, the subsidiary entered into an agreement with the investors in
  eZoneXchange regarding the payment of the remaining $4.0 million due to the
  investors originally due on May 1, 2005. The subsidiary agreed to pay $2.0
  million on May 1, 2005, $1.0 million on April 1, 2006 and $1.0 million on
  August 1, 2006. The investors may, at their sole discretion, convert all or
  any portion of the $1.0 million payable on August 1, 2006 into the
  subsidiarys Common shares, at a conversion price per each share of $3.20. In
  addition, the interest due on the remaining amount was changed to Libor+2.5%.
  The first installment of $2.0 million was paid as required at the beginning
  of May 2005.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

|G. | In
March   2004, a subsidiary, as part of a private placement, issued convertible
  debentures and warrants to four institutional investors in a total amount of
  approximately $5 million.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F31

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2    Certain Transactions (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|H. | On September
  23, 2004, F.V.T. and Transtech Control Ltd. (Transtech) a subsidiary of
  F.V.T, entered into an agreement with funds under which the Funds and F.V.T.
  invested in Transtech $19 million (of which $14 million were invested by Giza
  and Accel) for preferred shares representing 47% in the equity of Transtech.
  The Funds were also granted an option to purchase 50% of their original
  investment for a price of 150% of the current purchase price. The option is
  for 5 years.
|   | Furthermore,
  the Funds were granted an option for 3 months to increase the total
  investment to $25 million under the above terms.                                                                                                                                                                                                                                                                                                                                                                        
|   | No gain or loss
  arose from the transaction since the preferred shares cannot be treated as an
  investment in common shares (per SAB 51).                                                                                                                                                                                                                                                                                                                                                                  
|   | Pursuant to
  the transaction, F.V.T. held 36.7% of Transtech voting rights. In February
  2005, the Funds exercised their option and invested an additional $6 million.
  Following the investment, F.V.T. holds 31.14% of Transtech voting rights.                                                                                                                                                                                                                                                         

Note 3    Short-term Investments:

|   |          
|-- | ---------
|A. | Comprise:

| |                                 |  |                 |           |                         |  |        |  |  |       | 
| | ------------------------------- |  | --------------- | --------- | ----------------------- |  | ------ |  |  | ----- | 
| |                                 |  | Interest
  rate |           |                         |  |        | 
| |                                 |  |                 |           | December
  31,          | 
| |                                 |  | December
  31,  |           |                         | 
| |                                 |  | 2004            |           | 2004                    |  | 2003   | 
| |                                 |  |                 |           |                         |  |        | 
| |                                 |  | %               |           | (U.S. $ in
  thousands) | 
| |                                 |  |                 |           |                         | 
| |                                 |  |                 |           |                         |  |        |  |  |       | 
| | Trading
  securities            |  |                 |          |                         |  | 13,556 |  |  | 7,773 | 
| | Available-for-sale
  securities |  |                 |          |                         |  | 16,380 |  |  |      | 
| | Short-term
  deposits           |  |                 |          |                         |  |       |  |  | 1,000 | 
| | Restricted
  deposits           |  |                 | 0.753.52 |                         |  | 9,137  |  |  |      | 
| |                                 |  |                 |           |                         |  |        |  |  |       | 
| | Total                           |  |                 |           |                         |  | 39,073 |  |  | 8,773 | 
| |                                 |  |                 |           |                         |  |        |  |  |       | 

F32

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3    Short-term Investment (cont.):

|   |                                                                                                       
|-- | ------------------------------------------------------------------------------------------------------
|B. | The following is a summary of marketable debt securities which are
  classified as available-for-sale:

| |                                                  |  |                         |        |                               |  |                |   |                   |        |                               |  |                |  |  |   |  |  |   | 
| | ------------------------------------------------ |  | ----------------------- | ------ | ----------------------------- |  | -------------- | - | ----------------- | ------ | ----------------------------- |  | -------------- |  |  | - |  |  | - | 
| |                                                  |  | December
  31,          |       
| |                                                  |  |                         |       
| |                                                  |  | 2004                    |        | 2003                          | 
| |                                                  |  |                         |        |                               | 
| |                                                  |  | (U.S. $ in
  thousands) |       
| |                                                  |  |                         |       
| |                                                  |  | Amortized
  cost        |        | Unrealized
  gains
  (losses) |  | Market
  value |   | Amortized
  costs |        | Unrealized
  gains
  (losses) |  | Market
  value | 
| |                                                  |  |                         |        |                               |  |                |   |                   |        |                               |  |                | 
| |                                                  |  |                         |        |                               |  |                |   |                   |        |                               |  |                |  |  |   |  |  |   | 
| | Available-for-sale:                              |  |                         |        |                               |  |                |   |                   |        |                               |  |                |  |  |   |  |  |   | 
| | Government debentures                            |  |                         | 3,513  |                               |  | (11            | ) |                   | 3,502  |                               |  |               |  |  |  |  |  |  | 
| | Commercial
  debentures                          |  |                         | 11,960 |                               |  | (103           | ) |                   | 11,857 |                               |  |               |  |  |  |  |  |  | 
| | Equity funds                                     |  |                         | 980    |                               |  | 41             |   |                   | 1,021  |                               |  |               |  |  |  |  |  |  | 
| |                                                  |  |                         |        |                               |  |                |   |                   |        |                               |  |                |  |  |   |  |  |   | 
| | Total available-for-sale marketable
  securities |  |                         | 16,453 |                               |  | (73            | ) |                   | 16,380 |                               |  |               |  |  |  |  |  |  | 
| |                                                  |  |                         |        |                               |  |                |   |                   |        |                               |  |                |  |  |   |  |  |   | 

| |                                                                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | During 2004,
  the Company recorded proceeds from sales of marketable securities in the amount
  of $3,130 thousands and related gains of $11 thousands in financial income,
  net.                                                                                                                                                                     
| | Since the
  Company has the ability and intent to hold these investments until a recovery
  of fair value, the Company does not consider these investments to be other
  than temporarily impaired as of December 31, 2004. In addition, these
  securities have been in a continuous unrealized losses position for a period
  not more than 12 months.
| |                                                                                                                                                                                                                                                                                                                                                         
| | The
  estimated fair value of available-for-sale investments as of December 31,
  2004, by contractual maturity, are as follows:                                                                                                                                                                                                                        

| |                                 |  |                         |        |                |  |                   |  |                |   |  |  |   | 
| | ------------------------------- |  | ----------------------- | ------ | -------------- |  | ----------------- |  | -------------- | - |  |  | - | 
| |                                 |  | December
  31,          |       
| |                                 |  |                         |       
| |                                 |  | 2004                    |        | 2003           | 
| |                                 |  |                         |        |                | 
| |                                 |  | (U.S. $ in
  thousands) |       
| |                                 |  |                         |       
| |                                 |  | Cost                    |        | Market
  value |  | Amortized
  costs |  | Market
  value |  
| |                                 |  |                         |        |                |  |                   |  |                |  
| |                                 |  |                         |        |                |  |                   |  |                |   |  |  |   | 
| | Available-for-sale:             |  |                         |        |                |  |                   |  |                |   |  |  |   | 
| | Matures in one year             |  |                         | 980    |                |  | 1,021             |  |                |  |  |  |  | 
| | Matures in one to five years    |  |                         | 9,835  |                |  | 9,684             |  |                |  |  |  |  | 
| | Matures in more than five years |  |                         | 5,638  |                |  | 5,675             |  |                |  |  |  |  | 
| |                                 |  |                         |        |                |  |                   |  |                |   |  |  |   | 
| |                                 |  |                         | 16,453 |                |  | 16,380            |  |                |  |  |  |  | 
| |                                 |  |                         |        |                |  |                   |  |                |   |  |  |   | 

F33

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 4    Loans and Other Investments:

Comprise:

|                             |  |                 |     |         |  |                         |  |                |       |  |  |       |  
|---------------------------- |  | --------------- | --- | ------- |  | ----------------------- |  | -------------- | ----- |  |  | ----- | -
|                             |  |                 |     |         |  |                         |  | December
  31, |      
|                             |  |                 |     |         |  |                         |  |                |      
|                             |  | Interest
  rate |     |         |  | 2004                    |  | 2003           |      
|                             |  |                 |     | Linkage |  |                         |  |                |      
|                             |  | %               |     | basis   |  | (U.S. $ in
  thousands) | 
|                             |  |                 |     |         |  |                         | 
|                             |  |                 |     |         |  |                         |  |                |       |  |  |       |  
|Cost of
  shares (1)         |  |                 |     |         |  |                         |  |                | 1,788 |  |  | 1,760 | *
|                             |  |                 |     |         |  |                         |  |                |       |  |  |       |  
|Long-term
  prepaid expenses |  |                 |     |         |  |                         |  |                | 640   |  |  | 1,082 |  
|                             |  |                 |     |         |  |                         |  |                |       |  |  |       |  
|                             |  |                 |     |         |  |                         |  |                |       |  |  |       |  
|Restricted
  deposit         |  |                 |    |         |  | Dollar                  |  |                | 1,532 |  |  |      |  
|Deposit                      |  |                 |    |         |  | Dollar                  |  |                | 55    |  |  |      |  
|Deposit                      |  |                 |    |         |  | CPI                     |  |                | 348   |  |  | 250   |  
|Deposit                      |  |                 | 03 |         |  | Yen                     |  |                | 378   |  |  |      |  
|Loan (2)                     |  |                 |    |         |  | CPI                     |  |                | 506   |  |  |      |  
|                             |  |                 |     |         |  |                         |  |                |       |  |  |       |  
|                             |  |                 |     |         |  |                         |  |                | 2,819 |  |  | 250   |  
|                             |  |                 |     |         |  |                         |  |                |       |  |  |       |  
|Total                        |  |                 |     |         |  |                         |  |                | 5,247 |  |  | 3,092 |  
|                             |  |                 |     |         |  |                         |  |                |       |  |  |       |  

|    |                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | During 2004
  and 2003 impairment losses on cost investments have been identified in the
  amounts of $93 thousand and $862 thousand respectively.
|   
|(2) | No repayment
  date has been set.                                                                                                                 

F34

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 5    Investments in Affiliates:

|   |                                                       
|-- | ------------------------------------------------------
|A. | The Investments are composed and presented as follows:

| |                                                                                              |  |                         |         |      |  |        |  
| | -------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ------ | -
| |                                                                                              |  | December
  31,          |        
| |                                                                                              |  |                         |        
| |                                                                                              |  | 2004                    |         | 2003 | 
| |                                                                                              |  |                         |         |      | 
| |                                                                                              |  | (U.S. $ in
  thousands) |        
| |                                                                                              |  |                         |        
| | Investment in shares:                                                                        |  |                         |         |      |  |        |  
| | Cost                                                                                         |  |                         | 28,188  |      |  | 6,503  |  
| | Goodwill and allocated original excess cost
  ***                                            |  |                         | (12,174 | )    |  | (272   | )
| |                                                                                              |  |                         |         |      |  |        |  
| | Net asset value as of acquisition date                                                       |  |                         | 16,014  |      |  | 6,231  |  
| | Equity in post-acquisition undistributed
  retained losses, net                              |  |                         | (4,159  | )    |  | (5,982 | )
| |                                                                                              |  |                         |         |      |  |        |  
| | Net asset value as of the balance sheet
  date                                               |  |                         | 11,855  |      |  | 249    |  
| | Balance of goodwill                                                                          |  |                         | 12,297  |      |  |       |  
| |                                                                                              |  |                         |         |      |  |        |  
| |                                                                                              |  |                         | 24,152  |      |  | 249    |  
| |                                                                                              |  |                         |         |      |  |        |  
| | Loans to affiliates:                                                                         |  |                         |         |      |  |        |  
| | Index-linked and interest-free *                                                             |  |                         | 117     |      |  | 196    |  
| | Linked to the dollar and bearing annual
  interest of 3.71%*                                 |  |                         | 120     |      |  |       |  
| | Linked to the dollar and interest-free,
  repayment on January 2007                          |  |                         |        |      |  | 400    |  
| | Linked to the dollar and interest-free**                                                     |  |                         |        |      |  | 761    |  
| | Linked to the dollar and bearing annual
  interest of LIBOR + 1%, repayment on February 2007 |  |                         |        |      |  | 1,767  |  
| |                                                                                              |  |                         |         |      |  |        |  
| | Total                                                                                        |  |                         | 24,389  |      |  | 3,373  |  
| |                                                                                              |  |                         |         |      |  |        |  

| |     |                                                                                                                                                                                                
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | *   | No repayment
  date has been set.                                                                                                                                                              
|
| | **  | 3 equal
  installments beginning May 2006 or when the current ratio of the affiliates
  exceeds 1.25.                                                                                          
|
| | *** | As from
  January 1, 2002, the investment is being tested for impairment on an annual
  basis rather than amortizing the goodwill as required by previous accounting
  standards (see Note 1H).

|   |                                                                                                                    
|-- | -------------------------------------------------------------------------------------------------------------------
|B. | Following are details relating to the financial position and results
  of operations of investees in the aggregate:

| |                     |  |                         |         |      |  |         |  
| | ------------------- |  | ----------------------- | ------- | ---- |  | ------- | -
| |                     |  | December
  31,          |        
| |                     |  |                         |        
| |                     |  | 2004                    |         | 2003 | 
| |                     |  |                         |         |      | 
| |                     |  | (U.S. $ in
  thousands) |        
| |                     |  |                         |        
| |                     |  |                         |         |      |  |         |  
| | Total assets        |  |                         | 92,849  |      |  | 17,105  |  
| |                     |  |                         |         |      |  |         |  
| | Total
  liabilities |  |                         | (31,984 | )    |  | (13,319 | )
| |                     |  |                         |         |      |  |         |  
| | Net income
  (loss) |  |                         | (7,784  | )    |  | (1,858  | )
| |                     |  |                         |         |      |  |         |  

F35

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 6    Property and Equipment:

Comprise:

| |                             |  |                         |        |      |  |        | 
| | --------------------------- |  | ----------------------- | ------ | ---- |  | ------ | 
| |                             |  | December
  31,          |       
| |                             |  |                         |       
| |                             |  | 2004                    |        | 2003 | 
| |                             |  |                         |        |      | 
| |                             |  | (U.S. $ in
  thousands) |       
| |                             |  |                         |       
| | Cost:                       |  |                         |        |      |  |        | 
| | Computers and equipment     |  |                         | 63,228 |      |  | 52,041 | 
| | Motor vehicles              |  |                         | 5,538  |      |  | 8,371  | 
| | Buildings                   |  |                         | 11,614 |      |  | 10,078 | 
| | Leasehold improvements      |  |                         | 8,434  |      |  | 6,396  | 
| |                             |  |                         |        |      |  |        | 
| |                             |  |                         | 88,814 |      |  | 76,886 | 
| |                             |  |                         |        |      |  |        | 
| |                             |  |                         |        |      |  |        | 
| | Accumulated
  Depreciation: |  |                         |        |      |  |        | 
| | Computers and equipment     |  |                         | 51,933 |      |  | 41,485 | 
| | Motor vehicles              |  |                         | 2,058  |      |  | 3,996  | 
| | Buildings                   |  |                         | 2,973  |      |  | 2,283  | 
| | Leasehold improvements      |  |                         | 5,321  |      |  | 3,366  | 
| |                             |  |                         |        |      |  |        | 
| |                             |  |                         | 62,285 |      |  | 51,130 | 
| |                             |  |                         |        |      |  |        | 
| | Depreciated
  balance       |  |                         | 26,529 |      |  | 25,756 | 
| |                             |  |                         |        |      |  |        | 

| |                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | Depreciation
  expense totaled $7,810 thousand; $7,251 thousand and $7,536 thousand for the
  years ended December 31, 2004, 2003 and 2002, respectively.
|
| | See Note 14
  with respect to pledges.                                                                                                                   

Note 7    Goodwill:

The changes in
the carrying amount of goodwill for the year ended December 31, 2004 are as
follows:

| |                                                       |  |                       |         |  
| | ----------------------------------------------------- |  | --------------------- | ------- | -
| |                                                       |  | U.S. $ in
  thousands |        
| |                                                       |  |                       |        
| |                                                       |  |                       |         |  
| | Balance as
  of January 1, 2004                       |  |                       | 142,214 |  
| | Acquisition
  of additional interest in subsidiaries  |  |                       | 6,357   |  
| | Realization
  and decrease in shareholding percentage |  |                       | (5,598  | )
| | Acquisition
  of newly-consolidated subsidiaries      |  |                       | 60,524  |  
| | Realization
  of previously consolidated subsidiaries |  |                       | (7,756  | )
| | Foreign
  currency translation adjustments            |  |                       | 1,180   |  
| |                                                       |  |                       |         |  
| | Balance as of December 31, 2004                       |  |                       | 196,921 |  
| |                                                       |  |                       |         |  

