---

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# UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

# FORM 20-F

|o | REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(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, 2008

OR

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

For the transition period from __________ to ___________

OR

|o | SHELL COMPANY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES  EXCHANGE ACT
       OF 1934
|- | -----------------------------------------------------------------------------------------------------

Date of event requiring this shell company report ______________

Commission File Number:
0-29442

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)

Guy Bernstein, CEO, 3 Abba Eban Boulevard, Herzliya 46725, IsraelTel: 972 9 9598800, Fax: 972 9 9598877(Name, Telephone, E-mail and/or Facsimile Number and Address of Company Contact Person)

---

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

|                                 |                                          
|-------------------------------- | -----------------------------------------
|
|
|
|
|Title of Each Class              | Name of Each Exchange On Which Registered
|Ordinary Shares, NIS 1 par value | Tel Aviv Stock Exchange                  
|American Depositary Shares       | NASDAQ Global Market                     

Securities registered or to be
registered pursuant to Section 12(g) of the Act:None



---

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Securities for which there is a
reporting obligation pursuant to Section 15(d) of the Act:None

As of December 31, 2008, the
registrant had 13,200,000 outstanding ordinary shares, NIS 1 par value, of which 388,274
were represented by American Depositary Shares as of such date.

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

Yes o No x

If this report is an annual or
transition report, indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes o No x

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

Indicated by check mark whether the
registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o                Accelerated filer x                Non-accelerated filer o

Indicate by check mark which basis of
accounting the registrant has used to prepare the financial statements included in this
filing:

U.S. GAAP x

International Financial Reporting Standards as issued by the International Accounting Standards Board o

Other o

If Other has been checked
in response to the previous question, indicate by check mark which financial statement
item the registrant has elected to follow.

Item 17 o Item 18 o

If this is an annual report, indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).

Yes o No x



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# P A R T  I

Some
of the statements in this annual report, including those in the Risk Factors, Item
3. Key InformationRisk Factors, Item 4Information on the
CompanyBusiness Overview and Item 5Operating and Financial Review
and Prospects, 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. These statements
reflect our current views with respect to future events and are based on assumptions and
are subject to risks and uncertainties. Except as required by applicable law, including
the securities laws of the United States, we do not intend to update or revise any
forward-looking statements, whether as a result of new information, future events or
otherwise.

We
have based these forward-looking statements on our current expectations and projections
about future events. 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 in Item 3. Key InformationRisk
Factors.

We
prepare our consolidated financial statements in accordance with accounting principles
generally accepted in the United States, commonly referred to as U.S. GAAP. In accordance
with U.S. GAAP, we use the United States dollar as our reporting currency. In accordance
with FASB Statement of Financial Accounting Standards No. 144 Accounting for the
Impairment or Disposal of Long-Lived Assets, and following the distribution of the
shares held by Formula in Formula Vision Technologies (F.V.T.) Ltd., or Formula Vision, as
a dividend to Formulas shareholders, in December 2006 and the sale of our entire
shareholdings in BluePhoenix Solutions Ltd., or BluePhoenix, in June 2007, Formula
Visions and BluePhoenixs results of operations, assets and liabilities were
classified as attributed to discontinued operations and as a result, we have restated
certain figures in our financial statements relating to prior periods.

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

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.

2

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---

# TABLE OF CONTENTS

|                                                                                      |   
|------------------------------------------------------------------------------------- | --
|
|
|
|
|ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS                         | 4 
|ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE                                       | 4 
|ITEM 3. KEY INFORMATION                                                               | 4 
|ITEM 4. INFORMATION ON THE COMPANY                                                    | 23
|ITEM 4A. UNRESOLVED STAFF COMMENTS                                                    | 41
|ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                  | 42
|ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                    | 57
|ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                             | 69
|ITEM 8. FINANCIAL INFORMATION                                                         | 72
|ITEM 9. THE OFFER AND LISTING                                                         | 73
|ITEM 10. ADDITIONAL INFORMATION                                                       | 75
|ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS                  | 90
|ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       | 91
|ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                              | 91
|ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 91
|ITEM 15. CONTROLS AND PROCEDURES                                                      | 91
|ITEM 16. [RESERVED]                                                                   | 92
|ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT                                            | 92
|ITEM 16B. CODE OF ETHICS                                                              | 92
|ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES                                      | 92
|ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES                  | 93
|ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS      | 93
|ITEM 16F. CHANGE IN REGISTRANT CERTIFYING ACCOUNTANT                                  | 93
|ITEM 16G. CORPORATE GOVERNANCE                                                        | 94
|ITEM 17. FINANCIAL STATEMENTS                                                         | 95
|ITEM 18. FINANCIAL STATEMENTS                                                         | 95
|ITEM 19. EXHIBITS                                                                     | 95

3

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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, 2006, 2007 and 2008, and the balance
sheet data as at December 31, 2007 and 2008 from our consolidated financial statements
included elsewhere in this annual report. Our consolidated financial statements have been
audited by Ziv Haft registered public accounting firm, BDO member firm. The consolidated
income statement data for the years ended December 31, 2004 and 2005 and the consolidated
balance sheet data for the years ended December 31, 2004, 2005 and 2006 are 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.

4

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|                                                   | Year Ended December 31,
|-------------------------------------------------- | -----------------------
|
|
|
|
|Consolidated Statement of Operations Data:         |                        
|Revenues                                           |                        
|Cost of revenues                                   |                        
|                                                   |                        
|Gross profit                                       |                        
|Research and development costs, net                |                        
|Selling, general and administrative expenses       |                        
|Restructuring and non-recurring costs              |                        
|                                                   |                        
|Operating income                                   |                        
|Financial expenses, net                            |                        
|Gain (loss) on realization of shareholdings, net   |                        
|Other income (expenses), net                       |                        
|                                                   |                        
|Income before taxes on income                      |                        
|Taxes on income                                    |                        
|Equity in gains (losses) of affiliated             |                        
|companies, net                                     |                        
|Minority interest in earnings of subsidiaries, net |                        
|                                                   |                        
|Income (loss) from continuing operations           |                        
|Income (loss) from discontinued operations, net    |                        
|                                                   |                        
|Net income                                         |                        
|Earnings (losses) per share generated from         |                        
|continuing operations                              |                        
|Basic                                              |                        
|Diluted                                            |                        
|Earnings (losses) per share generated from         |                        
|discontinued operations                            |                        
|Basic                                              |                        
|Diluted                                            |                        
|Earnings per share:                                |                        
|Basic earnings                                     |                        
|Diluted earnings                                   |                        
|Weighted average number of shares outstanding:     |                        
|Basic                                              |                        
|Diluted                                            |                        

|                                 | As of December 31,
|-------------------------------- | ------------------
|
|
|
|
|Consolidated Balance Sheet Data: |                   
|Total assets                     |                   
|Total liabilities                |                   
|Shareholders' equity             |                   

5

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# Dividends

In
January 2009, Formula distributed to its shareholders a cash dividend of $2.27 per share,
previously announced in December 2008. The aggregate amount distributed by Formula was
approximately $30 million.

In
April 2008, Formula distributed to its shareholders a cash dividend of approximately $0.76
per share. The aggregate amount distributed by Formula was approximately $10 million.

In
December 2006, Formula distributed to its shareholders a dividend consisting of 36,696,000 shares of Formula Vision held by
Formula and representing approximately 57% of the outstanding share capital of Formula
Vision. Formula Vision shares were distributed at a ratio of 2.78 shares of Formula Vision
for every one outstanding ordinary share of Formula, prior to withholding taxes.

In
June 2005, Formula distributed to its shareholders a cash dividend of approximately $4 per
share. The aggregate amount distributed by Formula was approximately $50.2 million.

Under
Formulas dividend policy adopted 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.

Cash
dividends may be declared and paid in New Israeli Shekels or dollars. Dividends to the
holders of the American Depositary Receipts, or ADRs, are paid by the depositary of the
ADRs, for the benefit of owners of ADRs. If the dividend is declared and paid in NIS, the
NIS amount is converted into dollars by the depositary of the ADRs.

Dividends
paid by an Israeli company to shareholders residing outside Israel, holding less than 10%
of the outstanding share capital of the company, are generally subject to withholding of
Israeli income tax at a rate of up to 20%. Shareholders holding 10% or more of our
outstanding share capital shall generally be subject to withholding of Israeli income tax
at a rate of up to 25% on dividends. Such tax rates apply unless a lower rate is provided
in a treaty between Israel and the shareholders country of residence.

|B. | Capitalization
and Indebtedness
|-- | -------------------------------

Not applicable.

|C. | Reasons
for the Offer and Use of Proceeds
|-- | -----------------------------------------

Not applicable.

|D. | Risk
Factors
|-- | ------------

Our
business, operating results and financial condition could be seriously harmed due to any
of the following risks. Additional risks and uncertainties that we are not aware of or
that we currently believe are immaterial may also adversely affect our business, financial
condition, results of operations and our liquidity. In addition, the trading price of our
ordinary shares could decline due to any of these risks, and you may lose all or part of
your investment.

6

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Risks Relating to Our
Business

The recent global economic and
financial crisis has had and will continue to have a negative effect on our business,
financial condition and results of operations.

The
recent global economic and financial market crisis has caused, among other things, a
general tightening in the credit markets, lower levels of liquidity, increases in the
rates of default and bankruptcy, and reduced corporate profits and capital spending, all
of which has had and will continue to have a negative effect on our business, results of
operations and financial condition.

Demand
for our products and services depends in large part upon the level of information
technology, or IT, capital spending and investment in IT projects by our customers. The
current economic conditions have reduced the willingness or ability of our customers and
prospective customers to commit funds to IT projects, and may reduce their ability to pay
for our products and services after purchase, whether as a result of possible customer
insolvencies or otherwise. This has resulted in a longer sales cycles and increased
pressure on pricing. Similarly, our suppliers may not be able to supply us with needed
components on a timely basis, may increase prices or go out of business, which could
result in our inability to meet customer demand, fulfill our contractual obligations or
affect our gross margins. We cannot predict the timing or duration of the global economic
crisis or the timing or strength of any subsequent economic recovery. Accordingly, we
cannot know how the economic conditions will affect our business. As a result, we cannot
assure you that we will be able to increase our revenues or keep our revenues at the same
level as in 2008.

If
the economy or markets in which we operate experience continued weakness at current levels
or deteriorate further, our business, financial condition and results of operations will
be materially and adversely impacted.