F36

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 8    Other Assets, Net:Comprised as
follows:

|   |                  
|-- | -----------------
|A. | Original amounts:

| |                                        |  |                         |         |      |  |         |  
| | -------------------------------------- |  | ----------------------- | ------- | ---- |  | ------- | -
| |                                        |  | December
  31,          |        
| |                                        |  |                         |        
| |                                        |  | 2004                    |         | 2003 | 
| |                                        |  |                         |         |      | 
| |                                        |  | (U.S. $ in
  thousands) |        
| |                                        |  |                         |        
| |                                        |  |                         |         |      |  |         |  
| | Capitalized software development costs |  |                         | 113,135 |      |  | 86,485  | *
| | Deferred expenses and others           |  |                         | 13,369  |      |  | 8,764   | *
| | Deferred tax asset                     |  |                         | 5,467   |      |  | 5,184   |  
| |                                        |  |                         |         |      |  |         |  
| |                                        |  |                         | 131,971 |      |  | 100,433 |  
| |                                        |  |                         |         |      |  |         |  
| | Accumulated
  amortization:            |  |                         |         |      |  |         |  
| | Capitalized software development costs |  |                         | 62,045  |      |  | 50,001  |  
| | Deferred expenses and others           |  |                         | 5,488   |      |  | 4,319   |  
| |                                        |  |                         | 67,533  |      |  | 54,320  |  
| |                                        |  |                         |         |      |  |         |  
| | Total                                  |  |                         | 64,438  |      |  | 46,113  |  
| |                                        |  |                         |         |      |  |         |  

|   |                                                                                                                                                                                                                         
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|B. | Amortized
  expenses totaled $11,496 thousand, $10,573 thousand and $5,370 thousand for
  the years ended December 31, 2004, 2003 and 2002, respectively.As for
  impairments of software development cost, see Note 1K.
|  
|C. | Estimated
  deferred expenses and other intangible assets amortization expenses for the
  years ended:                                                                                                                  

| |                       |  |  |                         |  |  | 
| | --------------------- |  |  | ----------------------- |  |  | 
| |                       |  |  |                         |  | 
| | December
  31,        |  |  | (U.S. $ in
  thousands) | 
| |                       |  |  |                         | 
| |                       |  |  |                         |  | 
| | 2005                  |  |  | 1,769                   |  | 
| | 2006                  |  |  | 1,285                   |  | 
| | 2007                  |  |  | 1,246                   |  | 
| | 2008                  |  |  | 1,119                   |  | 
| | 2009 and
  thereafter |  |  | 1,986                   |  | 

Note 9    Debentures:

|                                      |  |         |        |      |          |                         |      |                |        |  |  |        | 
|------------------------------------- |  | ------- | ------ | ---- | -------- | ----------------------- | ---- | -------------- | ------ |  |  | ------ | 
|                                      |  |         |        |      |          |                         |      | December
  31, |       
|                                      |  |         |        |      |          |                         |      |                |       
|                                      |  |         |        |      |          |                         | 2004 |                | 2003   | 
|                                      |  |         |        |      | Interest |                         |      |                |        | 
|                                      |  | Linkage |        | rate |          | (U.S. $ in
  thousands) |     
|                                      |  |         |        |      |          |                         |     
|Debenture
  (see note 2C)             |  |         | CPI    |      |          | 5.77%                   |      |                | 15,875 |  |  | 14,160 | 
|Convertible
  debenture (see note 2D) |  |         | CPI    |      |          | 4.95%                   |      |                | 14,139 |  |  |       | 
|Convertible
  debenture               |  |         | Dollar |      |          | 5%                      |      |                | 2,360  |  |  | 1,180  | 
|                                      |  |         |        |      |          |                         |      |                |        |  |  |        | 
|Total                                 |  |         |        |      |          |                         |      |                | 32,374 |  |  | 15,340 | 
|                                      |  |         |        |      |          |                         |      |                |        |  |  |        | 

F37

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 10    Liabilities to Banks and Others:

|   |             
|-- | ------------
|A. | Composition:

| |       |  |                     |           |                 |  |                         |                       |                      |                       |                                                             |  |                                                             |  |  |        |  |  |        | 
| | ----- |  | ------------------- | --------- | --------------- |  | ----------------------- | --------------------- | -------------------- | --------------------- | ----------------------------------------------------------- |  | ----------------------------------------------------------- |  |  | ------ |  |  | ------ | 
| |       |  | Interest
  rate     |           | Linkage
  basis |  | Long-term
  liabilities |                       | Current
  maturities |                       | Total
  long-term
  liabilities net of
  current maturities |  | Total
  long-term
  liabilities net of
  current maturities | 
| |       |  |                     |           |                 |  |                         |                       |                      |                       |                                                             |  |                                                             | 
| |       |  | December
  31, 2004 |           |                 |  |                         | December
  31, 2004   |                      | December
  31, 2003   |                                                            
| |       |  |                     |           |                 |  |                         |                       |                      |                       |                                                            
| |       |  | %                   |           |                 |  |                         | (U.S. $ in thousands) |                      | (U.S. $ in thousands) |                                                            
| |       |  |                     |           |                 |  |                         |                       |                      |                       |                                                            
| |       |  |                     | 37.5     |                 |  | Dollar                  |                       |                      | 26,352                |                                                             |  | 13,315                                                      |  |  | 13,037 |  |  | 19,800 | 
| |       |  |                     | 4.327.66 |                 |  | CPI                     |                       |                      | 4,129                 |                                                             |  | 1,920                                                       |  |  | 2,209  |  |  | 1,911  | 
| |       |  |                     | 09.35    |                 |  | Others                  |                       |                      | 6,337                 |                                                             |  | 2,114                                                       |  |  | 4,223  |  |  | 189    | 
| |       |  |                     |           |                 |  |                         |                       |                      |                       |                                                             |  |                                                             |  |  |        |  |  |        | 
| |       |  |                     |           |                 |  |                         |                       |                      | 36,818                |                                                             |  | 17,349                                                      |  |  | 19,469 |  |  | 21,900 | 
| |       |  |                     |           |                 |  |                         |                       |                      |                       |                                                             |  |                                                             |  |  |        |  |  |        | 
| |       |  |                     | Warrants  |                 |  |                         |                       |                      | 320                   |                                                             |  |                                                            |  |  | 320    |  |  |       | 
| |       |  |                     |           |                 |  |                         |                       |                      |                       |                                                             |  |                                                             |  |  |        |  |  |        | 
| | Total |  |                     |           |                 |  |                         |                       |                      | 37,138                |                                                             |  | 17,349                                                      |  |  | 19,789 |  |  | 21,900 | 
| |       |  |                     |           |                 |  |                         |                       |                      |                       |                                                             |  |                                                             |  |  |        |  |  |        | 

|   |                
|-- | ---------------
|B. | Maturity Dates:

| |                                   |  |                         |        |      |  |        | 
| | --------------------------------- |  | ----------------------- | ------ | ---- |  | ------ | 
| |                                   |  | December
  31,          |       
| |                                   |  |                         |       
| |                                   |  | 2004                    |        | 2003 | 
| |                                   |  |                         |        |      | 
| |                                   |  | (U.S. $ in
  thousands) |       
| |                                   |  |                         |       
| | First year
  (current maturities) |  |                         | 17,349 |      |  | 7,819  | 
| | Second year                       |  |                         | 17,909 |      |  | 16,761 | 
| | Third year                        |  |                         | 1,404  |      |  | 4,975  | 
| | Fourth year                       |  |                         | 102    |      |  | 42     | 
| | Fifth year                        |  |                         | 27     |      |  | 30     | 
| | Sixth year
  and thereafter       |  |                         | 347    |      |  | 92     | 
| |                                   |  |                         |        |      |  |        | 
| | Total                             |  |                         | 37,138 |      |  | 29,719 | 
| |                                   |  |                         |        |      |  |        | 

|   |                                                  
|-- | -------------------------------------------------
|C. | For details of liens and guarantees, see Note 14.

Note 11    Debentures:

Comprised as follows:

|                                       |  |         |        |                 |  |                         |  |                |        |      |  |        | 
|-------------------------------------- |  | ------- | ------ | --------------- |  | ----------------------- |  | -------------- | ------ | ---- |  | ------ | 
|                                       |  |         |        |                 |  |                         |  | December
  31, |       
|                                       |  |         |        |                 |  |                         |  |                |       
|                                       |  |         |        |                 |  |                         |  | 2004           |        | 2003 | 
|                                       |  |         |        |                 |  |                         |  |                |        |      | 
|                                       |  | Linkage |        | Interest
  rate |  | (U.S. $ in
  thousands) | 
|                                       |  |         |        |                 |  |                         | 
|                                       |  |         |        |                 |  | Six-month               |  |                |        |      |  |        | 
|Convertible
  debenture (see Note 2G)  |  |         | Dollar |                 |  | Libor                   |  |                | 5,149  |      |  |       | 
|Convertible
  debenture (see Note 2D)  |  |         | CPI    |                 |  | 4.95%                   |  |                | 17,363 |      |  | 21,221 | 
|Convertible
  debenture                |  |         | Dollar |                 |  | 5%                      |  |                | 4,720  |      |  | 4,720  | 
|Convertible
  debentuere (see Note 2E) |  |         | Dollar |                 |  | 6%                      |  |                | 18,246 |      |  | 16,672 | 
|Convertible
  debentuere (see Note 2F) |  |         | Dollar |                 |  | 5%                      |  |                |       |      |  | 11,505 | 
|                                       |  |         |        |                 |  |                         |  |                |        |      |  |        | 
|                                       |  |         |        |                 |  |                         |  |                | 45,478 |      |  | 54,118 | 
|Deferred
  issuance expenses, net      |  |         |        |                 |  |                         |  |                | 1,894  |      |  | 1,955  | 
|                                       |  |         |        |                 |  |                         |  |                |        |      |  |        | 
|                                       |  |         |        |                 |  |                         |  |                | 43,584 |      |  | 52,163 | 
|Current
  maturities                   |  |         |        |                 |  |                         |  |                | 2,360  |      |  | 1,180  | 
|Current
  maturities (see note 2D)     |  |         |        |                 |  |                         |  |                | 14,139 |      |  |       | 
|                                       |  |         |        |                 |  |                         |  |                |        |      |  |        | 
|                                       |  |         |        |                 |  |                         |  |                | 27,086 |      |  | 50,983 | 
|                                       |  |         |        |                 |  |                         |  |                |        |      |  |        | 

F38

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 12    Employee Option Plans in
Subsidiaries:

Certain
subsidiaries granted options to their employees to purchase shares in the
respective companies. The options were mainly granted in the years 1999-2003.
In general, the options are exercisable 2-3 years after the date of grant and
expire 7-10 years after grant. Most of the options were granted as part of
plans that were adopted in accordance with the provisions of Section 102 of the
Israeli Income Tax Ordinance, which stipulate, inter alia, that the
subsidiaries will be able to claim the benefit that was charged to the
employees as an expense for tax purposes, if and when the employees become
liable for tax on the said benefit. For further information with respect to
expenses relating to the benefit to the employees, and additional disclosure
required by FAS 123, see Note 1X.

|   |                                                                                                                                                             
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | The
  following is a summary of the status of options plans in BluePhoenix as of
  December 31, 2004, 2003 and 2002 and changes during the years then ended:

| |                                                                   |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
| | ----------------------------------------------------------------- |  | ------------------------------ | --------- | ------------------------------------- |  | ------------------------------ |  | ------------------------------------- | --------- | ------------------- |  | ------------------------------------- |  |  | --------- | - |  | ---- | 
| |                                                                   |  | Year ended
  December 31, 2004 |           | Year ended
  December 31, 2003        |  | Year ended
  December 31, 2002 | 
| |                                                                   |  |                                |           |                                       |  |                                | 
| |                                                                   |  | Number
  of options            |           | Weighted
  Average
  Exercise
  Price |  | Number
  of options            |  | Weighted
  Average
  Exercise
  Price |           | Number
  of options |  | Weighted
  Average
  Exercise
  Price | 
| |                                                                   |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       | 
| |                                                                   |  |                                |           | $                                     |  |                                |  | $                                     |           |                     |  | $                                     | 
| |                                                                   |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       | 
| | Options outstanding at the beginning of the
  year                |  |                                | 2,159,993 |                                       |  | 4.99                           |  |                                       | 1,347,260 |                     |  | 6.56                                  |  |  | 1,193,650 |   |  | 7.55 | 
| |                                                                   |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
| | Changes
  during the year:                                        |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
| | Granted                                                           |  |                                | 163,721   |                                       |  | 6.00                           |  |                                       | 923,000   |                     |  | 3.03                                  |  |  | 353,560   |   |  | 3.00 | 
| | Exercised                                                         |  |                                | (33,767   | )                                     |  | 3.56                           |  |                                       | (35,267   | )                   |  | 2.33                                  |  |  | (90,000   | ) |  | 3.57 | 
| | Forfeited                                                         |  |                                | (157,360  | )                                     |  | 6.29                           |  |                                       | (75,000   | )                   |  | 9.46                                  |  |  | (109,950  | ) |  | 8.9  | 
| |                                                                   |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
| | Options outstanding at the end of the
year                        |  |                                | 2,132,587 |                                       |  | 5.00                           |  |                                       | 2,159,993 |                     |  | 4.99                                  |  |  | 1,347,260 |   |  | 6.56 | 
| |                                                                   |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
| |                                                                   |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
| | Options exercisable at year-end                                   |  |                                | 877,049   |                                       |  | 6.08                           |  |                                       | 1,233,575 |                     |  | 6.04                                  |  |  | 888,333   |   |  | 7.63 | 
| |                                                                   |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
| | Weighted-average fair value of options
  granted during the year* |  |                                |           |                                       |  | 1.71                           |  |                                       |           |                     |  | 0.54                                  |  |  |           |   |  | 1.09 | 
| |                                                                   |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 

|  |                                                                                                                                                                                                                                                                                                                                                                                                        
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|* | The fair
  value of each option that was granted is estimated on the date of grant,
  using the Black-Scholes option-pricing model with the following weighted
  average assumptions: dividend yield of 0% for all years; expected volatility:
  2004  26%, 2003  28%, 2002  33%, risk-free interest rate 2004  2.78%,
  2003  2.1%, 2002  3.1% and expected life: 2004, 2003 and 2002  3 years.

F39

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 12    Employee Option Plans in
Subsidiaries (cont.):

|   |                                                                                                          
|-- | ---------------------------------------------------------------------------------------------------------
|A. | (cont.):                                                                                                 
|   |                                                                                                          
|   | The
  following table summarizes information in respect of outstanding options as
  of December 31, 2004.

| |                              |  |                                               |  |                                                 |           |                                   |  |                                               |  |                                     |  |  |  |  |       |  |  |  |  |         |  |  |  |  |       |  | 
| | ---------------------------- |  | --------------------------------------------- |  | ----------------------------------------------- | --------- | --------------------------------- |  | --------------------------------------------- |  | ----------------------------------- |  |  |  |  | ----- |  |  |  |  | ------- |  |  |  |  | ----- |  | 
| |                              |  | Options Outstanding                           |  | Options Exercisable                             |          
| |                              |  |                                               |  |                                                 |          
| | Range of
  Exercise
  Prices |  | Number
  Outstanding
  at December
  31, 2004 |  | Weighted Average
  Remaining
  Contractual Life |           | Weighted Average
  Exercise Price |  | Number
  Exercisable at
  December 31,
  2004 |  | Weighted
  Average
  Exercise Price | 
| |                              |  |                                               |  |                                                 |           |                                   |  |                                               |  |                                     | 
| | $                            |  |                                               |  | Years                                           |           | $                                 |  |                                               |  | $                                   | 
| |                              |  |                                               |  |                                                 |           |                                   |  |                                               |  |                                     | 
| | 2.25                         |  |                                               |  |                                                 | 416,000   |                                   |  |                                               |  | 8.25                                |  |  |  |  | 2.25  |  |  |  |  | 41,000  |  |  |  |  | 2.25  |  | 
| | 3.00                         |  |                                               |  |                                                 | 116,000   |                                   |  |                                               |  | 8.50                                |  |  |  |  | 3.00  |  |  |  |  | 36,000  |  |  |  |  | 3.00  |  | 
| | 3.00                         |  |                                               |  |                                                 | 183,250   |                                   |  |                                               |  | 7.50                                |  |  |  |  | 3.00  |  |  |  |  | 122,167 |  |  |  |  | 3.00  |  | 
| | 3.00                         |  |                                               |  |                                                 | 80,000    |                                   |  |                                               |  | 7.09                                |  |  |  |  | 3.00  |  |  |  |  | 53,333  |  |  |  |  | 3.00  |  | 
| | 3.50                         |  |                                               |  |                                                 | 70,000    |                                   |  |                                               |  | 8.50                                |  |  |  |  | 3.50  |  |  |  |  |        |  |  |  |  | 3.50  |  | 
| | 3.50                         |  |                                               |  |                                                 | 20,500    |                                   |  |                                               |  | 8.75                                |  |  |  |  | 3.50  |  |  |  |  |        |  |  |  |  | 3.50  |  | 
| | 4.00                         |  |                                               |  |                                                 | 200,000   |                                   |  |                                               |  | 8.83                                |  |  |  |  | 4.00  |  |  |  |  | 83,333  |  |  |  |  | 4.00  |  | 
| | 4.50                         |  |                                               |  |                                                 | 39,483    |                                   |  |                                               |  | 6.50                                |  |  |  |  | 4.50  |  |  |  |  | 39,483  |  |  |  |  | 4.50  |  | 
| | 4.50                         |  |                                               |  |                                                 | 10,000    |                                   |  |                                               |  | 8.25                                |  |  |  |  | 4.50  |  |  |  |  | 10,000  |  |  |  |  | 4.50  |  | 
| | 5.20                         |  |                                               |  |                                                 | 139,500   |                                   |  |                                               |  | 1.75                                |  |  |  |  | 5.20  |  |  |  |  | 139,500 |  |  |  |  | 5.20  |  | 
| | 5.50                         |  |                                               |  |                                                 | 13,000    |                                   |  |                                               |  | 5.83                                |  |  |  |  | 5.50  |  |  |  |  | 13,000  |  |  |  |  | 5.50  |  | 
| | 6.00                         |  |                                               |  |                                                 | 28,000    |                                   |  |                                               |  | 9.00                                |  |  |  |  | 6.00  |  |  |  |  |        |  |  |  |  | 6.00  |  | 
| | 6.00                         |  |                                               |  |                                                 | 163,721   |                                   |  |                                               |  | 9.42                                |  |  |  |  | 6.00  |  |  |  |  |        |  |  |  |  | 6.00  |  | 
| | 6.50                         |  |                                               |  |                                                 | 311,900   |                                   |  |                                               |  | 1.21                                |  |  |  |  | 6.50  |  |  |  |  |        |  |  |  |  | 6.50  |  | 
| | 6.50                         |  |                                               |  |                                                 | 2,000     |                                   |  |                                               |  | 9.00                                |  |  |  |  | 6.50  |  |  |  |  |        |  |  |  |  | 6.50  |  | 
| | 8.00                         |  |                                               |  |                                                 | 92,000    |                                   |  |                                               |  | 4.50                                |  |  |  |  | 8.00  |  |  |  |  | 92,000  |  |  |  |  | 8.00  |  | 
| | 9.00                         |  |                                               |  |                                                 | 10,000    |                                   |  |                                               |  | 4.75                                |  |  |  |  | 9.00  |  |  |  |  | 10,000  |  |  |  |  | 9.00  |  | 
| | 9.63                         |  |                                               |  |                                                 | 70,000    |                                   |  |                                               |  | 5.25                                |  |  |  |  | 9.63  |  |  |  |  | 70,000  |  |  |  |  | 9.63  |  | 
| | 10.50                        |  |                                               |  |                                                 | 167,233   |                                   |  |                                               |  | 6.25                                |  |  |  |  | 10.50 |  |  |  |  | 167,233 |  |  |  |  | 10.50 |  | 
| |                              |  |                                               |  |                                                 |           |                                   |  |                                               |  |                                     |  |  |  |  |       |  |  |  |  |         |  |  |  |  |       |  | 
| |                              |  |                                               |  |                                                 | 2,132,587 |                                   |  |                                               |  |                                     |  |  |  |  |       |  |  |  |  | 877,049 |  |  |  |  |       |  | 
| |                              |  |                                               |  |                                                 |           |                                   |  |                                               |  |                                     |  |  |  |  |       |  |  |  |  |         |  |  |  |  |       |  | 

|   |                                                                                                                    
|-- | -------------------------------------------------------------------------------------------------------------------
|B. | The
  following table is a summary of the status of option plans in Magic as of
  December 31, 2004, 2003 and 2002:

| |                                                                  |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
| | ---------------------------------------------------------------- |  | ------------------------------ | --------- | ------------------------------------- |  | ------------------------------ |  | ------------------------------------- | --------- | ------------------- |  | ------------------------------------- |  |  | --------- | - |  | ---- | 
| |                                                                  |  | Year ended
  December 31, 2004 |           | Year ended
  December 31, 2003        |  | Year ended
  December 31, 2002 | 
| |                                                                  |  |                                |           |                                       |  |                                | 
| |                                                                  |  | Number of
  Options            |           | Weighted
  Average
  Exercise
  Price |  | Number of
  Options            |  | Weighted
  Average
  Exercise
  Price |           | Number of
  Options |  | Weighted
  Average
  Exercise
  Price | 
| |                                                                  |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       | 
| |                                                                  |  |                                |           | $                                     |  |                                |  | $                                     |           |                     |  | $                                     | 
| |                                                                  |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       | 
| | Options outstanding at the beginning of the year                 |  |                                | 3,346,406 |                                       |  | 2.26                           |  |                                       | 2,751,937 |                     |  | 2.31                                  |  |  | 3,711,655 |   |  | 3.22 | 
| | Granted                                                          |  |                                | 406,601   |                                       |  | 4.84                           |  |                                       | 1,924,283 |                     |  | 2.57                                  |  |  | 195,773   |   |  | 1.28 | 
| | Exercised                                                        |  |                                | (973,551  | )                                     |  | 1.28                           |  |                                       | (775,284  | )                   |  | 1.17                                  |  |  | (55,169   | ) |  | 1.38 | 
| | Cancelled                                                        |  |                                |          |                                       |  |                               |  |                                       |          |                     |  |                                      |  |  | (375,207  | ) |  | 8.16 | 
| | Forfeited                                                        |  |                                | (266,219  | )                                     |  | 3.6                            |  |                                       | (554,530  | )                   |  | 3.35                                  |  |  | (725,115  | ) |  | 3.01 | 
| |                                                                  |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
| | Outstanding at the end of
  the year                             |  |                                | 2,513,237 |                                       |  | 2.95                           |  |                                       | 3,346,406 |                     |  | 2.26                                  |  |  | 2,751,937 |   |  | 2.31 | 
| |                                                                  |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
| |                                                                  |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
| | Exercisable at the end of
  the year                             |  |                                | 1,423,970 |                                       |  | 2.28                           |  |                                       | 1,304,338 |                     |  | 1.92                                  |  |  | 2,103,941 |   |  | 2.35 | 
| |                                                                  |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
| | Weighted average fair value of options granted during the year
* |  |                                |           |                                       |  | 2.2                            |  |                                       |           |                     |  | 1.28                                  |  |  |           |   |  | 0.67 | 
| |                                                                  |  |                                |           |                                       |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 

F40

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 12    Employee
Option Plans in Subsidiaries (cont.):

|   |          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-- | -------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|B. | (cont.):
|   |          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | *        | The fair value of each option granted is estimated on the date of
  grant, using the Black-Scholes Option Valuation Model, with the following
  weighted-average assumptions for each of the three years in the period ended
  December 31, 2004: expected volatility of 67.3%, 66.6% and 99.6%,
  respectively, risk-free interest rates of 2.8%, 1.5% and 1.5% respectively,
  dividend yields of 0% for each year, and a weighted average expected life of
  the option of four years for each year.
|   |          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

| | The
following table summarizes information regarding options   outstanding as of December 31,
2004:
| | ---------------------------------------------------------------------------------------------------

| |                             |  |                                                 |           |                                                     |   |                                       |  |                                               |  |                                       |           |  |  |       |  | 
| | --------------------------- |  | ----------------------------------------------- | --------- | --------------------------------------------------- | - | ------------------------------------- |  | --------------------------------------------- |  | ------------------------------------- | --------- |  |  | ----- |  | 
| |                             |  | Options
  Outstanding                           |           | Options
  Exercisable                               |  
| |                             |  |                                                 |           |                                                     |  
| | Range of
  Exercise
  Price |  | Number
  Outstanding
  at
  December 31,
  2004 |           | Weighted
  Average
  Remaining
  Contractual
  Life |   | Weighted
  Average
  Exercise
  Price |  | Number
  Exercisable at
  December 31,
  2004 |  | Weighted
  Average
  Exercise
  Price |          
| |                             |  |                                                 |           |                                                     |   |                                       |  |                                               |  |                                       |          
| | $                           |  |                                                 |           | Years                                               |   | $                                     |  |                                               |  | $                                     |          
| |                             |  |                                                 |           |                                                     |   |                                       |  |                                               |  |                                       |          
| |                             |  |                                                 |           |                                                     |   |                                       |  |                                               |  |                                       |          
| | 01                         |  |                                                 | 313,915   |                                                     | 7 |                                       |  | 0.86                                          |  |                                       | 263,812   |  |  | 0.84  | 
| | 12                         |  |                                                 | 824,090   |                                                     | 6 |                                       |  | 1.16                                          |  |                                       | 706,859   |  |  | 1.17  | 
| | 23                         |  |                                                 | 15,900    |                                                     | 5 |                                       |  | 2.45                                          |  |                                       | 14,567    |  |  | 2.42  | 
| | 34                         |  |                                                 | 665,213   |                                                     | 9 |                                       |  | 3.91                                          |  |                                       | 234,862   |  |  | 3.93  | 
| | 45                         |  |                                                 | 484,958   |                                                     | 9 |                                       |  | 4.12                                          |  |                                       | 150,209   |  |  | 4.13  | 
| | 56                         |  |                                                 | 155,500   |                                                     | 9 |                                       |  | 5.95                                          |  |                                       |          |  |  |      | 
| | 67                         |  |                                                 | 1,011     |                                                     | 5 |                                       |  | 6.14                                          |  |                                       | 1,011     |  |  | 6.14  | 
| | 1011                       |  |                                                 | 43,650    |                                                     | 5 |                                       |  | 10.16                                         |  |                                       | 43,650    |  |  | 10.16 | 
| | 1819                       |  |                                                 | 9,000     |                                                     | 5 |                                       |  | 18.79                                         |  |                                       | 9,000     |  |  | 18.79 | 
| |                             |  |                                                 |           |                                                     |   |                                       |  |                                               |  |                                       |           |  |  |       | 
| |                             |  |                                                 | 2,513,237 |                                                     | 9 |                                       |  | 2.95                                          |  |                                       | 1,423,970 |  |  | 2.28  | 
| |                             |  |                                                 |           |                                                     |   |                                       |  |                                               |  |                                       |           |  |  |       | 

|   |                                                                                                                                                    
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|C. | The
  following is a  summary of the status
  of option plans in Matrix as of December 31, 2004 and 2003 and changes during
  the years then ended:

|                                                                    |  |                                |           |                                       |  |                     |  |                                       |           |   |  |      | 
|------------------------------------------------------------------- |  | ------------------------------ | --------- | ------------------------------------- |  | ------------------- |  | ------------------------------------- | --------- | - |  | ---- | 
|                                                                    |  | Year ended
  December 31, 2004 |           | Year ended
  December 31, 2003        | 
|                                                                    |  |                                |           |                                       | 
|                                                                    |  | Number of
  options            |           | Weighted
  Average
  Exercise
  Price |  | Number of
  options |  | Weighted
  Average
  Exercise
  Price |          
|                                                                    |  |                                |           |                                       |  |                     |  |                                       |          
|                                                                    |  |                                |           | $                                     |  |                     |  | $                                     |          
|                                                                    |  |                                |           |                                       |  |                     |  |                                       |          
|                                                                    |  |                                |           |                                       |  |                     |  |                                       |          
|Options outstanding at the beginning of the year                    |  |                                | 5,665,002 |                                       |  | 1.62                |  |                                       | 3,183,840 |   |  | 1.48 | 
|Changes
  during the year:                                          |  |                                |           |                                       |  |                     |  |                                       |           |   |  |      | 
|Granted                                                             |  |                                | 1,359,000 |                                       |  | 2.26                |  |                                       | 2,483,562 |   |  | 1.65 | 
|Exercised                                                           |  |                                | (890,831  | )                                     |  | 1.6                 |  |                                       |          |   |  |     | 
|Forfeited                                                           |  |                                | (101,791  | )                                     |  | 1.64                |  |                                       | (2,400    | ) |  | 1.60 | 
|                                                                    |  |                                |           |                                       |  |                     |  |                                       |           |   |  |      | 
|Options outstanding at the end of the
year                          |  |                                | 6,031,380 |                                       |  | 1.8                 |  |                                       | 5,665,002 |   |  | 1.62 | 
|                                                                    |  |                                |           |                                       |  |                     |  |                                       |           |   |  |      | 
|Options exercisable at end of
  year                                |  |                                | 3,689,752 |                                       |  | 1.65                |  |                                       | 2,995,699 |   |  | 1.61 | 
|                                                                    |  |                                |           |                                       |  |                     |  |                                       |           |   |  |      | 
|Weighted average fair value
  of options granted during the year(*) |  |                                |           |                                       |  | 1.15                |  |                                       |           |   |  | 5.43 | 
|                                                                    |  |                                |           |                                       |  |                     |  |                                       |           |   |  |      | 

F41

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 12    Employee Option Plans in
Subsidiaries (cont.):

|   |                                                                                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- | --------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|C. | (cont.):                                                                                                 
|   |                                                                                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | *                                                                                                         | The fair
  value of each option granted is estimated on the date of grant using the
  Black-Scholes option-pricing model, with the following weighted average
  assumptions used for grants: dividend yield of 0% for all the years; expected
  volatility: 2004  31.3%, 2003  47.31%, 2002  56.7%, risk-free interest
  rate (in NIS terms) of 3.5% in 2004, 5.5% in 2003 and 3.5% in 2002, and
  expected lives: 2004  9.98 years, 2003  7.1 years and 2002  7 years.
|   |                                                                                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | The
  following table summarizes information in respect of options outstanding as
  of December 31, 2004:

| |                              |  |                                               |           |                     |                                                   |      |                                     |  |                                                 |   |  |                                     |  |  |      | 
| | ---------------------------- |  | --------------------------------------------- | --------- | ------------------- | ------------------------------------------------- | ---- | ----------------------------------- |  | ----------------------------------------------- | - |  | ----------------------------------- |  |  | ---- | 
| |                              |  | Options Outstanding                           |           | Options Exercisable
| |                              |  |                                               |           |                    
| | Range of
  Exercise
  Prices |  | Number
  Outstanding
  at December
  31, 2004 |           |                     | Weighted
  Average
  Remaining
  Contractual Life |      | Weighted
  Average
  Exercise Price |  | Number
  Exercisable
  at
  December
  31, 2004 |   |  | Weighted
  Average
  Exercise Price
| |                              |  |                                               |           |                     |                                                   |      |                                     |  |                                                 |   |  |                                    
| | $                            |  |                                               |           | Years               |                                                   | $    |                                     |  |                                                 | $
| |                              |  |                                               |           |                     |                                                   |      |                                     |  |                                                 |  
| | 1.39                         |  |                                               | 509,924   |                     |                                                   | 5.67 |                                     |  | 1.39                                            |   |  | 475,124                             |  |  | 1.39 | 
| | 1.62                         |  |                                               | 3,159,456 |                     |                                                   | 4.56 |                                     |  | 1.62                                            |   |  | 2,295,302                           |  |  | 1.62 | 
| | 1.86                         |  |                                               | 1,122,000 |                     |                                                   | 5.67 |                                     |  | 1.86                                            |   |  | 919,326                             |  |  | 1.86 | 
| | 2.32                         |  |                                               | 1,240,000 |                     |                                                   | 9.67 |                                     |  | 2.32                                            |   |  |                                    |  |  | 2.32 | 
| |                              |  |                                               |           |                     |                                                   |      |                                     |  |                                                 |   |  |                                     |  |  |      | 
| |                              |  |                                               | 6,031,380 |                     |                                                   |      |                                     |  |                                                 |   |  | 3,689,752                           |  |  |      | 
| |                              |  |                                               |           |                     |                                                   |      |                                     |  |                                                 |   |  |                                     |  |  |      | 

|D. | The
  following is a summary of the status of options plans in Sapiens as of December
  31, 2004, 2003 and 2002 and changes during the years then ended:
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                                 |  |                                |           |                                       |   |                                |  |                                       |           |                     |  |                                       |  |  |           |    |  |       | 
| | --------------------------------------------------------------- |  | ------------------------------ | --------- | ------------------------------------- | - | ------------------------------ |  | ------------------------------------- | --------- | ------------------- |  | ------------------------------------- |  |  | --------- | -- |  | ----- | 
| |                                                                 |  | Year ended
  December 31, 2004 |           | Year ended
  December 31, 2003        |   | Year ended
  December 31, 2002 | 
| |                                                                 |  |                                |           |                                       |   |                                | 
| |                                                                 |  | Number of
  options            |           | Weighted
  Average
  Exercise
  Price |   | Number of
  options            |  | Weighted
  Average
  Exercise
  Price |           | Number of
  options |  | Weighted
  Average
  Exercise
  Price | 
| |                                                                 |  |                                |           |                                       |   |                                |  |                                       |           |                     |  |                                       | 
| |                                                                 |  |                                |           |                                       | $ |                                |  |                                       |           | $                   |  |                                       |  |  | $         |   
| |                                                                 |  |                                |           |                                       |   |                                |  |                                       |           |                     |  |                                       |  |  |           |   
| | Options outstanding at the beginning of the year                |  |                                | 1,558,495 |                                       |   | 10.25                          |  |                                       | 1,580,713 | **                  |  | 11.25                                 |  |  | 1,569,698 | ** |  | 12.50 | 
| | Changes during the year:                                        |  |                                |           |                                       |   |                                |  |                                       |           |                     |  |                                       |  |  |           |    |  |       | 
| | Granted                                                         |  |                                | 321,539   |                                       |   | 4.05                           |  |                                       | 157,600   |                     |  | 4.06                                  |  |  | 274,300   |    |  | 4.70  | 
| | Exercised                                                       |  |                                | (5,000    | )                                     |   | 4.07                           |  |                                       | (6,820    | )                   |  | 3.91                                  |  |  | (55,080   | )  |  | 0.20  | 
| | Forfeited                                                       |  |                                | (234,163  | )                                     |   | 10.23                          |  |                                       | (172,998  | )                   |  | 14.05                                 |  |  | (208,205  | )  |  | 15.70 | 
| |                                                                 |  |                                |           |                                       |   |                                |  |                                       |           |                     |  |                                       |  |  |           |    |  |       | 
| | Options outstanding at the end of the
year                      |  |                                | 1,640,871 | **                                    |   | 9.05                           |  |                                       | 1,558,495 | **                  |  | 10.25                                 |  |  | 1,580,713 | ** |  | 11.25 | 
| |                                                                 |  |                                |           |                                       |   |                                |  |                                       |           |                     |  |                                       |  |  |           |    |  |       | 
| | Options exercisable at
  year-end                               |  |                                | 1,143,432 |                                       |   | 11.24                          |  |                                       | 1,095,779 |                     |  | 11.86                                 |  |  | 908,784   |    |  | 12.85 | 
| |                                                                 |  |                                |           |                                       |   |                                |  |                                       |           |                     |  |                                       |  |  |           |    |  |       | 
| | Weighted-average fair value of options granted during the
year* |  |                                |           |                                       |   | 1.46                           |  |                                       |           |                     |  | 2.30                                  |  |  |           |    |  |       | 
| |                                                                 |  |                                |           |                                       |   |                                |  |                                       |           |                     |  |                                       |  |  |           |    |  |       | 