The loss of, or significant
reduction or delay in, purchases by our customers could reduce our revenues and
profitability.

The
loss of any of our major customers or a decrease or delay in orders or anticipated
spending by such customers could reduce our revenues and profitability. Our customers
could also engage in business combinations, which could increase their size, reduce their
demand for our products and solutions as they recognize synergies or rationalize assets
and increase or decrease the portion of our total sales concentration to any single
customer.

7

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If we are unable to effectively
control our costs while maintaining our customer relationships, our business, results of
operations and financial condition could be adversely affected.

It
is critical for us to appropriately align our cost structure with prevailing market
conditions, to minimize the effect of economic downturns on our operations, and in
particular, to continue to maintain our customer relationships while protecting
profitability and cash flow. If we are unable to align our cost structure in response to
such downturns on a timely basis, or if such implementation has an adverse impact on our
business or prospects, then our financial condition, results of operations and cash flows
may be negatively affected.

Conversely,
adjusting our cost structure to fit economic downturn conditions may have a negative
effect on us during an economic upturn or periods of increasing demand for our IT
solutions. If we have too aggressively reduced our costs, we may not have sufficient
resources to capture new IT projects and meet customer demand. If, for example, during
periods of escalating demand for our products, we were unable to add engineering and
technical staff capacity quickly enough to meet the needs of our customers, they may turn
to our competitors making it more difficult for us to retain their business. Similarly, if
we are unable for any other reason to meet delivery schedules, particularly during a
period of escalating demand, our relationships with our customers could be adversely
affected. If we are unable to effectively manage our resources and capacity to capitalize
on periods of economic upturn, there could be a material adverse effect on our business,
financial condition, results of operations and cash flows.

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 American Depositary Shares.

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:

| |  | global
economic trends, like the recent global economic crisis;
| | - | ---------------------------------------------------------------

| |  | 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;
| | - | ---------------------------------------------------------------------------------

8

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---

| |  | currency
fluctuations; 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.

Many of our customers are
financial institutions. A negative impact of the recent global economic and financial
crisis on their business may cause a negative effect on our business, financial condition
and results of operations.

A
portion of our revenues in 2008 was derived from financial institutions. The recent global
economic and financial market crisis had an adverse affect on various financial
institutions and the banking sector. Lower levels of liquidity, increases in the rates of
default and bankruptcy, and reduced corporate profits and capital spending, may have an
adverse effect on our business, results of operations and financial condition.

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

We
established relationships with strategic partners to provide an 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. If we cannot maintain our existing
relationships with these partners, if our partners encounter financial difficulties, 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.

9

---

---

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:

| |  | 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. Current and potential competitors have
established or may establish cooperative relationships among themselves or with third
parties to increase such competitors ability to successfully market their tools and
services. We also expect that competition will increase as a result of consolidation
within the industry. 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.

We
may be unable to differentiate our tools and services from those of our competitors or
successfully develop and introduce new tools and services that are less costly than, or
superior to, those of our competitors. This could have a material adverse effect on our
ability to compete.

Furthermore,
several software development centers worldwide offer software development services at
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.

10

---

---

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.

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.

Our future results could be
adversely affected by an impairment of the value of certain intangible assets.

The
assets listed in our consolidated balance sheet include, among other things, goodwill,
capitalized research and development costs and intangible assets related to
customers relations. The applicable accounting standards require that:

| | goodwill
is not amortized, but rather is subject to an annual impairment test. We perform an
annual impairment test, as well as periodic impairment tests if impairment indicators are
present. Intangible assets that are not considered to have an indefinite useful life are
amortized using the straight-line basis over their estimated useful lives. The carrying
amount of these assets is reviewed whenever events or changes in circumstances indicate
that the carrying value of an asset may not be recoverable. Recoverability of these
assets is measured by comparison of the carrying amount of the asset to the future
undiscounted cash flows the assets is expected to generate. If the asset is considered to
be impaired, the amount of any impairment is measured as the difference between the
carrying value and the fair value (usually discounted cash flow) of the impaired asset;
and
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | acquired
technology and development costs of software that is intended for sale that were incurred
after the establishment of technological feasibility of the relevant product, be
capitalized and tested for impairment on a regular basis, and written down when
capitalized costs exceed its net realizable value.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

11

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---

If
our goodwill or capitalized research and development costs were deemed to be impaired in
whole or in part due to our failure to achieve our goals, or if we fail to accurately
predict the useful life of the capitalized research and development costs, we could be
required to reduce or write off such assets, thus adversely affecting our operating
results.

Certain amounts have been
allocated to goodwill on our balance sheet as a result of acquisitions made by us from
time to time and should it become necessary to write-off a material part of this, our
results of operations could be materially adversely affected.

We
acquire businesses from time to time and as a result, certain amounts have been allocated
to goodwill on our balance sheet. Goodwill and other intangible assets that have
indefinite useful lives are tested at least annually for impairment. Should a test
disclose that there has been a permanent impairment of a material part of the value of
goodwill, it would be necessary to write-off such amount, and this could materially
adversely affect our results of operations.

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
last few years, 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 or unavailability of financing 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.

The
loan agreements of our subsidiaries contain a number of conditions and limitations on the
way in which they can operate their business, including limitations on their ability to
raise debt and sell or acquire assets. These loan agreements also contain various
covenants which require them 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.

12

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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 2007 and 2008, we received approximately 35% and 32% of our total revenues,
respectively, 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.

Corporate
organizational changes, as well as growth of our business, if any, 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.

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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.

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 and if this occurs, customers may have
the ability to 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.

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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.

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.

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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. 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.

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. 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 claim, with or without merit, could be
expensive and time-consuming to defend, and would probably divert our managements
attention and resources. In addition, such a claim if submitted may require us to enter
into royalty or licensing agreements to obtain the right to use a necessary product or
component. Such royalty or licensing agreements, if required, may not be available to us
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. From time to time, we
also provide our software directly to customers. This may increase the likelihood of
misappropriation or other misuse of our software.

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# Our largest shareholder,
Emblaze Ltd., owns the majority of our ordinary shares and controls the outcome of
matters that require shareholder approval.

Emblaze
Ltd., or Emblaze, owns approximately 51. 7% of our outstanding ordinary shares. Therefore,
Emblaze has the power to control 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 affiliates of Emblaze. 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.

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

A
significant portion of our worldwide sales is currently denominated in dollars and euros,
while a substantial portion of our expenses, principally salaries and related personnel
expenses, is in New Israeli Shekels (NIS). As a result, a decrease in the value of the
dollar or euro relative to other foreign currencies, in particular the NIS, would increase
our operating costs and, therefore, could adversely affect our results and harm our
competitive position in the markets. In recent periods, the value of the dollar and the
euro was decreased significantly in relation to the NIS. We cannot know whether this trend
will continue in the future. If the dollar or euro value in relation to the NIS continues
to decrease, our operating costs would increase, and in turn, our results of operation may
be harmed. 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 or euro against the NIS.
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 Functional and
Reporting Currency.

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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 Magic Software
Enterprises Ltd., or Magic Software, Matrix IT Ltd., or Matrix, and Sapiens International
Corporation N.V., or Sapiens. 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.

Risks Related to our
Traded Securities

The market price of our ordinary shares
and American Depositary Shares 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, and in particular, during recent year, a sharp decline as part of the global
economic and financial crisis. 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 have affected and are expected to continue to affect the market price
of our ordinary shares and American Depositary Shares, or ADSs.

The
high and low market price of our ordinary shares traded on the Tel Aviv Stock Exchange, or
the TASE, under the symbol FORT, and the high and low market price of our ADSs
traded on the Nasdaq Global Market, under the symbol FORTY during each of the
last three years, are summarized in the table below:

|     | Nasdaq Global Market
In $ | TASE
In NIS
|---- | ------------------------- | -----------
|
|
|
|
|2008 |                           |            
|2007 |                           |            
|2006 |                           |            

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;
| | - | --------------------------------------------------------------------------------

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| |  | 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;
| | - | -------------------------------------------------------------

| |  | public
announcements concerning distribution of dividends and payment of dividends;
| | - | -----------------------------------------------------------------------------------

| |  | 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.
| | - | -------------------------------------

In
addition, global and local 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 and ADSs.

Our shares are traded on more than
one market and this may result in price variations.

Our
ordinary shares are traded on the TASE and our ADRs are traded on the NASDAQ Global
Market. Trading in our ordinary shares and ADRs on these markets takes place in different
currencies (dollars on the NASDAQ Global Market and NIS on the TASE), and at different
times (resulting from different time zones, different trading days and different public
holidays in the United States and Israel). The trading prices of our ordinary shares and
ADRs on these two markets may differ due to these and other factors. Any decrease in the
trading price of our ordinary shares or ADRs, as applicable, on one of these markets could
cause a decrease in the trading price on the other market.

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 2008, we cannot assure you that we will not be treated
as a PFIC in 2009 or in future years. We would be a PFIC if 75% or more of our gross
income in a taxable year is passive income. We would also be a PFIC 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 PFIC, United States investors could be subject to adverse tax consequences,
including having gain realized on the sale of our ordinary shares or ADSs being treated as
ordinary income, as opposed to capital gain income, and having potentially punitive
interest charges apply to such sale proceeds. Rules similar to those applicable to gains
derived from the disposition of our ordinary shares also apply to certain excess
distributions. A decline in the value of our ordinary shares or ADSs could result in
our company being classified as a PFIC. United States investors should consult with their
own tax advisors with respect to the United States tax consequences of investing in our
ordinary shares.

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For
a discussion of how we might be characterized as a PFIC and related tax consequences, see
Item 10. Additional InformationTaxationUnited States Federal Income Tax
Considerations.

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 generated approximately 32% of our revenues in 2008 from international
markets, we are, nonetheless, directly influenced by the political, economic and military
conditions affecting Israel. Over the past several decades, a number of armed conflicts
have occurred between Israel and its Arab neighbors. A state of hostility, varying in
degree and intensity has led to security and economic problems for Israel. Since 2000,
there have been ongoing hostilities between Israel and the Palestinians, which have
adversely affected the peace process and at times have negatively influenced Israels
economy as well as its relationship with several other countries. In 2006, Israel
experienced a war with Hezbollah militants in Lebanon. Hamas, an Islamist movement
responsible for many attacks, including missile strikes, against Israelis, won the
majority of the seats in the Parliament of the Palestinian Authority in 2006 and took
control of the entire Gaza Strip by force in 2007. In January 2009, Israel engaged in a
military action against Hamas in Gaza to prevent continued rocket attacks against Israel.
These developments have further strained relations between Israel and the Palestinians.
The current political situation between Israel and its neighbors may not improve. These
political, economic and military conditions in Israel could have a material adverse effect
on our business, financial condition, results of operations and future growth.