F42

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 12    Employee Option Plans in
Subsidiaries (cont.):

|   |          |                                                                                                                                                                                                                                                                                                                                                                                                                    
|-- | -------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|D. | (cont.):
|   |         
|   | *        | The fair
  value of each option granted is estimated on the date of grant, using the
  Black-Scholes option-pricing model with the following weighted average
  assumptions: dividend yield of 0% for all years; expected volatility: 2004   65%, 2003  83%, 2002  97%, risk-free interest rate 2004  3.74%, 2003  2%,
  2002  2% and expected life: 2004  2.5 years, 2003  3.5 years and 2002  6
  years.
|   |          |                                                                                                                                                                                                                                                                                                                                                                                                                    
|   | **       | Including
  102,100, repriced to zero, as of December 31, 2002, 2003 and 2004.                                                                                                                                                                                                                                                                                                                                     
|   |          |                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |          | The
  following table summarizes information in respect of options outstanding as
  of December 31, 2004:                                                                                                                                                                                                                                                                                                          

| |                           |  |                                                 |  |       |                                                     |   |                                       |       |  |                                               |           |  |                                        |       | 
| | ------------------------- |  | ----------------------------------------------- |  | ----- | --------------------------------------------------- | - | ------------------------------------- | ----- |  | --------------------------------------------- | --------- |  | -------------------------------------- | ----- | 
| |                           |  | Options Outstanding                             |  |       | Options Exercisable                                 |  
| |                           |  |                                                 |  |       |                                                     |  
| | Range of
  Exercise Price |  | Number
  Outstanding
  at
  December 31,
  2004 |  |       | Weighted
  Average
  Remaining
  Contractual
  Life |   | Weighted
  Average
  Exercise
  Price |       |  | Number
  Exercisable at
  December 31,
  2004 |           |  | Weighted 
  Average
  Exercise
  Price |      
| |                           |  |                                                 |  |       |                                                     |   |                                       |       |  |                                               |           |  |                                        |      
| | $                         |  |                                                 |  | Years |                                                     | $ |                                       |       |  |                                               | $         | 
| |                           |  |                                                 |  |       |                                                     |   |                                       |       |  |                                               |           |  |                                       
| |                          |  | 102,100                                         |  |       | 5.98                                                |   |                                       |      |  |                                               | 102,100   |  |                                        |      | 
| | 1.862.63                 |  | 135,650                                         |  |       | 9.37                                                |   |                                       | 2.57  |  |                                               |          |  |                                        |      | 
| | 3.253.75                 |  | 188,500                                         |  |       | 7.37                                                |   |                                       | 3.57  |  |                                               | 120,425   |  |                                        | 3.49  | 
| | 4.065.70                 |  | 863,812                                         |  |       | 6.71                                                |   |                                       | 4.53  |  |                                               | 570,098   |  |                                        | 4.43  | 
| | 11.2516.875              |  | 153,810                                         |  |       | 0.88                                                |   |                                       | 11.81 |  |                                               | 153,810   |  |                                        | 11.81 | 
| | 19.37529.375             |  | 48,600                                          |  |       | 5.56                                                |   |                                       | 28.91 |  |                                               | 48,600    |  |                                        | 28.91 | 
| | 32.547.5                 |  | 110,799                                         |  |       | 4.13                                                |   |                                       | 37.35 |  |                                               | 110,799   |  |                                        | 37.35 | 
| | 61.2569.375              |  | 37,600                                          |  |       | 5.03                                                |   |                                       | 67.78 |  |                                               | 37,600    |  |                                        | 67.78 | 
| |                           |  |                                                 |  |       |                                                     |   |                                       |       |  |                                               |           |  |                                        |       | 
| |                           |  | 1,640,871                                       |  |       |                                                     |   |                                       | 9.05  |  |                                               | 1,143,432 |  |                                        | 11.24 | 
| |                           |  |                                                 |  |       |                                                     |   |                                       |       |  |                                               |           |  |                                        |       | 

F43

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 12    Employee Option Plans in
Subsidiaries (cont.):

|   |                                                                                                                                              
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------
|E. | The following is a summary of the status of options plans in Formula
  Vision as of December 31, 2004 and changes during the year then ended:

| |                                                                 |  |                                |           |                                     |   |  |     |  | 
| | --------------------------------------------------------------- |  | ------------------------------ | --------- | ----------------------------------- | - |  | --- |  | 
| |                                                                 |  | Year ended
  December 31, 2004 |          
| |                                                                 |  |                                |          
| |                                                                 |  | Number of
  options            |           | Weighted
  Average
  Exercise price |  
| |                                                                 |  |                                |           |                                     |  
| |                                                                 |  |                                |           |                                     | $ | 
| |                                                                 |  |                                |           |                                     |   | 
| |                                                                 |  |                                |           |                                     |   |  |     |  | 
| | Options outstanding at
  beginning of the year                  |  |                                | 1,930,000 |                                     |   |  | 0.3 | 
| | Changes during the year:                                        |  |                                |           |                                     |   |  |     |  | 
| | Exercised                                                       |  |                                | (130,500  | )                                   |   |  | 0.3 | 
| | Forfeited                                                       |  |                                | (20,000   | )                                   |   |  | 0.3 | 
| |                                                                 |  |                                |           |                                     |   |  |     | 
| |                                                                 |  |                                |           |                                     |   |  |     |  | 
| | Options outstanding at the
  end of the year                    |  |                                | 1,779,500 |                                     |   |  | 0.3 | 
| |                                                                 |  |                                |           |                                     |   |  |     | 
| |                                                                 |  |                                |           |                                     |   |  |     |  | 
| | Options exercisable at
  year-end                               |  |                                |           |                                     |   |  |     |  | 
| | Weighted-average fair value of options granted during the
year* |  |                                |          |                                     |   |  |     |  | 
| |                                                                 |  |                                |           |                                     |   |  |     |  | 
| |                                                                 |  |                                |           |                                     |   |  |     |  | 

|   |                                                                                                           |                                                                                                                                                                                                                                                                                                                              
|-- | --------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | *                                                                                                         | The fair value of each
  option granted is estimated on the date of grant, using the Black-Scholes
  option-pricing model with the following weighted average assumptions:
  dividend yield of 0% for all years; expected volatility: 2004  37%,
  risk-free interest rate: 2004  3.5% and expected life: 2004  6.7 years.
|   |                                                                                                           |                                                                                                                                                                                                                                                                                                                              
|F. | The following table
  summarizes information in respect of options outstanding as of December 31,
  2004:

| |                            |  |                                                |           |                                                   |  |                                     |  |                                               |     |                                     |  |           |  |  |     | 
| | -------------------------- |  | ---------------------------------------------- | --------- | ------------------------------------------------- |  | ----------------------------------- |  | --------------------------------------------- | --- | ----------------------------------- |  | --------- |  |  | --- | 
| |                            |  | Options
  outstanding                          |           | Options
  exercisable                             | 
| |                            |  |                                                |           |                                                   | 
| | Range of 
  exercise price |  | Number
  Outstanding at 
  December 31,
  2004 |           | Weighted
  Average
  Remaining
  Contractual Life |  | Weighted
  Average
  Exercise Price |  | Number
  Exercisable at
  December 31,
  2004 |     | Weighted
  Average
  Exercise Price | 
| |                            |  |                                                |           |                                                   |  |                                     |  |                                               |     |                                     | 
| | $                          |  |                                                |           |                                                   |  | Years                               |  |                                               | $   |                                     |  |           |  |  | $   | 
| |                            |  |                                                |           |                                                   |  |                                     |  |                                               |     |                                     | 
| |                            |  |                                                |           |                                                   |  |                                     |  |                                               |     |                                     |  |           |  |  |     | 
| | 0.3                        |  |                                                | 1,779,500 |                                                   |  | 4                                   |  |                                               | 0.3 |                                     |  | 1,779,500 |  |  | 0.3 | 
| |                            |  |                                                |           |                                                   |  |                                     |  |                                               |     |                                     |  |           |  |  |     | 

F44

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 13    Unrealized Gains:

The unrealized gains are composed of the following:

|                                                                                |  |                         |  |      |  |       |  |       |  |  | 
|------------------------------------------------------------------------------- |  | ----------------------- |  | ---- |  | ----- |  | ----- |  |  | 
|                                                                                |  | December 31,            | 
|                                                                                |  |                         | 
|                                                                                |  | 2004                    |  | 2003 | 
|                                                                                |  |                         |  |      | 
|                                                                                |  | (U.S. $ in
  thousands) | 
|                                                                                |  |                         | 
|                                                                                |  |                         |  |      |  |       |  |       |  |  | 
|                                                                                |  |                         |  |      |  |       |  |       |  |  | 
|Gain resulting from the sale
  of certain companies to Formula Vision  Note 2B |  |                        |  |      |  | 1,147 | 
|                                                                                |  |                         |  |      |  |       |  |       |  |  | 
|Gain
  resulting from a reverse acquisition of Matrix  Note 2A                 |  |                         |  |     |  |       |  | 2,975 | 
|Gain
  resulting from Sintec Media Ltd.                                         |  |                         |  |     |  |       |  | 227   | 
|Gain
  resulting from T-Soft                                                    |  |                         |  |     |  |       |  | 110   | 
|                                                                                |  |                         |  |      |  |       | 
|                                                                                |  |                         |  |     |  |       |  | 4,459 | 
|                                                                                |  |                         |  |      |  |       | 

Note 14    Commitments and Contingencies:

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                 
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------
|A. | Commitments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                 
|   | Some of the Companys subsidiaries have commitments to the Chief Scientist in the Ministry of
  Industry and Trade and to the Marketing Promotion Fund, to pay royalties at a
  rate of 3%3.5% of the proceeds
  from the sale of software products which were developed with the assistance
  of the Chief Scientist and marketed with the assistance of the Marketing
  Promotion Fund. The amount of royalties is limited to 100%150% of the amount
  received. The subsidiaries are only obliged to repay the grants received from the Office of the Chief
  Scientist if revenue is generated from the sale of the said software
  products.
|  
|   | The balance of the contingent liability in respect of the aforesaid, amounted to approximately $11.3 million
  as at December 31, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                 
|B. | Liens:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                 
|   | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | Some
  of the subsidiaries have liens on leased vehicles, leased equipment and other
  assets in favor of the leasing companies.
|  
|   | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | The
  Company has pledged securities of certain subsidiaries and bank accounts in
  favor of banks.                             
|  
|   | 3.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | Some
  of subsidiaries have given floating charges in favor of banks and other
  financial institusions                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                 
|C. | Guarantees:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                 
|   | Formula
  is a guarantor for the completion of projects performed by some of its
  subsidiaries.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

F45

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 14    Commitments and Contingencies (cont.):

|   |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                                                                                    
|-- | ------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|D. | Others:
|   |        
|   | 1.      | In connection with credit facilities the
  Company have entered into a bank agreement with various banks, accordingly
  the Company committed, among other things:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   |         | a.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | To maintain certain financial ratios.                                                                                                                                                                              
|   |         | b.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | Not to grant a security interest in all or
  substantially all their respective assets.                                                                                                                            
|   |         | c.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | Not to distribute dividends.                                                                                                                                                                                       
|   |         | d.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | To repay the loans provided by the banks,
  if so required by the banks, at the discretion of the banks, in the event
  that Dan Goldstein or Gad Goldstein cease to serve in their current positions
  in Formula.
|   |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                                                                                    
|   |         | In connection with one of the Company
  credit facilities, Formula committed, among other things, not to distribute
  dividends. The bank did not object to the distribution of the dividend made
  by Formula in June 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   | 2.      | Under Israels Stamp Tax on Documents Law, certain documents are
  subject to stamp tax. Recently promulgated regulations provide for a gradual
  phase-out of the stamp tax by 2008. In 2004, however, the tax authorities
  began an enforcement campaign involving extensive audits of companies
  compliance with the stamp tax obligation with respect to all agreements which
  had been signed since June 2003.                                                                                                                                                                                                                                                                                                                                                                    
|   |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |         | Formula and certain subsidiaries have received legal advice that
  there are a variety of defenses relating to its obligation to pay stamp tax
  or the amount to be paid. The Groups management believes that the applicable
  provision in its financial statements as of December 31, 2004 is adequate to
  cover probable costs arising from this law.                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   | 3.      | On February 13, 2004 there were public reports that a leak of
  Microsoft source code had occurred on the Internet. These reports indicated
  that the source code contained trace references to a subsidiary of a
  subsidiary (Mainsoft) servers and personnel. Mainsofts management team
  immediately adopted a policy of full cooperation with local authorities, the
  FBI, and Microsoft in their respective investigation. The FBI has confirmed
  to the Company that its investigation was continuing as of December 31, 2004.
  While Mainsoft believes its relationship with Microsoft will continue on
  terms acceptable to Mainsoft, a change in the relationship could materially
  adversely affect Mainsofts business, results of operation, and financial
  condition.

F46

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 14    Commitments and Contingencies (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|E. | Legal Proceedings:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | In July 2003, a former Liraz Systems Ltd. Or Liraz shareholders filed
  an application with the Tel Aviv Jaffa District Court to approve a claim
  filed by him against BluePhoenix, as a class action. The claim relates to the
  acquisition of Liraz shares, which BluePhoenix completed in March 2003. The
  shareholder alleges that the share price BluePhoenix paid to Lirazs shareholders
  in the tender offer and in a subsequent mandatory purchase was lower than the
  fair price of Liraz shares. The maximum amount of the claim is approximately
  $5.8 million in the aggregate. In the lawsuit, the plaintiff has applied for
  the courts approval to represent all of the shareholders of Liraz who sold
  their shareholdings pursuant to the tender offer and the mandatory
  acquisition. No hearing has been scheduled for this lawsuit. Based on
  BluePhoenixs analysis of the statement of claim, including and evaluation of
  the fair value of the Liraz shares, and the price paid for Liraz in a
  previous transaction immediately prior to the tender offer, the Company
  believes that the allegations against BluePhoenix in this proceeding are
  without merit and intend to vigorously defend the claim and contest the
  allegations made therein.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|F. | Lease Commitments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | The following are details
  of the future minimum lease commitments under non-cancelable
  operating leases as of December 31, 2004:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

| |                       |  |                       |        | 
| | --------------------- |  | --------------------- | ------ | 
| |                       |  | U.S. $ in
  thousands |       
| |                       |  |                       |       
| |                       |  |                       |        | 
| | 2005                  |  |                       | 11,976 | 
| | 2006                  |  |                       | 8,719  | 
| | 2007                  |  |                       | 6,425  | 
| | 2008                  |  |                       | 4,136  | 
| | 2009
  and thereafter |  |                       | 4,446  | 
| |                       |  |                       |        | 
| |                       |  |                       | 35,702 | 
| |                       |  |                       |        | 
| |                       |  |                       |        | 

| |                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Rent
  expenses for the years ended December 31, 2004, 2003 and 2002, were
  approximately $10,215 thousand, $10,293 thousand and $7,418 thousand,
  respectively.

Note 15    Shareholders Equity:

|   |                                                    
|-- | ---------------------------------------------------
|A. | Share Capital Authorized,
  Issued and Outstanding:

|                                        |  |                   |            |                   |  |             |  |            |            |        |  |             |  |  |            |  |  |            | 
|--------------------------------------- |  | ----------------- | ---------- | ----------------- |  | ----------- |  | ---------- | ---------- | ------ |  | ----------- |  |  | ---------- |  |  | ---------- | 
|                                        |  | December 31, 2004 |            | December 31, 2003 | 
|                                        |  |                   |            |                   | 
|                                        |  | Authorized        |            | Issued            |  | Outstanding |  | Authorized |            | Issued |  | Outstanding | 
|                                        |  |                   |            |                   |  |             |  |            |            |        |  |             | 
|                                        |  | NIS               |            | NIS               |  | NIS         |  | NIS        |            | NIS    |  | NIS         | 
|                                        |  |                   |            |                   |  |             |  |            |            |        |  |             | 
|                                        |  |                   |            |                   |  |             |  |            |            |        |  |             |  |  |            |  |  |            | 
|Ordinary shares, NIS 1 par
  value each |  |                   | 25,000,000 |                   |  | 10,824,780  |  |            | 10,800,000 |        |  | 25,000,000  |  |  | 10,824,780 |  |  | 10,800,000 | 
|                                        |  |                   |            |                   |  |             |  |            |            |        |  |             |  |  |            |  |  |            | 
|                                        |  |                   |            |                   |  |             |  |            |            |        |  |             |  |  |            |  |  |            | 

F47

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 15    Shareholders Equity (cont.):

|   |                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-- | ----------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | Share Capital Authorized,
  Issued and Outstanding (cont.):
|   |                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | 1.                                                          | The
  shares are traded on the TASE and through ADSs, each representing one
  ordinary share of NIS 1 par value, quoted on the NASDAQ National Market
  in the United States. The closing price of the share on the TASE as of December 31, 2004, was NIS 73.03. The closing
  price of the ADS on the NASDAQ National Market on that date was $17.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | 2.                                                          | On
  June 25, 1998, Formula completed a public offering of its shares on the
  over-the-counter market in the U.S. Formula received $56 million, net, in
  exchange for 1,600,000 ADSs. The offering price was $35 per share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | 3.                                                          | In
  November 1998, Formula raised approximately $3 million in a private placement
  of 107,100 of Formulas
  shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | 4.                                                          | Formulas
  General Meetings, in September 1999 and in August 2000, approved the allotment of options to purchase 1,000,000 and
  500,000 ordinary shares of Formula, respectively, to Shandol Ltd. (a company
  transfered to Formula Vision within the framework of the the companies
  transferred from the Company to Formula Vision  see Note 2B), a wholly-owned
  subsidiary. The 1,000,000 options were issued in order to assure the
  availability of Formulas shares in the event of a request from Shamrock to
  exercise their option. The 500,000 options were issued in order to assure the
  availability of Formulas shares so long as the convertible options are
  outstanding, with no need for additional action in the future. The exercise
  price of the options is equal to
  Formulas share market price.
|   |                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | 5.                                                          | In
  November 2001, Shandol exercised options to purchase 1,000,000 shares of
  Formula for a consideration of $12 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | 6.                                                          | In
  November 2001 and January 2002, Shamrock exercised its exchange option for Formulas shares with respect to
  companies transferred to Formula Vision, Transtech and Airport Intersystems. In
  consideration for the shares
  in the said companies, Shandol transferred to Shamrock 1,000,000 ordinary shares of
  Formula.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | 7.                                                          | During
  2002, Formula repurchased 324,780 of its ordinary shares in the open market
  for an aggregate of $3.4 million.During 2003, Formula
  sold 300,000 of its ordinary shares for an aggregate of $4.8 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | 8.                                                          | In
  December 2003, Formula issued 500,000 ordinary shares consequent to the exercise
  of options to acquire 500,000 ordinary shares. The options were granted by Formula to Shandol on
  August 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

F48

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 15    Shareholders Equity (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|B. | Details of Share Options Granted to Employees:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | In November
  2000, Formulas Board of Directors adopted an option plan pursuant to which
  Formula may grant options to employees of Formula to purchase up to a total
  of 300,000 ordinary shares. In accordance with this plan, employees of
  Formula and its subsidiaries were granted, for no consideration, 64,500
  options, each of which may be exercised into one ordinary share of Formula at
  an exercise price of $30.8 per share, linked to the CPI. Any option not
  exercised within five years will expire.                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | The
  options will be exercisable as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | In the
  period from the end of one year after the grant of the options until the end
  of three years from the time of grant, each grantee will be entitled to
  exercise one third of the options granted to him, at the end of each year.
  The above mentioned option plans comply with the provisions of Section 102 of
  the Israeli Income Tax Ordinance, which provides, inter alia, that Formula
  will be able to claim the benefit charged to employees for tax purposes as a
  tax-deductible expense, if and when the employees become liable for tax on
  such benefit.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | The following is a summary of
  the status of Formulas option plans as of December 31, 2004, 2003 and 2002
  and for the years then ended:                                                                                                                                                                                                                                                                                                                                                                                                                                          

|                                                                 |  |                                |        |                                |                                         |                                |  |   |        |                                        |  |      |  |                                        |         |   |  |      | 
|---------------------------------------------------------------- |  | ------------------------------ | ------ | ------------------------------ | --------------------------------------- | ------------------------------ |  | - | ------ | -------------------------------------- |  | ---- |  | -------------------------------------- | ------- | - |  | ---- | 
|                                                                 |  | Year ended
  December 31, 2004 |        | Year ended
  December 31, 2003 |                                         | Year ended
  December 31, 2002 | 
|                                                                 |  |                                |        |                                |                                         |                                | 
|                                                                 |  |                                |        |                                | Weighted 
  Average
  Exercise 
  Price |                                |  |   |        | Weighted 
  Average
  Exercise
  Price |  |      |  | Weighted 
  Average
  Exercise
  Price |        
|                                                                 |  | Number of                      |        |                                |                                         | Number of                      |  |   |        | Number of                              |  |      | 
|                                                                 |  | Options                        |        | $                              |                                         | Options                        |  | $ |        | Options                                |  | $    | 
|                                                                 |  |                                |        |                                |                                         |                                |  |   |        |                                        |  |      | 
|                                                                 |  |                                |        |                                |                                         |                                |  |   |        |                                        |  |      |  |                                        |         |   |  |      | 
|Outstanding options at the beginning of the year                 |  |                                | 64,500 |                                |                                         | 30.8                           |  |   | 64,500 |                                        |  | 30.8 |  |                                        | 122,850 |   |  | 25   | 
|Changes during the year:                                         |  |                                |        |                                |                                         |                                |  |   |        |                                        |  |      |  |                                        |         |   |  |      | 
|Granted                                                          |  |                                |       |                                |                                         |                               |  |   |       |                                        |  |     |  |                                        |        |   |  |     | 
|Exercised                                                        |  |                                |       |                                |                                         |                               |  |   |       |                                        |  |     |  |                                        |        |   |  |     | 
|Expired and forfeited                                            |  |                                |       |                                |                                         |                               |  |   |       |                                        |  |     |  |                                        | (58,350 | ) |  | 18.6 | 
|                                                                 |  |                                |        |                                |                                         |                                |  |   |        |                                        |  |      |  |                                        |         |   |  |      | 
|                                                                 |  |                                |        |                                |                                         |                                |  |   |        |                                        |  |      |  |                                        |         |   |  |      | 
|Outstanding options at the end of the year                       |  |                                | 64,500 |                                |                                         | 30.8                           |  |   | 64,500 |                                        |  | 30.8 |  |                                        | 64,500  |   |  | 30.8 | 
|                                                                 |  |                                |        |                                |                                         |                                |  |   |        |                                        |  |      |  |                                        |         |   |  |      | 
|Exercisable options at the end of the year                       |  |                                | 64,500 |                                |                                         | 30.8                           |  |   | 64,500 |                                        |  | 30.8 |  |                                        | 43,000  |   |  | 30.8 | 
|                                                                 |  |                                |        |                                |                                         |                                |  |   |        |                                        |  |      |  |                                        |         |   |  |      | 
|                                                                 |  |                                |        |                                |                                         |                                |  |   |        |                                        |  |      |  |                                        |         |   |  |      | 
|Weighted avarage fair value of
  options granted during the year |  |                                |        |                                |                                         |                               |  |   |        |                                        |  |     |  |                                        |         |   |  |     | 
|                                                                 |  |                                |        |                                |                                         |                                |  |   |        |                                        |  |      |  |                                        |         |   |  |      | 

F49

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 15    Shareholders Equity (cont.):

|   |                                                                                                        
|-- | -------------------------------------------------------------------------------------------------------
|B. | Details of Share Options Granted to Employees (cont.):                                                 
|   |                                                                                                        
|   | The following table summarizes
  information in respect of outstanding options as at December 31, 2004:

| |                            |  |                             |                     |                                                 |  |                                     |  |                                            |      |                                     |  |        |  |  |      | 
| | -------------------------- |  | --------------------------- | ------------------- | ----------------------------------------------- |  | ----------------------------------- |  | ------------------------------------------ | ---- | ----------------------------------- |  | ------ |  |  | ---- | 
| |                            |  | Options Outstanding         | Options Exercisable |                                                
| |                            |  |                             |                     |                                                 | 
| | Range of 
  exercise price |  | Number 
  Outstanding 
  at |                     | Weighted Average
  Remaining
  Contractual Life |  | Weighted
  Average
  Exercise Price |  | Number 
  ExercisableatDecember 31,
  2004 |      | Weighted
  Average
  Exercise Price | 
| |                            |  |                             |                     |                                                 |  |                                     |  |                                            |     
| | $                          |  | December 31,
  2004         |                     | Years                                           |  | $                                   |  |                                            | $    |                                    
| |                            |  |                             |                     |                                                 |  |                                     |  |                                            |      |                                     | 
| |                            |  |                             |                     |                                                 |  |                                     |  |                                            |      |                                     |  |        |  |  |      | 
| | 30.8                       |  |                             | 64,500              |                                                 |  | 0.92                                |  |                                            | 30.8 |                                     |  | 64,500 |  |  | 30.8 | 
| |                            |  |                             |                     |                                                 |  |                                     |  |                                            |      |                                     |  |        |  |  |      | 
| |                            |  |                             |                     |                                                 |  |                                     |  |                                            |      |                                     |  |        |  |  |      | 

|   |                                                                                                                                                                                        
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|C. | Dividends:                                                                                                                                                                             
|   |                                                                                                                                                                                        
|   | Formula
  has not paid any cash dividends on its ordinary shares in the past.
  Subsequent to December 31,2004 the Company distributed a cash dividend of $53
  million (see Note 19A).

Note 16    Taxes on Income:

|   |                    
|-- | -------------------
|A. | Tax Laws in Israel:

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. | Tax
  benefits under the Israeli Law for the Encouragement of Capital Investments,
  1959 (hereafter  the Law):                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | Some operations of certain
  subsidiaries have been granted Approved Enterprise status under the Law.
  Since the subsidiaries have elected to receive alternative benefits under
  the Law (i.e. waiver of grants in exchange for a tax exemption for a limited
  period), the following tax rates will apply to its income from the Approved
  Enterprise (which will be determined based on the increase in the revenue of
  the subsidiaries during the year, in relation to the revenue in the year
  preceding the first year of their having the above-mentioned status):
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | Tax exemption for 2 years,
  commencing in the first year it generates taxable income. For the remainder
  of the benefit period  5 years  a reduced tax rate of 25%.                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | For some subsidiaries, the
  percentage of its share capital held by foreign shareholders has exceeded
  25%. Therefore its Approved Enterprises qualify for reduced tax rates for an
  additional three years after the seven years mentioned above.                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | The period of tax benefits
  described above will terminate after 710 years elapse from the first year in
  which the subsidiaries have taxable income and 14 years elapse since the
  Approved Enterprise was granted and 12 years after the commencement of the
  Approved Enterprise.                                                                                                                                                                                                                                                                                           

F50

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 16    Taxes on Income
(cont.):

|   |                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-- | --------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | Tax Laws in Israel (cont.):
|   |                            
|   | 1.                          | Tax
  benefits under the Israeli Law for the Encouragement of Capital Investments,
  1959 (hereafter  the Law) (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   |                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                             | The entitlement to the
  above benefits is subject to final ratification by the Investment Center in
  the Ministry of Industry and Trade, such ratification being conditional upon
  fulfillment of all terms of the approved program.                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   |                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                             | In the event of a
  distribution of a cash dividend out of retained earnings, which are tax
  exempt due to the above benefits, the subsidiaries would have to pay tax with
  respect to the amount distributed. Deferred taxes for such taxes were not
  provided because such undistributed earnings are essentially permanent in
  duration and could be distributed to shareholders tax free in liquidation,
  subject to certain conditions.                                                                                                                                                                                                                                               
|   |                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                             | The Law also provides that
  an Approved Enterprise is entitled to accelerated depreciation on its
  property and equipment that is included in an approved investment program.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                             | In the event the
  subsidiaries fail to comply with the approved program terms, the tax benefits
  may be canceled and the subsidiaries may be required to refund the amount of
  the benefits they utilized, in whole or in part, with the addition of linkage
  differences and interest.                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   | 2.                          | Measurement
  of results for tax purposes under the Income Tax (Inflationary Adjustments) Law, 1985 (hereafter  the Inflationary Adjustments Law):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                             | Results for tax purposes
  in Israel are measured and reflected in real terms in accordance with the
  change in the CPI. The consolidated financial statements are presented in
  dollars. The differences between the change in the Israeli CPI and in the
  NIS/dollar exchange rate causes a difference between taxable income or loss
  and the income or loss before taxes reflected in the consolidated financial
  statements. In accordance with paragraph 9(f) of SFAS No. 109, Accounting
  for Income Taxes (SFAS No. 109), the Company has not provided deferred
  income taxes on this difference between the reporting currency and the tax
  bases of assets and liabilities.
|   |                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   | 3.                          | Tax
  benefits under the Law for the Encouragement of Industry (Taxation), 1969:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                             | Some subsidiaries
  currently qualifies as an Industrial Company as defined by this law, and as
  such is entitled to certain tax benefits including, inter alia, depreciation
  at increased rates as stipulated by regulations published under the
  Inflationary Adjustments Law and the right to deduct for tax purposes, over a
  period of 3 years, expenses relating to public issue of shares. If realized,
  any tax benefit relating to issuance expenses is credited to capital surplus.                                                                                                                                                                                           

F51

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 16    Taxes on Income
(cont.):

|   |                            
|-- | ---------------------------
|A. | Tax Laws in Israel (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                       
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | 4.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Tax Rates
  Applicable to Income from Other Sources in Israel:                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | Income not eligible for
  Approved Enterprise benefits mentioned in 1. above is taxed at the regular
  corporate tax rate of 35% in 2004, 34% in 2005, 32% in 2006 and 30% in 2007
  and thereafter.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                       
|B. | Subsidiaries Outside Israel:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                       
|   | Subsidiaries that are not an Israeli resident are taxed in the
  countries in which they are resident, according to the tax laws in those
  countries.                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                       
|C. | Cumulative Tax Losses:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                       
|   | The
  Company have cumulative operating losses for tax purposes as of December 31,
  2004 totaling approximately $323,995 thousand, of which $229,091 thousand is
  in respect of Companies in Israel (December 31, 2003  $127,183 thousand),
  and approximately $94,904 thousand in respect of Companies abroad (December
  31, 2003  $63,796 thousand). The likelihood of the utilization of most of
  these losses in the future is low. Therefore, no deferred tax asset has been
  recorded in respect of such losses.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                       
|D. | Income Tax Assessments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                       
|   | Formula
  received final tax assessments through the tax year 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                       
|E. | Deferred Taxes:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                       
|   | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Composition:                                                                                                                                                                                          

| |                                      |  |                       |         |      |  |         |   |  |         |  
| | ------------------------------------ |  | --------------------- | ------- | ---- |  | ------- | - |  | ------- | -
| |                                      |  | December 31,          |        
| |                                      |  |                       |        
| |                                      |  | 2004                  |         | 2003 |  | 2002    |  
| |                                      |  |                       |         |      |  |         |   |  |         |  
| |                                      |  | (U.S. $ in thousands) |        
| |                                      |  |                       |        
| |                                      |  |                       |         |      |  |         |   |  |         |  
| | Net operating losses carried forward |  |                       | 98,756  |      |  | 85,560  |   |  | 71,795  |  
| |                                      |  |                       |         |      |  |         |   |  |         |  
| | Software development costs           |  |                       | 2,329   |      |  | 1,080   |   |  | 324     |  
| |                                      |  |                       |         |      |  |         |   |  |         |  
| | Allowances and reserves              |  |                       | 4,865   |      |  | 5,465   |   |  | 6,633   |  
| |                                      |  |                       |         |      |  |         |   |  |         |  
| |                                      |  |                       | 105,950 |      |  | 92,105  |   |  | 78,752  |  
| |                                      |  |                       |         |      |  |         |   |  |         |  
| | Valuation allowance                  |  |                       | (97,690 | )    |  | (85,335 | ) |  | (76,105 | )
| |                                      |  |                       |         |      |  |         |   |  |         |  
| | Total                                |  |                       | 8,260   |      |  | 6,770   |   |  | 2,647   |  
| |                                      |  |                       |         |      |  |         |   |  |         |  