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 it 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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Political relations could limit
our ability to sell or buy internationally.

We
could be adversely affected by the interruption or reduction of trade between Israel and
its trading partners. Some countries, companies and organizations continue to participate
in a boycott of Israeli firms and others doing business with Israel or with Israeli
companies. Also, over the past several years there have been calls in Europe and elsewhere
to reduce trade with Israel. There can be no assurance that restrictive laws, policies or
practices directed towards Israel or Israeli businesses will not have an adverse impact on
our business.

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. Subject to compliance with
applicable requirements, the portion of our subsidiarys undistributed income derived
from our Approved Enterprise programs was exempt from income tax during the
first two years, followed by a five year tax reduced tax rate of 25% instead of 26% 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 April 20, 2009, 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.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Provisions of Israeli law may
delay, prevent or make more difficult an acquisition of us.

The
Israeli Companies Law generally requires that a merger be approved by the board of
directors and a majority of the shares voting on the proposed merger. For purposes of the
shareholder vote, unless a court rules otherwise, the merger will not be deemed approved
if shares representing a majority of the voting power present at the shareholders meeting,
and which are not held by the other party to the merger (or by any person who holds 25% or
more of the shares or the right to appoint 25% or more of the directors of the other party
or its general manager) have voted against the merger. Upon the request of any creditor of
a party to the proposed merger, a court may delay or prevent the merger if it concludes
that there is a reasonable concern that, as a result of the merger, the surviving company
will be unable to satisfy the obligations of the surviving company. Finally, a merger may
generally not be completed unless at least (i) 50 days have passed since the filing of a
merger proposal signed by both parties with the Israeli Registrar of Companies; and (ii)
30 days have passed since the merger was approved by the shareholders of each of the
parties to the merger. Also, in certain circumstances an acquisition of shares in a public
company must be made by means of a tender offer. Lastly, Israeli tax law treats some
acquisitions, such as stock-for-stock exchanges between an Israeli company and a foreign
company, less favorably than U.S. tax laws. These provisions of Israeli corporate and tax
law may have the effect of delaying, preventing or make more difficult an acquisition of
or merger with us, which may adversely affect its ability to engage in a business
combination and could depress our share price.

As a foreign private issuer whose
shares are listed on the NASDAQ Global Market, we may follow certain home country
corporate governance practices instead of certain NASDAQ requirements.

As
a foreign private issuer whose shares are listed on the NASDAQ Global Market, we are
permitted to follow certain home country corporate governance practices instead of certain
requirements of the NASDAQ Marketplace Rules. A foreign private issuer that elects to
follow a home country practice instead of such requirements, must submit to NASDAQ in
advance a written statement from an independent counsel in such issuers home country
certifying that the issuers practices are not prohibited by the home countrys
laws. In addition, a foreign private issuer must disclose in its annual reports filed with
the Securities and Exchange Commission, or the SEC, or on its website each such
requirement that it does not follow and describe the home country practice followed by the
issuer instead of any such requirement. As a foreign private issuer listed on the NASDAQ
Global Market, we may follow home country practice with regard to, among other things,
composition of our board of directors, director nomination procedure, compensation of
officers, and quorum at shareholders meetings. In addition, we may follow our home
country law, instead of the NASDAQ Marketplace Rules, which require that we obtain
shareholder approval for certain dilutive events, such as for the establishment or
amendment of certain equity based compensation plans, an issuance that will result in a
change of control of the company, certain transactions other than a public offering
involving issuances of a 20% or more interest in the company and certain acquisitions of
the stock or assets of another company.

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# ITEM 4. INFORMATION ON
THE COMPANY

|A. | History
and Development of the Company
|-- | --------------------------------------

Both
our legal name and our commercial name is Formula Systems (1985) Ltd. 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 Global 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 2007 and 2008, see Item
5. Operating and Financial Review and ProspectsLiquidity and Capital
Resources.

Purchase
of TACT. In 2008, our subsidiary, Matrix, purchased all the shares of TACT Computers
and Systems Ltd., or TACT, for an aggregate consideration of $12.5 million. The sellers
are entitled to an additional consideration to be calculated based on the difference
between (x) TACTs value in 2008 to be calculated pursuant to an agreed upon formula
(based on a multiple of the operating profit), subject to the application of agreed upon
adjustments and calculations, and (y) the consideration paid on the date of completion. As
of the date of this annual report, a commitment has been incurred for additional
consideration of approximately $6.5 million.

Sale
of AAOD. On December 30, 2007, our subsidiary, Magic Software, sold its wholly-owned
subsidiary, Advanced Answers on Demand Holding Corporation, or AAOD, a Florida corporation
that develops and markets application software targeted at the long-term care industry, to
Fortissimo Capital for $17 million. Fortissimo paid Magic Software $1 million of the sale
price in December 2007 and the remaining $16 million in March 2008. In addition, as part
of the transaction, Magic Software entered into a three-year license agreement with AAOD
according to which AAOD will continue to sell Magic Softwares products, as an OEM
partner, in consideration for $3 million, to be paid to AAOD quarterly over the three
years starting in 2008.

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Debenture
Offering by Matrix. On August 19, 2007, our subsidiary, Matrix, completed an offering
of debentures in an aggregate principal amount of approximately $62 million (NIS 250
million). The debentures were sold to institutional and other investors in Israel. The
debentures bear an interest at an annual rate of 5.15%. The principal will be paid in four
equal installments on December 31 of each of the years 2010 through 2013. The principal
and interest are linked to the Israeli consumer price index. On February 21, 2008, Matrix
listed the debentures for trading on the TASE.

Sale
of BluePhoenix shares. On June 20, 2007, we completed the sale of an aggregate of
8,038,526 shares of our subsidiary BluePhoenix Solutions Ltd., or BluePhoenix,
constituting our entire holdings in BluePhoenix, to international institutional investors
for aggregate consideration of approximately $64 million.

Private
Placement by Sapiens. In June 2007, our subsidiary, Sapiens, entered into a private
placement investment transaction with several institutional investors, private investors
and Formula for an aggregate gross investment amount of $20 million (excluding
finders fees and out of pocket expenses), $6.5 million of which was by
Formula.  Sapiens issued to the investors an aggregate of 6,666,667 common shares (of
which 2,166,666 common shares were issued to Formula), at a price per share of $3.00,
which reflected a premium of approximately 25% above the trading price of Sapiens
common shares (as of the date Sapiens board of directors approved the
investment).

Spin-Off
of Formula Vision. On December 26, 2006, we distributed to our shareholders a dividend
consisting of 36,696,000 shares of Formula Vision, held by us and representing
approximately 57% of the outstanding share capital of Formula Vision. Formula Vision
shares were distributed at a ratio of 2.78 shares of Formula Vision for every one
outstanding ordinary share of Formula, prior to withholding taxes. As a result, we no
longer hold an interest in Formula Vision. For more information, see Item 5.
Operating and Financial Review and ProspectsCritical Accounting
PoliciesSpin-off of the Investment in Formula VisionDiscontinued
Operation.

Repayment of Formula Vision Debt. On December 31, 2006, Formula Vision paid
approximately $51 million to us, as a full repayment of the principal of the debentures
issued by Formula Vision to Formula in 2001 and 2002, including interest accrued thereon.
In January 2004, Formula exchanged approximately $35 million of the aggregate amount of
the debentures for 38,000,000 shares of Formula Vision and constituting 59.4% of the
outstanding share capital of Formula Vision at that time. In December 2005, the general
meeting of shareholders approved an amendment to the debentures, pursuant to which the
repayments due in 2005 and 2006 would be deferred to December 31, 2006, provided, however
that the amount of cash and cash equivalents that Formula Vision held did not exceed the
amount of its bank loans (including the amount of guarantees made by Formula Vision to
banks in relation to loans granted to its subsidiaries).

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Repayment
of the Debenture to FIMI and IDB. In December 2005 and April 2006, we repaid to First
Israel Mezzanine Investors Ltd., or FIMI, and Israel Discount Bank, or IDB, a debenture in
the aggregate principal amount of $4.7 million issued by Formula in 2002.

|B. | Business
Overview
|-- | -----------------

General

We
are a global 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 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, from time to time, 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.
At present, we have no voting agreements in effect. 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, based on STKI.INFO and IDC annual surveys. Matrix employs over 4,000 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.

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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.

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 and services include the
following components: (i) development of dedicated customer software systems; (ii)
customization of software developed by Matrix or by third parties to provide a response to
customers requirements; (iii) systems assimilation; (iv) offshore and domestic
services, mainly for software developments and quality assurance and software testing; and
(iv) integration of all or part of these components. The scope of 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 sales and
support of software products in various categories, mainly customer relationship
management, referred to as CRM, systems management and business 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 and testing tools.

Infrastructure
solutions and hardware products.Matrixs operations in this area 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 Linux 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 technological training and qualification centers
providing advanced professional courses for hi-tech personnel, training and assimilation
of computer systems, applications courses, professional training and training for capital
market operations.

Matrix
provides solutions, services and products primarily to the following four market sectors
(or verticals): banking and finance, telecommunications, commerce and manufacturing, and
the public and security forces sector.

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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 separate headquarters for each particular market sector, which manages the
operations relating to that sector.

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
divisions providing specialist services for all of the different sectors of operations.
These entities include:

| |        
Expertise
centers  Matrix operates about 20 expertise centers, in areas such as:
SOA (service oriend architecture), Mobility (Mobile Technology), CRM, Open Source, J2EE
and M/F. These expertise centers are based on market concept, which is targeted to yield
significant added value to the companys customers, including: group of
professionals that are focused and have expertise in the related technologies, hands-on
experience and expertise in the related technologies, methodologies, and best practices;
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, including 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 Bank),
telecommunications services providers (Bezeq, Bezeq International and Barak), cellular
operators(Cellcom, Orange and Pelephone), credit card companies (Visa Cal,
Isracard and Leumicard), leasing companies, insurance companies (such as Harel Hamishmar,
Phoenix, Clal, Migdal), security agencies, satellite operators (YES), hi-tech companies(such as Comverse, Motorola and Amdocs), the Israeli Defense Force and government
ministries and public agencies such as Israel Electric Company, Social Security, Mekorot,
and media and publishing entities.