F52

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 16    Taxes on Income
(cont.):

|   |                         |                                                                                                                                                                                                                                                         
|-- | ----------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|E. | Deferred Taxes (cont.):
|   |                        
|   | 1.                      | Composition (cont.):                                                                                                                                                                                                                                    
|   |                         |                                                                                                                                                                                                                                                         
|   |                         | Most
  of the valuation allowances, the Company and its subsidiaries provided, are
  against the deferred tax assets in respect of its tax losses carryforward. As
  a result most of the valuation allowance is for long term.                         
|   |                         |                                                                                                                                                                                                                                                         
|   |                         | Valuation
  allowances relating to the acquisition of Formula Vision totaled $22 million
  as of December 31, 2004. If this valuation allowance is decreases, the
  reversal will reduce the goodwill that was established in the acquisition.          
|   |                         |                                                                                                                                                                                                                                                         
|   |                         | As a
  result of Formla Vision acquisition, the Companys valuation allowance
  increased by $22 million which was offset by a decrease in Matrix valuation
  allowance in the amount of $9 million. due to the use of net oparating loss
  caryforward.

| |    |                                
| | -- | -------------------------------
| | 2. | Presentation in balance sheets:

| |                                    |  |                         |       |      |  |       |  
| | ---------------------------------- |  | ----------------------- | ----- | ---- |  | ----- | -
| |                                    |  | December 31,            |      
| |                                    |  |                         |      
| |                                    |  | 2004                    |       | 2003 | 
| |                                    |  |                         |       |      | 
| |                                    |  | (U.S. $ in
  thousands) |      
| |                                    |  |                         |      
| |                                    |  |                         |      
| | Stated
  in current assets         |  |                         | 3,751 |      |  | 2,528 |  
|
| | Stated
  in other assets           |  |                         | 5,467 |      |  | 5,184 |  
| |                                    |  |                         |       |      |  |       |  
| | Stated
  in long term liabilities  |  |                         | (958  | )    |  | (942  | )
| |                                    |  |                         |       |      |  |       |  
| | Total
  included in balance sheets |  |                         | 8,260 |      |  | 6,770 |  
| |                                    |  |                         |       |      |  |       |  
| |                                    |  |                         |       |      |  |      

|   |                                       | 
|-- | ------------------------------------- | 
|F. | Income (Loss) Before Taxes on Income:

| |          |  |                         |        |      |  |        |  |  |      |  
| | -------- |  | ----------------------- | ------ | ---- |  | ------ |  |  | ---- | -
| |          |  | Year ended December 31, |       
| |          |  |                         |       
| |          |  | 2004                    |        | 2003 |  | 2002   | 
| |          |  |                         |        |      |  |        | 
| |          |  | (U.S. $ in
  thousands) |       
| |          |  |                         |       
| | Domestic |  |                         | 25,205 |      |  | 2,498  |  |  | (178 | )
|
| | Foreign  |  |                         | (7,472 | )    |  | 8,351  |  |  | (335 | )
| |          |  |                         |        |      |  |        |  |  |      |  
| | Total    |  |                         | 17,733 |      |  | 10,849 |  |  | (513 | )
| |          |  |                         |        |      |  |        |  |  |      |  

F53

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 16    Taxes on Income (cont.):

|   |                                                      
|-- | -----------------------------------------------------
|G. | Taxes on Income Included in Statements of Operations:

| |                                             |  |                         |       |      |  |       |   |  |       |  
| | ------------------------------------------- |  | ----------------------- | ----- | ---- |  | ----- | - |  | ----- | -
| |                                             |  | Year ended December 31, |      
| |                                             |  |                         |      
| |                                             |  | 2004                    |       | 2003 |  | 2002  |  
| |                                             |  |                         |       |      |  |       |  
| |                                             |  | (U.S. $ in
  thousands) |      
| |                                             |  |                         |      
| | Current taxes:                              |  |                         |       |      |  |       |   |  |       |  
|
| | In Israel                                   |  |                         | 4,445 |      |  | 1,584 |   |  | 2,112 |  
|
| | Abroad                                      |  |                         | 798   |      |  | 924   |   |  | 1,221 |  
| |                                             |  |                         |       |      |  |       |   |  |       |  
| |                                             |  |                         | 5,243 |      |  | 2,508 |   |  | 3,333 |  
| |                                             |  |                         |       |      |  |       |   |  |       |  
| | Taxes in Israel in respect of
  prior years |  |                         | 184   |      |  | (795  | ) |  | (954  | )
| |                                             |  |                         |       |      |  |       |   |  |       |  
| | Deferred taxes, net                         |  |                         | (796  | )    |  | 827   |   |  | (365  | )
| |                                             |  |                         |       |      |  |       |   |  |       |  
| | Total                                       |  |                         | 4,631 |      |  | 2,540 |   |  | 2,014 |  
| |                                             |  |                         |       |      |  |       |   |  |       |  

|   |                                                                                                                                                                                                                      
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|H. | Theoretical Tax:                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                      
|   | The
  following is a reconciliation between the theoretical tax expense, assuming
  that all income was taxed at ordinary tax rates, and the actual income tax
  expense, as recorded in the statement of operations:

| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | -------------------------------------------------------------------------------------- |  | ----------------------- | ------ | ---- |  | ------ | - |  | ------ | -
| |                                                                                        |  | Year ended December 31, |       
| |                                                                                        |  |                         |       
| |                                                                                        |  | 2004                    |        | 2003 |  | 2002   |  
| |                                                                                        |  |                         |        |      |  |        |  
| |                                                                                        |  | (U.S. $ in thousands)   |       
| |                                                                                        |  |                         |       
| | Income (loss) before taxes on
  income, as per the statement of operations             |  |                         | 17,733 |      |  | 10,849 |   |  | (513   | )
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Statutory tax rate in Israel                                                           |  |                         | 35     | %    |  | 36     | % |  | 36     | %
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Theoretical tax expense
  (benefit)                                                    |  |                         | 6,207  |      |  | 3,906  |   |  | (185   | )
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Additional tax (tax savings)
  in respect of:                                          |  |                         |        |      |  |        |   |  |        |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Non-deductible expenses                                                                |  |                         | 1,727  |      |  | (162   | ) |  | 421    |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Tax-exempt income (mainly
  relating to decrease in shareholdings)                     |  |                         | (2,677 | )    |  | (71    | ) |  | (2,117 | )
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Tax-exempt income and reduced
  tax rates in companies which have approved enterprises |  |                         | (461   | )    |  | (74    | ) |  | 228    |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Losses and temporary
  differences for which deferred taxes were not recorded          |  |                         | 66     |      |  | (55    | ) |  | 5,083  |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Taxes in respect of previous
  years                                                   |  |                         | 118    |      |  | (795   | ) |  | (954   | )
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Effect of the Inflationary
  Adjustments Law                                           |  |                         | (140   | )    |  | 41     |   |  | (717   | )
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Other                                                                                  |  |                         | (209   | )    |  | (250   | ) |  | 255    |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Taxes on
  income as per the statement of operations                                   |  |                         | 4,631  |      |  | 2,540  |   |  | 2,014  |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Effective tax rate  in %                                                              |  |                         | 26.1   |      |  | 23.4   |   |  |       |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  

F54

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 16    Taxes on
Income (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|I. | Tax reform:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   | On January
  1, 2003, a comprehensive tax reform took effect in Israel. Pursuant to the
  reform, resident companies are subject to Israeli tax on income accrued or
  derived in Israel or abroad. In addition, the concept of  controlled foreign corporation was
  introduced, according to which an Israeli Company may become subject to
  Israeli taxes on certain income of a non-Israeli subsidiary if the
  subsidiarys primary source of income is passive income (such as interest,
  dividends, royalties, rental income or capital gains). The tax reform also
  substantially changed the system of taxation of capital gains. The Companys
  management cannot estimate at present whether the reform will have an effect
  on the Groups future results of operations.

Note 17    Supplementary Financial Statement
Information:

Balance Sheet:

|   |                        
|-- | -----------------------
|A. | Other Current
  Assets:
|   |                        
|   | Composition:           

| |                                                                            |  |                         |        |      |  |        | 
| | -------------------------------------------------------------------------- |  | ----------------------- | ------ | ---- |  | ------ | 
| |                                                                            |  |                         |       
| |                                                                            |  | December 31,            |       
| |                                                                            |  |                         |       
| |                                                                            |  | 2004                    |        | 2003 | 
| |                                                                            |  |                         |        |      | 
| |                                                                            |  | (U.S. $ in
  thousands) |       
| |                                                                            |  |                         |       
| |                                                                            |  |                         |        |      |  |        | 
| | Government departments                                                     |  |                         | 6,510  |      |  | 5,380  | 
| | Employees (1)                                                              |  |                         | 1,064  |      |  | 1,084  | 
| | Prepaid expenses and advances to
  suppliers                               |  |                         | 12,489 |      |  | 6,753  | 
| | Deferred taxes                                                             |  |                         | 3,751  |      |  | 2,528  | 
| | Affiliates                                                                 |  |                         | 109    |      |  | 646    | 
| | Accounts receivable resulting
  from realization of holdings in affiliates |  |                         |       |      |  | 312    | 
| | Other                                                                      |  |                         | 2,182  |      |  | 2,143  | 
| |                                                                            |  |                         |        |      |  |        | 
| | Total                                                                      |  |                         | 26,105 |      |  | 18,846 | 
| |                                                                            |  |                         |        |      |  |        | 

(1)     
Some of these balances are linked to the CPI, and bear interest at an annual
rate of 4%.

F55

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 17    Supplementary Financial Statement
Information (cont.):

|   |                                   
|-- | ----------------------------------
|B. | Liabilities to
  Banks and Others:
|   |                                   
|   | Composition:                      

| |                                                    |  |                 |              |              |                         |          |              |      |         |  |  |        |  
| | -------------------------------------------------- |  | --------------- | ------------ | ------------ | ----------------------- | -------- | ------------ | ---- | ------- |  |  | ------ | -
| |                                                    |  | Interest
  rate |              |              |                         |          |              |     
| |                                                    |  |                 |              |              |                         |          | December 31, |     
| |                                                    |  | December 31,    |              |              |                         |          |              |     
| |                                                    |  | 2004            |              |              |                         | 2004     |              | 2003 |        
| |                                                    |  |                 |              | Linkagebasis |                         |          |              |      |        
| |                                                    |  | %               |              |              | (U.S. $ in
  thousands) |         
| |                                                    |  |                 |              |              |                         |          |             
|
| | Bank overdraft                                     |  |                 | 4.5
   17.7 |              |                         | Unlinked |              |      | 3,647   |  |  | 6,179  |  
| | Short-term bank loans                              |  |                 | 4.7
   9.9  |              |                         | Unlinked |              |      | 49,633  |  |  | 15,224 |  
| | Short-term bank loans                              |  |                 | 2.8
   4.9  |              |                         | Dollar   |              |      | 32,759  |  |  | 19,215 |  
| | Short-term bank loans                              |  |                 | 5
   6.5    |              |                         | CPI      |              |      | 905     |  |  | 14,441 |  
| | Short-term bank loans                              |  |                 | 4.03         |              |                         | Euro     |              |      | 682     |  |  | 3,665  |  
| | Current maturities of long-term loans from
  banks |  |                 |              |              |                         |          |              |      | 17,349  |  |  | 7,819  | *
| |                                                    |  |                 |              |              |                         |          |              |      |         |  |  |        |  
| | Total                                              |  |                 |              |              |                         |          |              |      | 104,975 |  |  | 66,543 |  
| |                                                    |  |                 |              |              |                         |          |              |      |         |  |  |        |  

*     Reclassified.

|   |                          
|-- | -------------------------
|C. | Other Accounts
  Payable:
|   |                          
|   | Composition:             

| |                                                           |  |                         |        |      |  |        | 
| | --------------------------------------------------------- |  | ----------------------- | ------ | ---- |  | ------ | 
| |                                                           |  | December 31,            |       
| |                                                           |  |                         |       
| |                                                           |  | 2004                    |        | 2003 | 
| |                                                           |  |                         |        |      | 
| |                                                           |  | (U.S. $ in
  thousands) |       
| |                                                           |  |                         |       
|
| | Employees and other wage and
  salary related liabilities |  |                         | 25,933 |      |  | 24,961 | 
| | Government departments                                    |  |                         | 11,156 |      |  | 10,179 | 
| | Prepaid income and customer
  advances                    |  |                         | 32,676 |      |  | 18,809 | 
| | Accrued expenses and other
  current liabilities          |  |                         | 11,340 |      |  | 17,143 | 
| |                                                           |  |                         |        |      |  |        | 
| | Total                                                     |  |                         | 81,105 |      |  | 71,092 | 
| |                                                           |  |                         |        |      |  |        | 

F56

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 17    Supplementary Financial Statement
Information (cont.):

|   |                                         
|-- | ----------------------------------------
|D. | Restructuring
  and Non-Recurring Costs:

| |                                            |  |                         |   |      |  |      |  |  |       | 
| | ------------------------------------------ |  | ----------------------- | - | ---- |  | ---- |  |  | ----- | 
| |                                            |  | Year ended December 31, |  
| |                                            |  |                         |  
| |                                            |  | 2004                    |   | 2003 |  | 2002 | 
| |                                            |  |                         |   |      |  |      | 
| |                                            |  | (U.S. $ in
  thousands) |  
| |                                            |  |                         |  
|
| | Wages and related expenses                 |  |                         |  |      |  |     |  |  | 1,169 | 
| | Relocation expenses                        |  |                         |  |      |  |     |  |  | 396   | 
| | Expenses relating to closing of
  branches |  |                         |  |      |  |     |  |  | 264   | 
| | Other                                      |  |                         |  |      |  |     |  |  |      | 
| |                                            |  |                         |   |      |  |      |  |  |       | 
| | Total                                      |  |                         |  |      |  |     |  |  | 1,829 | 
| |                                            |  |                         |   |      |  |      |  |  |       | 

|   |                                                                                                                                                                                                                                 
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | Restructuring expenses were recorded by consolidated companies.
  During 2002, these companies announced the adoption of a restructurning plan in order to reduce expenses and
  improve organizational and business efficiency.
|   |                                                                                                                                                                                                                                 
|E. | Financial
  (Expenses) Income, Net:                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                 
|   | Composition:                                                                                                                                                                                                                    

| |                                                           |  |                         |        |      |  |        |   |  |        |  
| | --------------------------------------------------------- |  | ----------------------- | ------ | ---- |  | ------ | - |  | ------ | -
| |                                                           |  | Year ended December 31, |       
| |                                                           |  |                         |       
| |                                                           |  | 2004                    |        | 2003 |  | 2002   |  
| |                                                           |  |                         |        |      |  |        |  
| |                                                           |  | (U.S. $ in
  thousands) |       
| |                                                           |  |                         |       
|
| | Financing income                                          |  |                         | 4,047  |      |  | 4,726  |   |  | 12,621 |  
| | Financing costs related to
  long-term credit             |  |                         | (5,355 | )    |  | (3,347 | ) |  | (2,601 | )
| | Financing costs related to
  short-term credit and others |  |                         | (8,686 | )    |  | (6,046 | ) |  | (6,314 | )
| | Gain (loss) from marketable
  securities                  |  |                         | 1,090  |      |  | 991    |   |  | (101   | )
| |                                                           |  |                         |        |      |  |        |   |  |        |  
| | Total                                                     |  |                         | (8,904 | )    |  | (3,676 | ) |  | 3,605  |  
| |                                                           |  |                         |        |      |  |        |   |  |        |  

|   |                       
|-- | ----------------------
|F. | Other Expenses,
  Net:
|   |                       
|   | Composition:          

| |                                                                       |  |                         |      |      |  |      |   |  |        |  
| | --------------------------------------------------------------------- |  | ----------------------- | ---- | ---- |  | ---- | - |  | ------ | -
| |                                                                       |  | Year ended December 31,
| |                                                                       |  |                        
| |                                                                       |  | 2004                    |      | 2003 |  | 2002 |  
| |                                                                       |  |                         |      |      |  |      |  
| |                                                                       |  | (U.S. $ in
  thousands) |     
| |                                                                       |  |                         |     
|
| | Gain (loss) on
  sale of fixed assets, net                            |  |                         | 60   |      |  | 26   |   |  | (176   | )
| | Dividend received from another
  company                              |  |                         | 770  |      |  |     |   |  |       |  
| | Impairment in value of investment in
  affiliates and other companies |  |                         | (471 | )    |  | (915 | ) |  | (1,656 | )
| | Other                                                                 |  |                         | (691 | )    |  | 799  |   |  | (268   | )
| |                                                                       |  |                         |      |      |  |      |   |  |        |  
| | Total                                                                 |  |                         | (332 | )    |  | (90  | ) |  | (2,100 | )
| |                                                                       |  |                         |      |      |  |      |   |  |        |  