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Magic Software

Magic
Software Enterprises Ltd., develops, markets, sells and supports application platforms and
business and process integration solutions. Magic Softwares products and services
are available through a global network of regional offices, independent software vendors,
or ISVs, system integrators, value-added distributors, value-added resellersas
well as OEM and consulting partners in approximately 50 countries and supported by an
extensive global services organization. In addition to technology, Magic Software provides
its customers with maintenance and technical services, as well as professional services
and training.

Magic
Software Core Technology

With
over 25 years of experience and thousands of customers and partners, Magic Softwares
technology enables enterprises to accelerate the process of building, deploying and
integrating business software applications that can be rapidly customized to meet current
and future needs.

Magic
Softwares technology gives partners and customers the power to create any type of
business applications, leverage existing IT resources, enhance business ability, and focus
on core business priorities to gain maximum return on their existing and new IT
investments.

Magic
Software is known for its code-free approach, allowing users to focus on business logic
rather than technological requirements. This approach forms the driving principle of both
the uniPaaS application platform (the next generation of eDeveloper) and the iBOLT
business and process integration suites. Both uniPaaS and iBOLT enable enterprises to
accelerate the process of building and deploying applications that can be rapidly
customized and integrated with existing systems:

| |  | uniPaaS
Application Platform (the next generation of eDeveloper)  is a comprehensive
application platform that supports all deployment models including Full Client, Rich
Internet Applications (RIA) and Software-as-a-Service (SaaS).  It uses a single
development paradigm to handle all client and server partitioning and offers customers
the choice in how they deploy their applications, whether full client or web; on-premise
or on-demand; in the cloud or behind the corporate firewall; software or SaaS; or global
or local, and complies with event-driven and service-oriented architectural principles.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | By
offering technology transparency, uniPaaS allows customers to focus on their business
requirements rather than technological means. uniPaaS single development paradigm
significantly reduces the time and costs associated with the development and deployment
of RIAs. Application owners can leverage their initial investment when moving from full
client mode to RIA and SaaS, and eventually modify these choices as the situation
requires. Furthermore, enterprises can use cloud based uniPaaS applications in a SaaS
model and still have their databases in the privacy of their own data centers. It also
supports most hardware and operating system environments such as Windows, Unix, Linux and
AS/400, as well as multiple databases. uniPaaS is interoperable with .NET and Java
technologies.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | iBOLT
Business and Process Integration Suite  provides business integration and
process management solutions with a particular focus on enterprise applications. iBOLT
allows integration and interoperability of diverse solutions, including legacy
applications, in a quick and efficient manner.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Increasing
the usability and life span of existing legacy and other IT systems, iBOLT allows fast
enterprise application integration (EAI), development and customization of diverse
applications, systems and databases, assuring rapid return on invested capital and
time-to-market, increased profitability, and customer satisfaction. Magic Software offers
special editions of iBOLT targeted at specific enterprise application vendor ecosystems,
such as SAP Business One, SAP R/3, SAP Business All in One, JD Edwards, IBM i,
Salesforce.com, Lotus Notes, and HL7. These special editions contain specific features
and pricing tailored for these market segments.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Magic
Software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 and others), or platform (.NET,
J2EE).

Enabling
Business

Magic
Softwares technology enables enterprises to accelerate the process of building and
deploying business software applications that can be rapidly customized to meet current
and future needs.

Magic
Softwares technology and solutions are particularly in demand when time-to-market
considerations are critical, budgets are tight, integration is required with multiple
platforms or applications, databases or existing systems and business processes, as well
as for RIA, cloud computing and SaaS.

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

Professional
Services

Magic
Software provide a broad range of consulting and software development project management
services to customers developing, deploying and integrating distributed applications.

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Magic
Software offers fee-based consulting services in connection with installation assurance,
application audits and performance enhancement, application migration and application
prototyping and design. Consulting services are aimed at both generating additional
revenues and ensuring successful implementation of uniPaaS and iBOLT projects through
knowledge transfer.

Services
are offered as separately purchased add-on packages or as part of an overall software
development and deployment technology framework. Over the last several years, Magic
Software has built upon its established global presence to form joint ventures with its
MSPs (Magic Software providers) who use Magic Software technology to develop solutions for
their customers, and distributors to deliver successful solutions in focused market
sectors.

Partner
Alliances

Magic
Software forms partner alliances to help deliver complete solutions to customers. These
solutions encompass application integration, development, vertical domain expertise and
hardware implementation. Magic Software maintains strategic alliances with leading
vendors, like SAP, IBM, Oracle and Salesforce.com. Magic Softwares partnership with
SAP, entered into in 2004, focuses on providing a special edition of iBOLT which extends
the value of SAP Business One, SAP Business All in One and SAP R/3 implementations with
capabilities such as extended workflows, composite applications, multi-channel access,
interoperability and integration with other systems and platforms, as well as business
activity and performance monitoring. Magic Software applies the same marketing concept to
other leading enterprise application ecosystems, with special editions of iBOLT for
Salesforce.com, Oracles JD Edwards, IBM i, Lotus Notes and HL7. In addition, Magic
Software has alliances with system integrators, software and hardware vendors and
consulting organizations. These partnerships enable Magic Software 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, cargo handling and inventory control solutions.

        Cargo
handling  Hermes (formerly Magic eCargo) 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 departure control systems, interfacing,
scanning and verification of cargo, secured tracking and a comprehensive financial
package for all aspects of charging, collecting fees and invoicing.

       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.

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

adidas-Canada,
Administar Services Group, AFC Worldwide Express, Allstate, Anglo-Canadian Housewares,
Anritsu, Athlon Group, Boeing, Burger King, Carey International, City of Phoenix Police
Department, Club Med, CBIA, Charlotte Country Court System, Compass Group PLC, Danish
Ministry of Economic, Deka Bank, Deutsche Bank, DHL, Electricité de Strasbourg,
Electra, Esmee Fairbairn Foundation, Fortis Assurances, Fujitsu-Ten, Euroclear, Europ
Assistance Netherlands, Financial Times, FMRP, Fraport AG, GAP, GGD Amsterdam, Grange
Insurance, Heller Bank AG, Hitachi, ING Commercial Finance, Johnson & Johnson, John
Menzies, Kodak, LORD Corporation, Marconi Mobile, Merrill Lynch, Matsushita, Minolta,
NEC, Nestle Nespresso, Nintendo, New York State Public Defenders Association, Online
Trading Academy, OTOR, Paris Nord Villepinte Exhibition Center, Philip Morris, Primagas,
Prestwick House, Rosenbauer, San Francisco Courts, Semeru, Sharp System Products, Sklar
Peppler TEVA, Title Solutions, Titan Software, Vadim Software, Vodafone, the United
Nations, UPS, Victorinox, Vodafone, W3Com, Warren Board, and Washington State.

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
changes. 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 developed for leading
organizations such as AXA, Norwich Union, Liverpool Victoria, IAT Group, ING, OneBeacon,
Principal Financial Group, Texas Farm Bureau Insurance Companies, Menora Mivtachim
Insurance and Santam. Sapiens service offerings include a standard consulting
offering that helps customers make better use of IT in order to achieve their business
objectives.

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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. 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.

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 is a Premier Business 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, MQ and the WebSphere e-business platform. Sapiens is also a
member of 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 Sapiens 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 Sapiens INSIGHT family, are
based on 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:

| |  | Sapiens INSIGHT for
Property & Casualty 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.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Sapiens INSIGHT for
Life & Pensions is a powerful and comprehensive framework-based life and pensions
solution that serves companies administering life insurance, pension funds, health
insurance and saving plans. Sapiens INSIGHT for Life & Pensions is dynamic, is
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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Sapiens INSIGHT for
Closed Books, 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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Sapiens INSIGHT for
Reinsurance is a functional-rich solution for the insurance market, designed to
support insurance carriers 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 and multi-company environment.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Sapiens INSIGHT for
Underwriting (formerly MediRisk INSIGHT) is an underwriting solution for life,
health and disability insurance. It reduces a 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.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Sapiens
collaborates with its customers to tailor the Sapiens 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 and iSeries, HP UNIX at the host-side and Windows 2000/XP Web servers. They are
also compatible with open architecture standards such as .NET, Java EE, XML, Web Services
and application server platforms such as IBMs WebSphere.

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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.

Customers

Sapiens
INISGHT.Sapiens markets the Sapiens INISGHT suite of solutions to
insurance carriers in four main categories: Property & Casualty (known as General
Insurance in Europe); Life and Pensions (known as Life and Health in the US), Reinsurance
and Medical Underwriting. Sapiens customers and target markets have direct written
premiums in the range of $80 million to $5 billion per year. However, given the
flexibility and modularity of the Sapiens INISGHT suite of solutions, its offerings
can accommodate most situations and budgets.

Sapiens
eMerge.Sapiens markets Sapiens eMerge 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.

nextSource Inc.

nextSource
Inc., or nextSource, operates in the field of workforce management solutions by developing
and delivering an innovative and comprehensive suite of services and products. This model
allows customers to engage nextSource for one or any combination of capabilities that
address the challenges imposed by todays global and complex workforce issues.
nextSource offers customers the ability to manage their present and future workforce needs
with a high degree of flexibility, proven best practices and proprietary technology as a
single source. This positions nextSource as the workforce solutions provider of choice.

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nextSources
wheel of integrated solutions include:

| |  | Vendor
Management  Talent Acquisition Management Solution (TAMS)
| | - | -----------------------------------------------------------------

One
of nextSources key products is its intuitive, web-based vendor management system
named Talent Acquisition Management Solution, or TAMS. TAMS is a scalable, 8th generation
vendor management software application. TAMS automates the process of acquiring and
managing a customers workforce consisting of temporary staffing, contract workers,
consultants and direct hires. TAMS also facilitates the competitive sourcing and tracking
of fixed price, deliverable-based projects.