F57

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17    Supplementary Financial Statement
Information (cont.):

|   |                                             
|-- | --------------------------------------------
|G. | Gain on
  Realization of Shareholdings, Net:
|   |                                             
|   | Composition:                                

| |                                                                                 |  |                         |       |      |  |       |   |  |        |  
| | ------------------------------------------------------------------------------- |  | ----------------------- | ----- | ---- |  | ----- | - |  | ------ | -
| |                                                                                 |  | Year ended December 31, |      
| |                                                                                 |  |                         |      
| |                                                                                 |  | 2004                    |       | 2003 |  | 2002  |  
| |                                                                                 |  |                         |       |      |  |       |  
| |                                                                                 |  | (U.S. $ in
  thousands) |      
| |                                                                                 |  |                         |      
|
| | Loss from realization of Compubyte
  Computers                                  |  |                         |      |      |  |      |   |  | (609   | )
| | Gain from realization of investment in
  Level 8                                |  |                         | 171   |      |  | 376   |   |  | 5,466  |  
| | Gain (loss) from sale and decrease in
  shareholding percentage in Magic        |  |                         | 1,151 |      |  | 294   |   |  | (38    | )
| | Gain from realization of investment in the
  News Company                       |  |                         | 142   |      |  | 409   |   |  |       |  
| | Gain from sale and decrease in shareholding
  percentage in Formula Vision      |  |                         | 383   |      |  |      |   |  |       |  
| | Gain from sale and decrease in shareholding
  percentage in Matrix              |  |                         | 3,557 |      |  | 1,131 |   |  | 915    |  
| | Gain (loss) from sale and decrease in
  shareholding percentage in New Applicom |  |                         |      |      |  | (93   | ) |  |       |  
| | Realization of investment in warrants in
  Matrix                               |  |                         |      |      |  | 300   |   |  |       |  
| | Gain from decrease in shareholding
  percentage in Babylon                      |  |                         | 651   |      |  |      |   |  |       |  
| | Realization of unrealized gain in
  Matrix (see Note 2A)                        |  |                         | 2,820 |      |  | 342   |   |  |       |  
| | Gain (loss) on realization of other
  investments                               |  |                         | 18    |      |  | (3    | ) |  | (1,066 | )
| |                                                                                 |  |                         |       |      |  |       |   |  |        |  
| | Total                                                                           |  |                         | 8,893 |      |  | 2,756 |   |  | 4,668  |  
| |                                                                                 |  |                         |       |      |  |       |   |  |        |  

|   |                                                                                                                                                                                                                                                                                                                         
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|H. | Operating
  Segments:                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                         
|   | The Company operates in two
  principal business segments, IT Services and proprietary software
  solutions.                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                         
|   | Software
  Services                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                         
|   | The following is a list of the Groups principal
  activities: applications development, systems integration, migration of IT
  platforms, IT consulting, e-services, outsourcing, conversion services, application
  and implementation of ERP & CRM systems, imported software products and a
  training school.      
|   |                                                                                                                                                                                                                                                                                                                         
|   | The Group provides these IT
  services across the full system development lifecycle, including the definition
  of business requirements, system analysis, technical specifications, coding,
  testing, training, implementation and maintenance.  The Company performs its projects on-site or at its own
  facilities.

F58

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17    Supplementary Financial Statement
Information (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|H. | Operating Segments (cont.):                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Proprietary Software Products                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | The Group
  designs, develops and markets proprietary software solutions for sale in
  selected niche markets worldwide. The following is a list of the proprietary
  software solutions that are marketed by the Group:                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Modernization
  solutions, Magic-technology, Magic eMerchant, solutions for law enforcement,
  Application software for long term care industry, car rental solutions,
  solutions for banking and finance, solutions for telecommunications, CRM
  systems, Sapiens eMerge, re-engineering and AppBuilder, solutions for insurance
  industry such as Sapiens & Merge technology.                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | All of the
  Companys subsidiaries, including IT services companies and proprietary
  software solutions companies, recognize revenues from the delivery of
  software services, and most of them recognize revenues in both revenue
  categories. The Companys subsidiaries were classified into the following
  categories in accordance with the category in which most of the revenues of
  each subsidiary was earned.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | The
  following is a list of the companies included in each operating segment, as
  of December 31, 2004:                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Software Services:                                                                                                                                                                                                                                                                                                                                                                                                           
|   | Matrix IT
  Ltd.
  NextSource Inc.                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Proprietary Software Products:                                                                                                                                                                                                                                                                                                                                                                                               
|   | BluePhoenix
  Solutions Ltd.
  Magic Software Enterprises Ltd.
  Sapiens International Corporation N.V.
  Formula Vision Technologies (F.V.T.) Ltd.                                                                                                                                                                                                                                                                          

F59

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17    Supplementary Financial Statement
Information (cont.):

|   |                                                                                                                                                                                                                            
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|H. | Operating Segments (cont.):                                                                                                                                                                                                
|   |                                                                                                                                                                                                                            
|   | The Company
  evaluates the performances of each segment, software services and proprietary
  software products, based on operating income/loss. Headquarters expenses are
  allocated proportionally between the segments:

| |                              |  |                         |         |                                   |  |         |   |  |        
| | ---------------------------- |  | ----------------------- | ------- | --------------------------------- |  | ------- | - |  | -------
| |                              |  | Software
  Services     |         | Proprietary
  Software
  Products |  | Total   |  
| |                              |  |                         |         |                                   |  |         |  
| |                              |  | (U.S. $ in
  thousands) |        
| |                              |  |                         |        
| | Revenues:                    |  |                         |         |                                   |  |         |   |  |        
| | 2004                         |  |                         | 230,880 |                                   |  | 231,435 |   |  | 462,315
| | 2003                         |  |                         | 196,782 |                                   |  | 170,048 |   |  | 366,830
| | 2002                         |  |                         | 172,068 |                                   |  | 113,121 |   |  | 285,189
| |                              |  |                         |         |                                   |  |         |   |  |        
| | Inter-segment sales:         |  |                         |         |                                   |  |         |   |  |        
| | 2004                         |  |                         | 3,618   |                                   |  | 2,087   |   |  | 5,705  
| | 2003                         |  |                         |        |                                   |  |        |   |  |       
| | 2002                         |  |                         | 726     |                                   |  | 1,153   |   |  | 1,879  
| |                              |  |                         |         |                                   |  |         |   |  |        
| | Operating income (loss):     |  |                         |         |                                   |  |         |   |  |        
| | 2004                         |  |                         | 15,017  |                                   |  | 3,059   |   |  | 18,076 
| | 2003                         |  |                         | 8,289   |                                   |  | 3,570   |   |  | 11,859 
| | 2002                         |  |                         | (1,435  | )                                 |  | (5,251  | ) |  | (6,686 
| |                              |  |                         |         |                                   |  |         |   |  |        
| | Financial income (expenses): |  |                         |         |                                   |  |         |   |  |        
| | 2004                         |  |                         | (3,504  | )                                 |  | (5,400  | ) |  | (8,904 
| | 2003                         |  |                         | (3,205  | )                                 |  | (471    | ) |  | (3,676 
| | 2002                         |  |                         | 5,549   |                                   |  | (1,944  | ) |  | 3,605  
| |                              |  |                         |         |                                   |  |         |   |  |        
| | Net income (loss)            |  |                         |         |                                   |  |         |   |  |        
| | 2004                         |  |                         | 12,178  |                                   |  | (4,079  | ) |  | 8,099  
| | 2003                         |  |                         | 2,106   |                                   |  | 1,014   |   |  | 3,120  
| | 2002                         |  |                         | (1,105  | )                                 |  | (1,301  | ) |  | (2,406 

F60

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17    Supplementary Financial Statement
Information (cont.):

|   |                            
|-- | ---------------------------
|H. | Operating Segments (cont.):

| |                                |  |                      |         |                                   |  |         |  |  |         |  
| | ------------------------------ |  | -------------------- | ------- | --------------------------------- |  | ------- |  |  | ------- | -
| |                                |  | Software
  Services  |         | Proprietary
  Software
  Products |  | Total   | 
| |                                |  |                      |         |                                   |  |         | 
| |                                |  | (U.S.$ in thousands) |        
| |                                |  |                      |        
| | Identifiable assets:           |  |                      |         |                                   |  |         |  |  |         |  
| | 2004                           |  |                      | 181,200 |                                   |  | 380,107 |  |  | 561,307 |  
| | 2003                           |  |                      | 162,361 | *                                 |  | 236,915 |  |  | 399,276 | *
| |                                |  |                      |         |                                   |  |         |  |  |         |  
| | Identifiable liabilities:      |  |                      |         |                                   |  |         |  |  |         |  
| | 2004                           |  |                      | 133,458 |                                   |  | 230,203 |  |  | 363,661 |  
| | 2003                           |  |                      | 132,078 | *                                 |  | 116,179 |  |  | 248,257 | *
| |                                |  |                      |         |                                   |  |         |  |  |         |  
| | Depreciation and amortization: |  |                      |         |                                   |  |         |  |  |         |  
| | 2004                           |  |                      | 4,714   |                                   |  | 15,883  |  |  | 20,597  |  
| | 2003                           |  |                      | 5,602   |                                   |  | 12,945  |  |  | 18,547  |  
| | 2002                           |  |                      | 5,196   |                                   |  | 7,710   |  |  | 12,906  |  
| |                                |  |                      |         |                                   |  |         |  |  |         |  
| | Investments in segment assets: |  |                      |         |                                   |  |         |  |  |         |  
| | 2004                           |  |                      | 1,877   |                                   |  | 3,841   |  |  | 5,718   |  
| | 2003                           |  |                      | 1,924   |                                   |  | 2,963   |  |  | 4,887   |  

| |                                                                                                                                        |              
| | -------------------------------------------------------------------------------------------------------------------------------------- | -------------
| | *                                                                                                                                      | Reclassified.
| |                                                                                                                                        |              
| | Reconciliation between the data on sales and income of the operating
  segments and the data in the consolidated financial statements:

| |                                         |  |                         |         |      |  |         |  |  |         |  
| | --------------------------------------- |  | ----------------------- | ------- | ---- |  | ------- |  |  | ------- | -
| |                                         |  | 2004                    |         | 2003 |  | 2002    | 
| |                                         |  |                         |         |      |  |         | 
| |                                         |  | (U.S. $ in
  thousands) |        
| |                                         |  |                         |        
| | Revenues:                               |  |                         |         |      |  |         |  |  |         |  
| | Revenues as above                       |  |                         | 462,315 |      |  | 366,830 |  |  | 285,189 |  
| | Less inter-segment transactions         |  |                         | (5,705  | )    |  |        |  |  | (1,879  | )
| |                                         |  |                         |         |      |  |         |  |  |         |  
| | Revenues as per statement of
operations |  |                         | 456,610 |      |  | 366,830 |  |  | 283,310 |  
| |                                         |  |                         |         |      |  |         |  |  |         |  

F61

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17    Supplementary Financial Statement
Information (cont.):

|   |                            
|-- | ---------------------------
|H. | Operating Segments (cont.):

| |                                                        |  |                         |         |      |  |         |  
| | ------------------------------------------------------ |  | ----------------------- | ------- | ---- |  | ------- | -
| |                                                        |  | 2004                    |         | 2003 | 
| |                                                        |  |                         |         |      | 
| |                                                        |  | (U.S. $ in
  thousands) |        
| |                                                        |  |                         |        
| |                                                        |  |                         |         |      |  |         |  
| | Identifiable assets:                                   |  |                         |         |      |  |         |  
| | Total assets of operating segments                     |  |                         | 561,307 |      |  | 399,276 | *
| | Assets not identifiable to a particular
  segment      |  |                         | 127,766 |      |  | 159,436 |  
| | Elimination of inter-segment assets and
  other        |  |                         | (48,053 | )    |  | (14,684 | )
| |                                                        |  |                         |         |      |  |         |  
| | Total assets as per consolidated balance
  sheet       |  |                         | 641,020 |      |  | 544,028 |  
| |                                                        |  |                         |         |      |  |         |  
| |                                                        |  |                         |         |      |  |         |  
| | Identifiable liabilities:                              |  |                         |         |      |  |         |  
| | Total liabilities of operating
segments                |  |                         | 363,661 |      |  | 248,257 | *
| | liabilities not identifiable to a
  particular segment |  |                         | 42,030  |      |  | 65,730  |  
| | Elimination of inter-segment liabilities
  and other   |  |                         | (48,028 | )    |  | (14,214 | )
| |                                                        |  |                         |         |      |  |         |  
| | Total liabilities as per consolidated
  balance sheet  |  |                         | 357,663 |      |  | 299,773 |  
| |                                                        |  |                         |         |      |  |         |  

|   |                           |                                                
|-- | ------------------------- | -----------------------------------------------
|   | *                         | Reclassified.                                  
|   |                           |                                                
|I. | Geographical Information:
|   |                          
|   | 1.                        | The Companys Long-Lived Assets are as follows:

| |        |  |                       |        |      |  |        | 
| | ------ |  | --------------------- | ------ | ---- |  | ------ | 
| |        |  | December
  31,        |       
| |        |  |                       |       
| |        |  | 2004                  |        | 2003 | 
| |        |  |                       |        |      | 
| |        |  | (U.S. $ in thousands) |       
| |        |  |                       |       
| |        |  |                       |        |      |  |        | 
| | Israel |  |                       | 64,032 |      |  | 51,656 | 
| | U.S.A. |  |                       | 7,355  |      |  | 6,126  | 
| | Others |  |                       | 6,231  |      |  | 4,458  | 
| |        |  |                       |        |      |  |        | 
| | Total  |  |                       | 77,619 |      |  | 62,240 | 
| |        |  |                       |        |      |  |        | 

| | 2. | Revenues:                              
| | -- | ---------------------------------------
| |    |                                        
| |    | Revenues classified by geographic area:

| |                                                              |  |                           |         |      |  |         |  |  |         | 
| | ------------------------------------------------------------ |  | ------------------------- | ------- | ---- |  | ------- |  |  | ------- | 
| |                                                              |  | Year ended
  December 31, |        
| |                                                              |  |                           |        
| |                                                              |  | 2004                      |         | 2003 |  | 2002    | 
| |                                                              |  |                           |         |      |  |         | 
| |                                                              |  | (U.S. $ in
  thousands)   |        
| |                                                              |  |                           |        
| |                                                              |  |                           |         |      |  |         |  |  |         | 
| | Israel                                                       |  |                           | 213,020 |      |  | 171,108 |  |  | 156,212 | 
| | International:                                               |  |                           |         |      |  |         |  |  |         | 
| | United States                                                |  |                           | 106,849 |      |  | 93,695  |  |  | 65,654  | 
| | Other                                                        |  |                           | 136,741 |      |  | 102,027 |  |  | 61,444  | 
| |                                                              |  |                           |         |      |  |         |  |  |         | 
| |                                                              |  |                           | 243,590 |      |  | 195,722 |  |  | 127,098 | 
| |                                                              |  |                           |         |      |  |         |  |  |         | 
| | Total                                                        |  |                           | 456,610 |      |  | 366,830 |  |  | 283,310 | 
| |                                                              |  |                           |         |      |  |         |  |  |         | 
| | Classification
  was based on the location of the customers. | 