TAMS
introduces process improvements resulting in the elimination of inefficiencies, reducing
the amount of time HR managers and procurement teams spend in acquiring and tracking
contingent workforces. The application provides timekeeping, invoicing, online
requisitioning, online purchase orders and all approvals associated with each function.
nextSource is able to configure the application to fit its customers specifications
with minimal implementation time through nextSources highly experienced
implementation team.

| |  | Salary
& Rate Benchmarking  The PeopleTicker
| | - | ---------------------------------------------

nextSources
key product in this area, The People Ticker, is the industrys only
web-based, real-time rate and salary benchmarking tool for full-time and contingent
compensation. The People Ticker replaces the antiquated salary survey approach
by providing users with real time rate and salary data specific to an industry, geographic
region and job description. With this powerful application, customers are able to assess
and react to the cost of specific labor market fluctuations on a real-time basis. The
application takes the guesswork out of establishing geography and position specific,
hourly rates and full-time salaries for employees based on current market supply and
demand. Armed with this information, customers are now able to hire and retain employees,
procure contingent labor and budget for project-based initiatives in a cost effective
manner. Currently, The PeopleTicker is in its third generation and covers the United
States, Canada, United Kingdom and India.

| |  | Payrolling
Services/Third-Party Employer of Record Services
| | - | -----------------------------------------------------------

nextSource
offers a comprehensive payrolling and risk mitigation service. nextSource payrolling
services protect its customers and mitigate risks and the many legal issues surrounding
the acquisition of 1099s or independent contractors. nextSource serves as the employer of
record for these resources providing customers with the ability to maintain flexible
workforce capabilities. nextSource complements its payrolling services offering with
People Time, a web-based, time and attendance tracking application enabling
hiring managers to collect and report worker time and cost data.

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| |  | Staffing
| | - | --------

Through
ConsultingDirect, nextSource creates an efficient web-enabled labor
market/reverse auction through which a pool of pre-screened and pre-qualified members of
its Registry of Certified Consultants (ROCC), have the opportunity to bid for open
positions. ROCC members provide their requested hourly rate or project fee and the
customer is able to make an informed decision in a highly competitive, transparent
auction-type market for each job posting. nextSource believes that this system provides a
very efficient process for customers to reach a wide group of pre-screened, pre-negotiated
candidates.

| |  | Agency
Exchange
| | - | ---------------

In
2003, nextSource created The Multiple Listing Staffing Association (MLSA), an
industry-wide network of independent, nextSource-qualified staffing agencies. The MLSA
brings together staffing agencies working cooperatively with one another under the
nextSource umbrella. Members of the MLSA can post an unlimited number of openings of any
type on nextSources web-based portal and increase their own qualified candidate pool
by accessing the nextSource database of candidates, in addition to accessing new customers
and additional openings from other agencies.

| |  | HR/Procurement
Consulting
| | - | -------------------------

nextSource
provides HR and procurement consulting, including assisting customers with the negotiation
of rates and supplier agreements and the establishment of agency performance metrics.
nextSource also offers salary and compensation analysis, assessment of co-employment
risks, review of on-boarding and off-boarding procedures and other HR policies and
processes.

| |  | Pre-Employment
Screened Applicants  Certified Person
| | - | -----------------------------------------------------

The
newest addition to nextSources offerings is the Certified Person platform; a
sourcing tool that integrates background screening services. Certified Person removes the
uncertainty of whether or not a candidate passes employment pre-screening requirements.
All members of Certified Person will be put through a background screening process that
will ensure they meet our customers specific background and on-boarding requirements
prior to being engaged for any opportunities. Once they pass these requirements, these
candidates will be introduced in the appropriate recruiting cycle. This solution was
created to streamline the time to hire process by only sourcing and recruiting candidates
who have already passed the required on-boarding requirements.

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.

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

|                        | Software
Services | Proprietary
Software
Products | Total
|----------------------- | ----------------- | ----------------------------- | -----
|
|
|
|
|Year ended December 31, |                   |                               |      
|2008                    |                   |                               |      
|2007                    |                   |                               |      
|2006                    |                   |                               |      

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,
|-------------- | -----------------------
|
|
|
|
|Israel         |                        
|International: |                        
|United States  |                        
|Other          |                        
|               |                        
|               |                        
|               |                        
|Total          |                        
|               |                        

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.

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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 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.

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., Team-Malam, Taldor
and One1. Matrixs international competitors in the Israeli marketplace include HP,
EDS, IBM and Microsoft. These international competitors often use local subcontractors to
provide personnel for contracts performed in Israel. Most of these international entities
are also business partners of Matrix.

Magic
Softwares principal competitors in the market for the uniPaaS technology are Cordys,
IBM, Microsoft, Oracle, Pegasystems, Progress, Fiorano, Intersystems, Sun, TIBCO, Ultimus
and Unify. The principal competitors in the market for Magic Softwares iBOLT
Business and Process Integration Suite are Tibco, Informatica, Microsoft BizTalk and
Software AG.

Sapiens
competitors in the market for solutions offered to the insurance industry fall into
several categories: vendors of complete systems, vendors of insurance software products,
large multinational integrators and local integrators in the various territories where
Sapiens operates.

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Examples
of Sapiens competitors are: CSC, Camilion, SOLCORP, Fineos, SAP, SunGard, Navisys,
Fiserv, OneShield, Ascendant One, Insurity, IDP, The Innovation Group, Duck Creek and AQS
in the United States; Unisys, SunGard, FIS Software and RebusIs in the United Kingdom;
Falmeyer (FJA), COR AG Insurance Technologies and IDIT IDI Technologies in Europe.
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.

In
addition, Sapiens faces competition from its customers and potential customers
internal IT departments, who often prefer to develop solutions in-house.

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

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.

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|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 April 20, 2009.

|Subsidiary                             | Country of Incorporation     | Percentage
Of Ownership
|-------------------------------------- | ---------------------------- | -----------------------
|
|
|
|
|Matrix IT Ltd.                         | Israel                       | 50.0%                  
|                                      
|Magic Software Enterprises Ltd.        | Israel                       | 58.2%                  
|                                      
|Sapiens International Corporation N.V. | Netherlands Antilles Islands | 70.6%                  
|                                      
|nextSource Inc.                        | United States                | 100.00%                

The
ordinary shares of Magic Software and Sapiens are traded on the NASDAQ Global Market and
on the TASE, and the ordinary shares of Matrix 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 103,000 square feet of office space in Herzlia, pursuant to a lease which
expires on October 31, 2013. We also lease an aggregate of approximately 194,000 square
feet of office space in several other locations in Israel.

We
own a 39,300 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, 4,700
square feet in the United States and 13,800 square feet in Great Britain, Magic Software
leases approximately 5,100 square feet of office space in the United States and several of
our subsidiaries lease some additional office space and sales and support premises in the
United States, Europe and Asia.

We
believe that our properties are adequate for our present uses. If in the future we 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 4A. UNRESOLVED
STAFF COMMENTS

Not applicable.

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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 three publicly traded subsidiaries: Magic
Software, Matrix and Sapiens. In addition, we wholly own nextSource. We consolidate the
results of operations of our subsidiaries in which we hold a controlling interest with
ours. Our operating results are, and have been, 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.

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 the 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.

Our
functional and reporting currency

Beginning
in 2007, Formula changed its functional currency from NIS to the dollar since most of its
assets are denominated in dollars and Formula has no outstanding NIS loans. This,
according to indicators as mentioned in Financial Accounting Standards Board Statement no.
52 Foreign Currency Translation, referred to SFAS 52. Prior to 2007, Formula
operated primarily in the economic environment of the New Israeli Shekel (NIS) and its
functional currency was the NIS. The functional currencies of Formulas subsidiaries
are the NIS and the dollar. Formula has elected to use the dollar as its reporting
currency.

Formula
translates the financial statements of its subsidiaries whose functional currency is
the NIS, into dollars, under the principles described in SFAS 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 differences resulting from translation under shareholders
equity in the item accumulating other comprehensive income (loss). In the consolidation,
Formula presents the financial statements of subsidiaries whose functional currency is the
dollar, at the original amounts.

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The
comparative figures for 2006 have been measured under the assumption that Formulas
functional currency was the NIS. The financial statements of prior years of Formula and
most of its subsidiaries whose functional currency is the NIS have been translated into
dollars under the principles described in SFAS 52.

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.

SOP
No. 97-2 generally requires revenue earned from software arrangements involving multiple
elements to be allocated to each element based on the relative fair values of the elements
determined by the vendors specific objective evidence, or VSOE, of fair value.
Revenue is recognized under the residual method when VSOE of fair value exists
for all undelivered elements and VSOE of fair value does not exist for all of the
delivered elements, and when all SOP No. 97-2 criteria for revenue recognition are met, as
described above. The VSOE of the undelivered elements -PCS (post contract support) is
based on the price charged on PCS sold separately or renewed.

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Generally
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 customer 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.

We
recognize revenues from projects 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. 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.

We
recognize revenues from consulting fees with respect to projects billed on a time and
material basis, based on the number of hours performed. The VSOE for consulting services
in multiple element arrangements is established based on the price charged when the
consulting services are sold separately based on a time and material basis.

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.

Capitalized
Software Research and Development Costs

Development
costs of software that is intended for sale that were incurred after the establishment of
technological feasibility of the relevant product, are capitalized. Technological
feasibility is determined by our subsidiaries when detailed program design is completed
and verified in accordance with the provisions of the FASB Statement of Financial
Accounting Standards No. 86 (SFAS 86). Software development costs incurred by our
subsidiaries before technological feasibility is established are charged to the statement
of operations as incurred net of participation of the Office of the Chief Scientist (OCS).
Our subsidiaries policy on capitalized software costs determines the timing of our
recognition of certain development costs. In addition, this policy determines whether the
cost is classified as development expense or capitalized costs. Our subsidiaries
management is required to use professional judgment in determining whether development
costs meet the criteria for immediate expense or capitalization. Amortization of
capitalized software development costs begins when the product is available for general
release to customers. Annual amortization is computed by 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, whichever is higher. Currently,
amortization is computed by the straight-line method over a period of 3 to 5 years. Our
subsidiaries failure to accurately predict the useful life of capitalized software
could cause a one-time amortization, which could adversely affect our operating results.

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Impairment
of Goodwill and Intangible Assets

Our
business acquisitions resulted in goodwill and other intangible assets. We periodically
evaluate our goodwill, intangible assets, and investments in affiliates for potential
impairment indicators. Our judgments regarding the existence of impairment indicators are
based on legal factors, market conditions and operational performance of our acquired
businesses and investments.