F62

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17    Supplementary Financial Statement
Information (cont.):

|   |                                                                                                     
|-- | ----------------------------------------------------------------------------------------------------
|J. | Earnings (Loss) Per Share:                                                                          
|   |                                                                                                     
|   | The
  following table presents the computation of basic and diluted net earnings
  (loss) per share:

| |                                                                                   |  |                           |        |      |  |        |   |  |        |   
| | --------------------------------------------------------------------------------- |  | ------------------------- | ------ | ---- |  | ------ | - |  | ------ | --
| |                                                                                   |  | Year ended
  December 31, |       
| |                                                                                   |  |                           |       
| |                                                                                   |  | 2004                      |        | 2003 |  | 2002   |  
| |                                                                                   |  |                           |        |      |  |        |  
| |                                                                                   |  | (U.S. $ in
  thousands)   |       
| |                                                                                   |  |                           |       
| |                                                                                   |  |                           |        |      |  |        |   |  |        |   
| | Amount for basic earnings (loss) per share  income available to shareholders     |  |                           | 7,884  |      |  | 2,909  |   |  | (2,406 | ) 
| |                                                                                   |  |                           |        |      |  |        |   |  |        |   
| | Effect of dilutive securities of
  subsidiaries                                   |  |                           | (885   | )    |  | (466   | ) |  |       |   
| |                                                                                   |  |                           |        |      |  |        |   |  |        |   
| | Amount for diluted earnings (loss) per
  share  income available to shareholders |  |                           | 6,999  |      |  | 2,443  |   |  | (2,406 | ) 
| |                                                                                   |  |                           |        |      |  |        |   |  |        |   
| |                                                                                   |  |                           |        |      |  |        |   |  |        |   
| | Weighted average shares outstanding                                               |  |                           |        |      |  |        |   |  |        |   
| | Denominator for basic net earnings (loss)
  per share                             |  |                           | 10,800 |      |  | 10,037 |   |  | 10,171 |   
| | Effect of dilutive securities                                                     |  |                           |       | *)   |  | 248    |   |  |       | *)
| |                                                                                   |  |                           |        |      |  |        |   |  |        |   
| | Denominator for diluted net earnings (loss)
  per share                           |  |                           | 10,800 |      |  | 10,285 |   |  | 10,171 |   
| |                                                                                   |  |                           |        |      |  |        |   |  |        |   
| |                                                                                   |  |                           |        |      |  |        |   |  |        |   
| | Basic net earnings (loss) per share                                               |  |                           | 0.73   |      |  | 0.29   |   |  | (0.24  | ) 
| |                                                                                   |  |                           |        |      |  |        |   |  |        |   
| |                                                                                   |  |                           |        |      |  |        |   |  |        |   
| | Diluted net earnings (loss) per share                                             |  |                           | 0.65   |      |  | 0.24   |   |  | (0.24  | ) 
| |                                                                                   |  |                           |        |      |  |        |   |  |        |   

*)      Anti
dilutive.

| | Options
to purchase 500,000 Formula shares in 2002, at market price were outstanding, but were
not included in the computation of the diluted EPS because the options have an
anti-dilution effect. Options to purchase 2,000,000 shares and employees options to
purchase 64,500 shares in the year 2002 at an exercise price of $15.8 and $30.8,
respectively, were outstanding, but were not included in the computation of the diluted
EPS because the options have an anti-dilution effect.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F63

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 18    Transactions with Related Parties:

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | In July
  2001, Formula granted to Formula Vision, an option to purchase Formulas
  interests in certain privately-held companies. On November 28, 2001, Formula
  Vision exercised the option. Accordingly, Formula transferred to Formula Vision
  its entire interest, including related obligations, in certain companies for
  aggregate consideration of $58.9 million. Under the agreement with Formula
  Vision, Formula Vision issued to Formula in December 2001, a series of
  debentures in the amount of $58.9 million, linked to the CPI and bearing
  interest at an an annual rate of 5%.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | On March 31,
  2002, Formula lent an additional amount of $19.4 million to Formula Vision in
  consideration for a series of debentures with similar terms to the debentures
  issued in December 2001. . This series of transactions is considered a related
  party transaction since Dan and Gad Goldstein serve as directors of Formula
  and Formula Vision.                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | For more information about the transaction between
  Formula and Formula Vision, see Note 2B.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|B. | In November
  2002, Formula completed a sale to Matrix of its entire shareholdings in New
  Applicom, Sintec and Sivan, for an aggregate consideration of $29.6 million.                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|C. | In November
  2002, Formula sold to BluePhoenix, in a share exchange transaction, its 57.9%
  interest in Liraz. In consideration, BluePhoenix issued to Formula
  BluePhoenixs ordinary shares representing 9% of BluePhoenixs outstanding
  share capital. The exchange ratio was set at 1:1.67, which Formula believes
  reflects a fair ratio between the values of the two companies.                                                                                                                                                                                                              

F64

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 19    Subsequent Events:

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | On December
  29, 2004, Formula announced that it had concluded negotiations with FIMI,
  regarding a private placement of 2,400,000 Formula shares. The shares were
  issued to an entity which was established by Dan Goldstein, Formulas CEO and
  Chairman of the Board, and FIMI Opportunity Fund and parties related to it,
  in equal parts. Prior to the private placement, Dan Goldstein also
  transferred to the joint entity all of his 2,000,000 shares of Formula.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | The price
  per share in these transactions was $15.31 (the closing price of Formula
  shares on December 28, 2004), for a total of $36 million that was paid to
  Formula in the private placement.                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | Following
  the transactions, the joint entity holds a total of 4,400,000 Formula shares,
  which constitutes a controlling interest comprising of approximately 33% of
  Formulas outstanding shares. The joint entity also purchased Dan Goldsteins
  shares in Formula Vision.                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | On March 3,
  2005, Formula issued the said shares and received $35.5 million.                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|B. | On June 1,
  2005, Formula distributed a cash dividend, in the amount of $53 million.                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|C. | On June 20,
  2005, Formula repaid the outstanding amount of the debentures issued by it to
  the public in Israel, in May 2002 (see Note 2C).                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | The
  aggregate amount repaid by Formula to the debentures holders was
  approximately $14.9 million.                                                                                                                                                                                                                                                                                                                                                                            

F65

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REPORTS
OF INDEPENDENT AUDITORS WITH RESPECT TO SUBSIDIARIES

(ERNST & YOUNG LOGO)

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM

To the Shareholders of

MAGIC SOFTWARE ENTERPRISES LTD.

We
have audited the accompanying consolidated balance sheets of Magic Software
Enterprises Ltd. (the Company) and its subsidiaries as of December 31, 2003
and 2004, and the related consolidated statements of operations, changes in
shareholders equity and cash flows for each of the three years in the period
ended December
31, 2004. These financial statements are the responsibility of Companys
management. Our responsibility is to express an opinion on these financial statements
based on our audits. We did not audit the financial statements of certain subsidiaries, which statements reflect
total assets of 14% and 19% as of December
31, 2003 and 2004, respectively, and total revenues of 39%, 34% and 39% for
each of the three years in the
period ended December 31, 2004. Those statements were audited by other auditors
whose reports have been furnished to
us, and our opinion, insofar as it relates to the amounts included for those
subsidiaries, is based solely on the
reports of the other auditors.

We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Companys internal control over financial reporting. Our audits
included consideration of internal control over financial reporting as a basis for designing
audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Companys internal control
over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our audits and the
reports of other auditors provide a reasonable basis for our opinion.

In
our opinion, based on our audits and the reports of the other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company and its
subsidiaries at December 31, 2003 and 2004, and the related consolidated
results of their operations and
their cash flows for each of the three years in the period ended December 31,
2004, in conformity with U.S. generally
accepted accounting principles.

|                    | (-s- Kost Forer Gabbay & Kasierer)
|------------------- | ----------------------------------
|Tel-Aviv,
  Israel  | KOST FORER GABBAY & KASIERER      
|February
  15, 2005 | A Member of Ernst & Young Global  



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---



(LEVY CHOHEN & CO. LOGO)

|                                        |                                            
|--------------------------------------- | -------------------------------------------
|37
  Broadhurst Gardens, London NW6 3QT | Tel: 020 - 7624 2251
  Fax: 020 - 7372 2328
|                                        | E- mail:
  lc@levy-cohen.co.uk             

---

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of

Magic Software Enterprises
(UK) Limited

We have audited the accompanying
balance sheets of Magic Software Enterprises (UK) Limited(the Company), as of December 31, 2004 and
2003, and the related consolidated statements of operations, changes in shareholders equity for each of the three
years in the period ended December 31, 2004. These financial statements
are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with the
standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit
includes consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the
circumstrances, but not for the purpose of expressing an opinion on the effectiveness of the Companys
internal control over financial reporting. Accordingly, we express no
such opinion. An audit 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 management, as well as evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to
above present fairly, in an material respects, the consolidated financial position of the Company and its subsidiaries as
of December 31, 2003 and 2004, and the related results of their operations for
each of the three years in the period ended December 31, 2004, in conformity
with accounting principles generally accepted in the United States

|                               |                  
|------------------------------ | -----------------
|(-s- Levy Cohen & Co.)         |                  
|                               |                  
|LEVY
  COHEN & CO.             |                  
|Certified
  Public Accountants |                  
|and
  Registered Auditors      |                  
|                               | 7
  February 2005

|                       |                                                            
|---------------------- | -----------------------------------------------------------
|                      
|S.
  Levy C.P.A. (ISR) | Registered
  by The Institute of Chartered Accountants
  in
|                       | England and
  Wales
  to carry out Company Audit work      



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---



|                                                 |                      
|------------------------------------------------ | ---------------------
|Grant
  Thornton ASGCertified Public Accountants | (GRANT THORNTON LOGO)
|                                                 |                      

Report of
Independent Registered Public Accounting Firm



To the Board of Directors and
Shareholders ofMagic Software Japan K. K.

We have audited the accompanying
balance sheet of Magic Software Japan K. K. (the Company) as of December 31, 2004, and the related statements
of income and accumulated deficit, and cash flows for the year then ended.
These financial statements are the responsibility of the Companys management.
Our responsibility is to express an
opinion based on our audit.

We conducted our audit in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. 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 management, as
well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable
basis for our opinion.

In our opinion, the financial
statements referred to above present fairly, in all material respects, the
financial position of Magic Software
Japan K. K. as of December 31, 2004, and the results of its operations
and its cash flows for the year then ended
in conformity with generally accepted accounting principles in the
United States of America.

(-s- Grant Thornton ASG)

Tokyo, JapanJanuary 21, 2005



Member of Grant Thornton International



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|                     |   |                                                                           |   |                                                
|-------------------- | - | ------------------------------------------------------------------------- | - | -----------------------------------------------
|(ERNST & YOUNG LOGO) | § | Kost Forer Gabbay & Kasierer
  3 Aminadav
  St.
  Tel-Aviv
  67067 Israel | § | Phone
  972-3-6232525
  Fax       972-3-5622555

REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

To the Shareholders of

Sapiens International
Corporation N.V.

We
have audited the accompanying consolidated balance sheets of Sapiens
International Corporation N. V. and its subsidiaries (the Company) as of
December 31, 2003 and 2004 and the related consolidated statements of
operations, shareholders equity and cash flows for each of the three years in
the period ended December 31, 2004. These financial statements are the
responsibility of the Companys management.
Our responsibility is to express an opinion on these financial statements
based on our audits.

We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Companys internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a basis for designing
audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Companys internal control
over financial reporting. Accordingly we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and significant estimates
made by management, and 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 Sapiens
International Corporation N. V. and its subsidiaries as of December 31, 2003 and 2004 and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 2004 in conformity with U. S. generally
accepted accounting principles

|                                                                                                     |                                                                 
|---------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------
|                                                                                                     | -s- Kost Forer Gabbay & Kasierer                                
|Tel-Aviv,
  Israel
  February 9, 2005, except for Note 17b,
  as to
  which the date is May 30, 2005 | KOST FORER GABBAY & KASIERER 
  A Member of Ernst & Young Global



---

---

(ERNST & YOUNG LOGO)

REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To
the Board of Directors and Shareholders of

N.I.P. NIKUV INTERNATIONAL PROJECTS LTD.

We
have audited the accompanying consolidated balance sheets of N.I.P. Nikuv
International Projects Ltd. (the Company) and its subsidiaries as of December 31,
2004, and the related consolidated statements of income, changes in shareholders equity and cash
flows for the year ended December 31, 2004. 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). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Companys internal control over financial reporting. An
audit includes consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Companys
internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by 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 subsidiaries as of December 31, 2004, and the consolidated statements of income and its cash
flows for the year ended December 31, 2004, in conformity with accounting principles generally accepted in
the United States.

|                                 |                                                                   
|-------------------------------- | ------------------------------------------------------------------
|                                 | -s- Kost Forer Gabbay & Kasierer                                  
|Tel-Aviv, Israel 
  May 15, 2005 | KOST FORER GABBAY & KASIERER 
  A
  Member of Ernst & Young Global

---

---

SIGNATURES

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.

FORMULA
SYSTEMS (1985) LTD.

|                                                 |                     |               |      |  | 
|------------------------------------------------ | ------------------- | ------------- | ---- |  | 
|By:                                              | /s/ Dan
  Goldstein | June 30, 2005
|                                                 |                     |               |     
|Dan
  Goldstein                                  |                     |               | Date | 
|Chairman of the Board andChief Executive Officer |                     |               |      | 

97

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|              |  | 
|------------- |  | 
|Exhibit Index | 
|              |  | 

|              |  |                                                                                                                                                                      | 
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
|Exhibit
  No. |  |                                                                                                                                                                     
|              |  |                                                                                                                                                                      | 
|1.1           |  | Memorandum of Association*                                                                                                                                          
|              |  |                                                                                                                                                                     
|1.2           |  | Articles of Association as amended on January 7, 2001**                                                                                                             
|              |  |                                                                                                                                                                     
|2             |  | The description of terms of debentures issued by the Registrant in
  May 2002, contained in Section 2.3 of the prospectus of the Registrant dated
  May 23, 2002 ***
|              |  |                                                                                                                                                                     
|4.1           |  | Agreement dated October 1, 1999 between the Registrant and
Shamrock
  Holdings of California Inc.****                                                               
|              |  |                                                                                                                                                                     
|4.2           |  | Agreement dated January 24, 2001 among the Registrant, Sapiens
  International Corporation N.V. and Yarnfield International Limited**                               
|              |  |                                                                                                                                                                     
|4.3           |  | Amendment to the agreement among the Registrant, Sapiens
  International Corporation N.V. and Yarnfield International Limited, dated
  October 20, 2002*****        
|              |  |                                                                                                                                                                     
|4.4           |  | Agreement dated December 30, 2001 between the Registrant and
Formula
  Vision Technologies (F.V.T.) Ltd. (English summary accompanied by Hebrew
  original)******   
|              |  |                                                                                                                                                                     
|4.5           |  | Agreement dated December 15, 2003 between the Registrant and
Formula
  Vision Technologies (F.V.T.) Ltd. *****                                                      
|              |  |                                                                                                                                                                     
|4.6           |  | Share Purchase Agreement dated February 16, 2005 between the
  Registrant and FIMGold LP                                                                            
|              |  |                                                                                                                                                                     
|4.7           |  | Registration Rights Agreement dated March 3, 2005 between the
  Registrant and FIMGold LP                                                                           
|              |  |                                                                                                                                                                     
|4.8           |  | Form of the 1997 Share Option Plan (English translation from
Hebrew
  original)*                                                                                    
|              |  |                                                                                                                                                                     
|4.9           |  | Form of the 2000 Share Option Plan (English translation from
Hebrew
  original)**                                                                                   
|              |  |                                                                                                                                                                     
|4.10          |  | Letter of Indemnification, dated February 14, 2002******                                                                                                            
|              |  |                                                                                                                                                                     
|8             |  | List of Subsidiaries                                                                                                                                                
|              |  |                                                                                                                                                                     
|12.1          |  | Certification of the Chief Executive Officer pursuant to
§302 of the
  Sarbanes-Oxley Act                                                                           
|              |  |                                                                                                                                                                     
|12.2          |  | Certification of the Principal Financial Officer pursuant to
§302 of
  the Sarbanes-Oxley Act                                                                       
|              |  |                                                                                                                                                                     
|13.1          |  | Certification of the Chief Executive Officer pursuant to 18 U.S.C.
  sec. 1350, as adopted pursuant to sec. 906 of the Sarbanes-Oxley Act                           
|              |  |                                                                                                                                                                     
|13.2          |  | Certification of the Principal Financial
  Officer pursuant to 18 U.S.C. sec. 1350, as adopted pursuant to sec. 906 of
  the Sarbanes-Oxley Act                     

|                                                                                                                                          
|------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                          
|* Incorporated by reference to the
  Registration Statement on Form F-1 (File No. 333- 8858).                                             
|** Incorporated by reference to the Annual
  Report on Form 20-F filed with the Securities and Exchange Commission on June
  29, 2001.    
|*** Incorporated by reference to the Form
  6-K filed with the Securities and Exchange Commission on June 14, 2002.                       
|**** Incorporated by reference to the Annual
  Report on Form 20-F filed with the Securities and Exchange Commission on June
  21, 2000.  
|***** Incorporated by reference to the
  Annual Report on Form 20-F filed with the Securities and Exchange Commission
  on June 30, 2004. 
|****** Incorporated by reference to the
  Annual Report on Form 20-F filed with the Securities and Exchange Commission
  on June 28, 2002.

98

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