In
accordance with FASB Statement of Financial Accounting Standards No. 142 Goodwill
and Other intangible Assets, or SFAS 142, indefinite life intangible assets and
goodwill are not amortized but rather subject to annual impairment testing.

Goodwill
is tested for impairment by comparing the fair value of the reporting unit with its
carrying value. Fair value is generally determined using discounted cash flows, market
multiples and market capitalization. Significant estimates used in the fair value
methodologies include estimates of future cash flows, future short-term and long-term
growth rates, weighted average cost of capital and estimates of market multiples of the
reportable unit. If these estimates or their related assumptions change in the future, we
may be required to record impairment charges for our goodwill and intangible assets. These
write downs, if any, may have an adverse affect on our operating results. Future events
could cause us to conclude that impairment indicators exist and that additional intangible
assets associated with our acquired businesses are impaired.

The
process of evaluating the potential impairment of goodwill is subjective and requires
significant judgment at many points during the analysis. Changes in judgment on these
assumptions and estimates could result in a goodwill impairment charge. Any resulting
impairment loss could have a material adverse impact on our financial condition and
results of operations.

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, or SFAS 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.

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Spin-off
of the Investment in Formula Vision

According
to APB No. 29 Accounting for Nonmonetary Transactions, a spin off is accounted
as a decrease in the companys retained earnings and measured according to the book
value of the investment as of the spin-off date.

Discontinued
Operation

Under
SFAS 144, when a component of an entity, as defined in SFAS 144, has been disposed of or
is classified as held for sale, the results of its operations, including the gain or loss
on its disposal should be classified as discontinued operations and the assets and
liabilities of such component should be classified as assets and liabilities attributed to
discontinued operations. The operations, assets and liabilities of the component would be
eliminated from the companys consolidated operations and the company will no longer
have any significant continuing involvement in the operations of the component.

Share-Based
Payments

Effective
January 1, 2006, we adopted Statement of Financial Accounting Statement No. 123 (revised
2004), Share-Based Payment, referred to as SFAS 123(R), which is a revision of
FASB Statement No. 123, Accounting for Stock-Based Compensation, or SFAS 123,
which requires the measurement and recognition of compensation expense based on estimated
fair values for all shared based payments awards made to employees and directors. In March
2005, the SEC issued Staff Accounting Bulletin No. 107, or SAB 107, relating to SAFS
123(R). We have applied the provisions of SAB 107 in our adoption of SFAS 123(R).

SFAS
123(R) requires us to estimate the fair value equity-based payment awards on the date of
grant using an option-pricing model. The value of the portion of the awards that is
ultimately expected to vest is recognized as an expense over the requisite service periods
in our consolidated statement of operations. Prior to the adoption of SFAS 123(R), we
accounted for equity based awards under the fair value recognition provisions of SFAS 123.

We
adopted SFAS 123(R) using the Modified Prospective Method. Under that transition method,
compensation cost recognized in the year ended December 31, 2007 included: (a)
compensation cost for all share-based payments granted prior to, but not yet vested as of,
January 1, 2006, based on the grant date fair value estimated in accordance with the
original provisions of SFAS 123; and (b) compensation cost for all share-based payments
granted subsequent to January 1, 2006 based on the grant-date fair value estimated in
accordance with the provisions of the SFAS 123(R).

Beginning
on the date of adoption of SFAS 123(R), we estimate forfeitures based on historical
experience and other factors.

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|A. | Operating
Results
|-- | -----------------

Year
Ended December 31, 2008 Compared to Year Ended December 31, 2007

Revenues.
          Revenues increased 20% from $493.4 million in 2007 to $590.8 million in 2008.
          Revenues from the two categories of our operation were as follows: Revenues from
          the delivery of software services increased 24% from $392.5 million in 2007 to
          $485.4 million in 2008. 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 in 2008
          were $105.4 million compared to $100.8 million in 2007. This increase was
          attributable primarily to increase in Magic Softwares revenues.

Cost
of Revenues. Cost of revenues consists primarily of wages and related expenses and
hardware and other materials costs. Cost of revenues increased 23% from $369.1 million in
2007 to $452.3 million in 2008. As a percentage of revenues, cost of revenues were
relatively at the same level in 2007 and in 2008, 75% and 76%, respectively. Our software
services sales are generally characterized by a lower gross margin than sales of
proprietary software solutions. Cost of revenues for proprietary software solutions were
$53.5 million in 2008 and $52.9 million in 2007. Cost of revenues for software services
increased 26% from $316.1 million in 2007 to $398.9 million in 2008, primarily due to the
increase in the cost of revenues of our subsidiaries Matrix and nextSource.

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 2008 and 2007 were $13.2 million and $12.6 million,
respectively.  In 2008, we capitalized software costs of $6.7 million compared to
$6.2 million in 2007. Capitalization of software costs in 2008 was attributable to our
proprietary software solutions subsidiaries. Software development costs, net, were $6.6
million and $6.5 million, in 2008 and 2007, respectively.  As a percentage of
revenues, software development costs, net decreased from 1.3% in 2007 to 1.1% in
2008.  Software development costs in 2008 were attributable primarily by Magic
Software and Sapiens which had research and development expenditures of approximately $2.3
million and $3.9 million, respectively. Amortization of capitalized software costs was
$7.2 million in 2008 and $6.4 million in 2007, which amounts were included in cost of
revenues.

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 in 2008 and 2007 were $98.7 million and $90.5 million,
respectively. As a percentage of revenues, selling, general and administrative expenses
were 16.7% in 2008 and 18.3% in 2007. The increase in selling, general and administrative
expenses was attributable to an increase in selling, general and administrative expenses
of all of our subsidiaries.

Operating
Income. Our operating income increased from $27.2 million in 2007 to $33.4 million in
2008. The operating income in 2008 was attributable to the improvement in the operating
results of all of our subsidiaries, and in particular Matrix which had operating income of
$27.9 million, Magic Software which had operating income of $4.3 million and Sapiens which
had operating income $2.5 million. The operating income in 2007 was attributable to the
improvement in the operating results of our subsidiaries, and in particular Matrix which
had operating income of $24.5 million, Magic Software which had operating income of $1.3
million and Sapiens which had operating income of $800,000.

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Financial
Expenses, net. Financial expenses, net increased from $3.8 million in 2007 to $6.0
million in 2008. Financial expenses, net, is influenced by various factors, including our
cash balances, loan balances, 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. Financial expenses, net in 2008 are attributable to interest expenses incurred by our
subsidiaries, Matrix and Sapiens, which had financial expenses of $6.6 million and $2.0
million, respectively, resulting from issuance of debentures. These expenses were
primarily offset by financial income in Formula which resulted from interest derived from
short-term and long-term deposits and exchange rate differentials.

Other
expenses, net. Other expenses, net in 2008 and 2007 were $580,000 and $750,000,
respectively.

Gain
(Loss) on Realization of Shareholdings. Loss on realization of shareholdings in 2008
was $337,000 compared to a gain of $2.0 million in 2007.

Taxes
on Income. Taxes on income in 2008 were $3.5 million compared to $1.9 million in 2007.
The increase in taxes on income in 2008 was mainly attributable to the increase in taxes
of Matrix.

Companys
Equity in Results of Affiliates, net. Our equity in losses of affiliates, net were
$216,000 in 2008 compared to $653,000 in 2007. Equity in losses of affiliates in 2007 was
attributable primarily to equity in losses of affiliates of Matrix.

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 2008 was $10.8 million compared to $9.7
million in 2007. This increase was primarily attributable to the improvement in the
results of Magic Software and Sapiens.

Year
Ended December 31, 2007 Compared to Year Ended December 31, 2006

Revenues.
          Revenues increased 18% from $416.8 million in 2006 to $493.4 million in 2007.
          Revenues from the two categories of our operation were as follows: Revenues from
          the delivery of software services increased 23% from $320.0 million in 2006 to
          $392.5 million in 2007. 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 in 2007
          were $100.8 million compared to $96.9 million in 2006. This increase was
          attributable to increase in Magic Softwares revenues which were offset by
          a decrease in Sapienss revenues.

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Cost
of Revenues. Cost of revenues increased 19% from $309.4 million in 2006 to $369.1
million in 2007. As a percentage of revenues, cost of revenues were relatively at the same
level in 2006 and in 2007, 74% and 75%, respectively. Cost of revenues for proprietary
software solutions were $52.9 million in 2007 and $53.8 million in 2006. Cost of revenues
for software services increased 24% from $255.6 million in 2006 to $316.1 million in 2007,
primarily due to the increase in the cost of revenues of our subsidiaries Matrix and
nextSource.

Software
Development Costs, net.Software developments costs, gross, in 2007 and 2006 were
$12.6 million and $14.0 million, respectively. In 2007, we capitalized software costs of
$6.2 million compared to $8.5 million in 2006. Capitalization of software costs in 2007
was attributable to our proprietary software solutions subsidiaries. Software development
costs, net, increased from $5.5 million in 2006 to $6.5 million in 2007. As a percentage
of revenues, software development costs, net remained at the same level of 1.3% in 2006
and 2007. The increase in software development costs was attributable primarily to Magic
Software and Sapiens which had research and development expenditures of approximately $2.7
million and $3.5 million, respectively. Amortization of capitalized software costs was
$6.4 million in 2007 and $8.9 million in 2006, which amounts were included in cost of
revenues.

Selling,
General and Administrative Expenses. Selling, general and administrative expenses in
2007 and 2006 were $90.5 million and $88.8 million, respectively. As a percentage of
revenues, selling, general and administrative expenses were 18.3% in 2007 and 21.3% in
2006. The increase in selling, general and administrative expenses was primarily
attributable to an increase in selling, general and administrative expenses of Matrix
which was offset by a decrease in selling, general and administrative expenses of Sapiens
and Magic Software.

Restructuring
Costs.We had norestructuring costs in 2007.Restructuring costs in
2006 were $2.9 million and were primarily attributable to restructuring activities of
Magic Software, which had restructuring costs of $2.1 million, and Sapiens which had
restructuring costs of $758,000. The restructuring costs of Magic Software resulted mainly
from severance payments paid in connection with the restructuring and impairment plan
announced by Magic Software in the third quarter of 2006, which aimed to reduce costs and
improve profitability.

Operating
Income. Our operating income increased from $10.1 million in 2006 to $27.2 million in
2007, a 59% increase. The operating income in 2007 was attributable to the improvement in
the operating results of all of our subsidiaries, and in particular Matrix which had
operating income of $24.5 million, Magic Software which had operating income of $1.3
million and Sapiens which had operating income $800,000. The operating income in 2006 was
attributable to the improvement in the operating results of our subsidiaries, and in
particular Matrix which had operating income of $19.2 million and a decrease in the net
operating loss of Sapiens, which had operating loss of $1.3 million. This improvement was
offset by the operating loss of $6.7 million of Magic Software.

Financial
Expenses, net. Financial expenses, net decreased from $4.6 million in 2006 to $3.8
million in 2007. Financial expenses, net in 2007 were attributable to interest expenses
incurred by our subsidiaries, Matrix and Sapiens, which had financial expenses of $2.1
million and $2.8 million, respectively, resulting from issuance of debentures. These
expenses were offset by financial income in Formula which resulted from interest derived
from short-term deposits and exchange rate differentials.

49

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Other
income (expenses), net. Other expenses, net in 2007 and 2006 were $750,000 and $1.1
million, respectively.

Gain
on Realization of Shareholdings. Gain on realization of shareholdings in 2007 was $2.0
million compared to $3.7 million in 2006. Gain on realization of shareholdings in 2007 was
primarily attributable to a gain from a decrease in our shareholding in Sapiens due to a
private placement consummated by Sapiens. Gain on realization of shareholdings in 2006 was
attributable primarily to the sale by Matrix of its holdings in Matrix-1 One Ltd. and the
decrease in the percentage of shareholdings by Matrix of its subsidiary, Tiltan, which
resulted in aggregate consideration of approximately $4.0 million.

Taxes
on Income. Taxes on income in 2007 were $1.9 million compared to $3.8 million in 2006.
The decrease in taxes on income in 2007 was mainly attributable to the decrease in taxes
of Matrix.

Companys
Equity in Results of Affiliates, net. Our equity in losses of affiliates, net were
$653,000 in 2007 compared to a gain of $47,000 in 2006. Equity in losses of affiliates in
2006 was attributable primarily to equity in losses of affiliates of Matrix.

Minority
Interest, net. Minority interest in profits of subsidiaries in 2007 was $9.7 million
compared to $4.8 million in 2006. This increase was primarily attributable to the
improvement in the results of all of our subsidiaries, and, in particular, Matrix, Magic
and Sapiens.

Impact
of Inflation and Currency Fluctuations on Results of Operations

A
significant portion of our worldwide sales is currently denominated in dollars and euros.,
while a substantial portion of our expenses, principally salaries and related personnel
expenses, is in New Israeli Shekels (NIS). As a result, a decrease in the value of the
dollar or euro relative to other foreign currencies, in particular the NIS would increase
our operating costs and, therefore, could adversely affect our results and harm our
competitive position in the markets. In recent periods, the value of the dollar and the
euro decreased significantly in relation to the NIS. We cannot know whether this trend
will continue in the future. If the dollar or euro value in relation to the NIS continues
to decrease, our operating costs would increase, and in turn, our results of operation may
be harmed. 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 or euro against the NIS.
However, we cannot assure you that these measures will adequately protect us from material
adverse effects arising from the impact of inflation in Israel.

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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$
|------------------------------- | ------------------------ | ---------------------------------- | -----------------------------------
|
|
|
|
|2006                            |                          |                                    |                                    
|2007                            |                          |                                    |                                    
|2008                            |                          |                                    |                                    

|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, 2008 we had cash and cash equivalents and short-term investments of $156.8
million and at December 31, 2007, we had cash and cash equivalents and short-term
investments of $201.8 million. At December 31, 2008, we had indebtedness to banks and
others of $27.4 million, of which $10.7 million were current liabilities and $16.6 million
were long-term liabilities. At December 31, 2007, we had indebtedness to banks and others
of $50.6 million, of which $27.0 million were current liabilities and $23.7 million were
long-term liabilities.

Formula
received a loan of approximately $3 million from the First International Bank of Israel
Ltd which is secured by a pledge on a portion of our shareholdings in one of our
subsidiaries. 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 2008 was $47.4 million compared to cash flow
provided by operating activities of $43.2 million in 2007. Cash flow provided by operating
activities in 2008 was primarily comprised of $27.9 million provided by Matrix, $9.8
million by Sapiens and $7.7 million by Magic Software. Cash flow provided by operating
activities in 2007 was primarily comprised of $23.2 million provided by Matrix, $7.1
million by Sapiens and $7.9 million by Magic Software.

Financing
activities

Cash
flow used by financing activities in 2008 was $59.8 million compared to cash flow provided
in financing activities of $12.9 million in 2007. This was mainly the result of the
following transactions:

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In
April 2008, Formula distributed to its shareholders a cash dividend of approximately $0.76
per share. The aggregate amount distributed by Formula was approximately $10 million.

In
2008, Matrix distributed to its shareholders a cash dividend in the aggregate amount of
approximately $11.3 million, of which $5.6 million was received by Formula.

During
2008, Matrix repaid long-term loans to banks of approximately $10.2 million.

During 2008,
certain of our subsidiaries repaid short-term loans to banks of approximately $15.2
million, of which $6.7 million was repaid by Matrix, and $5.0 million was repaid by
Sapiens and $3.4 million was repaid by Magic Software.

In
2008, Sapiens re-purchased an aggregate amount of NIS 7.6 million nominal value of its
debentures, representing approximately $2.1 million. In addition, Sapiens paid to its
debenture holders $3.5 million, representing the third payment of the principal of the
debentures (Series A).

In
August 2007, Matrix completed an offering of debentures to institutional and other
investors in Israel, in an aggregate principal amount of approximately $62.0 million (NIS
250 million). In 2008, Matrix re-purchased an aggregate amount of NIS 47.7 million nominal
value of its debentures, representing approximately $12.6 million.

In
June 2007, Sapiens entered into a private placement investment transaction with several
institutional investors, private investors and Formula for an aggregate gross investment
amount of $20 million (excluding finders fees and out of pocket expenses), $6.5
million of which was by Formula.

In
2007, Matrix distributed to its shareholders a cash dividend in the aggregate amount of
approximately $14.1 million, of which $6.4 million was received by Formula.

During
2007, Formula and certain of our subsidiaries repaid long-term loans to banks of
approximately $61.6 million, of which $50.9 million was repaid by Formula and $9.4 million
was repaid by Matrix.

During
2007, Formula and certain of our subsidiaries repaid short-term loans to banks of
approximately $16.9 million, of which $5.4 million was repaid by Formula, $4.8 million was
repaid by Matrix and $4.6 million was repaid by Sapiens.

In
2007, Sapiens re-purchased an aggregate amount of NIS 15 million nominal value of its
debentures, representing approximately $3.5 million. In addition, Sapiens paid to its
debentures holders $4.4 million representing the second payment of the principal of the
debentures (Series A).

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Recent
financing activities

In
January 2009, Formula distributed to its shareholders a cash dividend of $2.27 per share,
previously declared in December 2008. The aggregate amount distributed by Formula was $30
million.

Investing
activities

In
2008, net cash used in investing activities was $41.0 million and in 2007, net cash used
by investing activities was $18.8 million. These investing activities were comprised of
the following transactions:

In
2008, we purchased in the open market shares of several of our subsidiaries as follows:
217,127 shares of Matrix for aggregate consideration of $800,000, 2,392,531 shares of
Magic Software for aggregate consideration of $4.5 million and 3,442,836 shares of Sapiens
for aggregate consideration of $6.3 million.

In
2008, Matrix purchased 25% of the outstanding shares of its subsidiary Tangram Soft Ltd.
for an aggregate consideration of $4.7 million.

In
2008, our subsidiaries capitalized software development costs and other costs in an
aggregate amount of $6.7 million.

In
2008, Matrix and Magic Software purchased marketable securities for aggregate
consideration of $7.2 million and $1.0 million, respectively.

On
December 30, 2007, Magic Software entered into an agreement, to sell its wholly-owned
subsidiary, AAOD, a Florida corporation, to Fortissimo Capital, for $17 million. Magic
Software received $1.0 million of the sale proceeds in December 2007 and $16.0 million in
March 2008.

In
2008, our subsidiary Matrix purchased all the shares of TACT Computers and Systems Ltd.
for an aggregate consideration of $12.5 million.

In
June 2007, we completed the sale of our entire shareholdings in BluePhoenix to
international institutional investors for aggregate consideration of approximately $64
million.

In
2007, we purchased in the open market shares of several of our subsidiaries as follows:
1,231,563 shares of Matrix for aggregate consideration of $4.3 million, 503,473 shares of
Magic Software for aggregate consideration of $1.0 million and 195,107 shares of Sapiens
for aggregate consideration of $326,535.

In
2007, Matrix purchased marketable securities for aggregate consideration of $26.3 million.

In 2007,
our subsidiaries capitalized software development costs and other costs in an aggregate
amount of $8.5 million.

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We
believe that our available cash revenues, together with cash flows from operating
activities, will be sufficient to meet our cash needs for at least 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. Should we require additional financing in the future, we cannot assure you that
such financing will be available on favorable terms or at all.

Commitments and
Contingent Liabilities

Formula
received a loan of approximately $3 million from the First International Bank of Israel
Ltd which is secured by a pledge on a portion of our shareholdings in one of our
subsidiaries. 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.

Other Contractual
Commitments

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. Major Shareholders and Related Party
Transactions  Related Party Transactions  Indemnification of Office Holders.

Effective Corporate Tax
Rates in Israel

Law
for the Encouragement of Capital Investments, 1959

Certain
of the companies in the Formula Group have been granted Approved Enterprise status under
the Law for the Encouragement of Capital Investments, 1959, known as 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.

On
April 1, 2005, the Israeli Parliament passed an amendment to the Investment Law, in which
it revised the criteria for investments qualified to receive tax benefits. An eligible
investment program under the amendment will qualify for benefits as a privileged
enterprise (rather than the previous terminology of approved enterprise). Among other
things, the amendment provides tax benefits to both local and foreign investors and
simplifies the approval process. If the investment programs of the Formula Group companies
comply with the requirements of the law, they will be entitled to certain tax benefits. We
cannot assure you that any additional investment program adopted by any of these companies
in the future will comply with the requirements of the law or that the tax benefits for
investment programs continue at current levels.

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Corporate
Tax

Following
the tax reform enacted in 2003, an Israeli company is subject to tax on its worldwide
income. 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. Israeli tax payers are also subject to tax on income from a
controlled foreign corporation, according to which an Israeli company may become subject
to Israeli taxes on certain income of a non-Israeli subsidiary, if such subsidiarys
primary source of income is a passive income (such as interest, dividends, royalties,
rental income, or capital gains).

On
January 1, 2006, an additional tax reform took place relating primarily to profits from
investments. The main goal of the reform was to unify the tax rates applicable to profits
from investments, such as interest, capital gains, and dividends. In addition, under the
new reform, the tax rates applicable to companies were reduced to 27% in 2008, 26% in
2009, and 25% from 2010 and on.

Our
international operations are taxed at the local effective corporate tax rate in the
countries of our subsidiaries residence. In the future we may derive an increasing
percentage of our income from operations outside of Israel. If that occurs, our effective
tax rate may increase. However, we expect that this increase will be offset by carried
forward accumulated losses of consolidated companies.

|C. | Research
and Development, Patents and Licenses
|-- | ----------------------------------------------

The
net amount we spent on research and development activities in 2008 and 2007 remain at the
same level and totaled $6.6 and $6.5 million, respectively. In 2006, we spent $5.5 million.
The increase in the amount spent on research and development activities in 2007 compared
to 2006 relates primarily to an increase in research and development expenditures of
Sapiens. For more information about our research and development activities, see
Item 4. Information on the Company  Business Overview  Software
Development.

For
information concerning our intellectual property rights, see Item 4. Information on
the Company  Business Overview  Intellectual Property Rights.

|D. | Trend
Information
|-- | -----------------

The
recent global economic and financial market crisis has caused, among other things, a
general tightening in the credit markets, lower levels of liquidity, increases in the
rates of default and bankruptcy, and reduced corporate profits and capital spending, all
of which have had and will continue to have a negative effect on our business, results of
operations and financial condition.

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Demand
for our products and services depends in large part upon the level of IT capital spending
and investment in IT projects by our customers. The current economic conditions have
reduced the willingness or ability of our customers and prospective customers to commit
funds to IT projects, and may reduce their ability to pay for our products and services
after purchase, whether as a result of possible customer insolvencies or otherwise. This
has already resulted in a longer sales cycles and increased pressure on pricing. We cannot
predict the timing or duration of the global economic crisis or the timing or strength of
any subsequent economic recovery. We also cannot know how the economic conditions will
affect our business. As we continue to market new products and penetrate international
markets, we expect our selling, general and administrative expenses to continue to be
relatively high.

|E. | Off-Balance
Sheet Arrangements
|-- | ------------------------------

We
do not have any off-balance sheet arrangements.

|F. | Tabular
Disclosure of Contractual Obligations
|-- | ---------------------------------------------

The
following table summarizes our contractual obligations and commitments as of December 31,
2008.

|                                                                          | Payments due by period
|------------------------------------------------------------------------- | ----------------------
|
|
|
|
|Long-term debt obligations (2)                                            |                       
|                                                                          |                       
|Lease obligations                                                         |                       
|                                                                          |                       
|Liability in respect of the acquisitionof activities                      |                       
|                                                                          |                       
|Other long-term liabilities reflected onour balance sheet under U.S. GAAP |                       
|                                                                          |                       
|                                                                          |                       
|Total                                                                     |                       
|                                                                          |                       

---

|(1) | Other
obligations include severance pay which was not funded by the Company, the           due
date of which is unknown.
|--- | ------------------------------------------------------------------------------------------------------------------------

|(2) | Does
not include interest.
|--- | --------------------------

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# 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
April 20, 2009.

|Name                   | Age |  | Position               
|---------------------- | --- |  | -----------------------
|
|
|
|
|Guy Bernstein          | 41  |  | Chief Executive Officer
|Naamit Salomon         | 44  |  | Chief Financial Officer
|Naftali Shani          | 59  |  | Chairman of the Board  
|Shimon Laor            | 42  |  | Director               
|Tal Barnoach           | 46  |  | Director               
|Hadas Gazit Kaiser     | 33  |  | Director               
|Dr. Shlomo Nass        | 49  |  | Director               
|Dr. Ronnie Vinkler (1) | 63  |  | Director               
|Ofer Lavie (1)         | 64  |  | Director               

---

(1)    
          Outside director under the Companies Law. See Item 6. Directors, Senior
          Management and Employees  Board Practices  Outside Directors; Audit
          Committee; Internal Auditor; Approval of Certain Transactions Under the
          Companies Law, below.

Guy
Bernstein was appointed our chief executive officer in January 2008. Mr. Bernstein
served as a member of our board of directors from November 2006 to December 2008. Since
December 2006 , Mr. Bernstein has served as chief executive officer of Emblaze, our
controlling shareholder, a publicly-traded company listed on the AIM, the London Stock
Exchange. Mr. Bernstein also serves as a director of Sapiens and he is the chairman of the
board of Matrix and Magic Software. From April 2004 to December 2006, Mr. Bernstein served
as the chief financial officer of Emblaze. He has served as a director of Emblaze since
April 2004. Prior thereto, Mr. Bernstein served as the chief financial and operations
officer of Magic Software, a position he held since 1999. He joined Magic Software from
Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, where he acted as
senior manager from 1994 to 1997. Mr. Bernstein holds a B.A. degree in accounting and
economics from Tel Aviv University and is a certified public accountant in Israel.

Naamit
Salomon has served as our chief financial officer since 1997. Ms. Salomon also serves
as a director of Magic Software 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 B.A. degree in economics and business administration from Ben Gurion University
and an LL.M. degree from the Bar-Ilan University.

Naftali
Shanihas served as chairman of our board of directors since January 2009. Mr. Shani
also serves as the chairman of the board of directors of Emblaze, our controlling
shareholder. Prior to founding Emblaze, Mr. Shani served as general manager of Bartrade
Ltd., a subsidiary of Bank Leumi, one of Israels leading banks and as general
manager of the Israeli Chemical Company, Pazchem. Prior thereto, Mr. Shani was the
treasurer and controller of the Israeli Prime Ministers office. Mr. Shani holds a
B.A. degree in economics.

Shimon
Laorhas served as one of our directors since November 2006. He also served as a
director of Emblaze and as its chief financial officer from 1995 to 2000. Since then, he
has been engaged in private business initiatives. Mr. Laor also serves as a director of
Emblaze VCON Ltd., a partially-owned subsidiary of Emblaze. Prior to joining Emblaze in
August 1995, Mr. Laor served as an economist at the head office foreign currency division
of the First International Bank of Israel. Mr. Laor holds a B.A. degree in economics and
accounting from Tel Aviv University.

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Tal
Barnoach has served as one of our directors since November 2006. Since 1994, Mr.
Barnoach has served as chairman and chief executive officer of S.E.A. Multimedia. In
addition, from 2002 to 2006, he served as the chief executive officer of BeInSync, a
company he co-founded in 2002. Mr. Barnoach also serves as the executive vice chairman of
zone IP of Emblaze. Since 1999, Mr. Barnoach has served as chairman of Orca Interactive
Ltd. Mr. Barnoach holds a B.A. degree in economics from Tel Aviv University.

Hadas
Gazit Kaiser has served as one of our directors since March 2007. Ms. Gazit Kaiser
also serves as the chief financial officer of Magic Software since January 2009. Ms. Gazit
Kaiser has served as the chief financial officer and finance director of Emblaze from
December 2006 until December 2008. During 2005 and 2006, she served as the vice president,
finance of Emblaze and the chief financial officer of Emblaze Mobile. From 2003 to 2005,
Ms. Gazit Kaiser served as the budget control manager of TTI Team Telecom International
Ltd., a NASDAQ-listed company. Prior thereto, Mrs. Gazit Kaiser acted as a manager at
Kost, Forer Gabbay & Kasierer. Mr. Gazit Kaiser is a director of Magic Software,
Sapiens, Matrix and Rad View Software Ltd. Ms. Gazit Kaiser holds a B.A. degree in
economics and accounting and an M.B.A. degree in finance, both from Tel Aviv University,
and she is a certified public accountant in Israel.

Dr. Shlomo Nasshas served as one of our directors since April 2003. Dr. Nass is
          a senior partner at Dr. Shlomo Nass and Co. Ltd., and a president of and a
          partner in I.G.B.  Israel Global Business, an investment group. Mr. Nass
          performed various public duties and serves as a director of I.G.B., IRS-TKB
          International Consultants Ltd., Mivnei Taasiya Ltd., TAO, N.M.C., Yuli Shukei
          Hon Ltd., The Azure Beach Development Company (Tel Aviv-Herzliya) Ltd., Shir Lak
          Ltd., M.D.K. Touch Ltd. and Haniman Enterprises Ltd. Mr. Nass holds a B.Sc.
          degree in economics and accounting, an LL.B. degree, and a Ph.D degree in law,
          all from Bar-Ilan University. He is a certified public accountant in Israel and
          a member of the Israel Bar.

Dr. Ronnie Vinkler has served as one of our outside directors since March 2007.
          Dr. Vinkler is an independent business development and management analysis
          consultant. Dr. Vinkler also serves as a director of Kaman Capital Ltd. In 2002
          and 2003, Dr. Vinkler served as general manager of Icom Mobile (Israel). From
          2000 to 2002, he served as general manager of B.I.S. Advanced Software Solutions
          Ltd. Since 2003, Dr. Vinkler has been in charge of business development with
          several companies like Tesnet, Aman Computers and more. Dr. Vinkler holds a
          B.Sc. degree in aeronautical engineering and industrial engineering and
          management from the Technion, Israel Institute of Technology, and a M.Sc. and
          Ph.D in aeronautical engineering from Caltech, California Institute of
          Technology.

Ofer
Lavie has served as one of our outside directors since March 2007. Mr. Lavie is an
independent financial business development consultant. From 1999 to 2005, Mr. Lavie served
as the chief financial officer of Metalink Ltd., a public company listed on the NASDAQ
Global Market and the TASE. Mr. Lavie also serves as a director of Yozma Pension Fund for
Self Employed Ltd., a Migdal Group fund, and of Alpa Cosmetics Ltd. Mr. Lavie also serves
as an outside director of Procognia (Israel) Ltd., a public company traded on the TASE and
Shaniv Paper Industries Ltd. In addition, Mr. Lavie serves as the chief executive officer
of the Education Center in the CFO Forum in Israel Mr. Lavie holds a B.Sc. degree in
economics from Tel Aviv University.

58

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|B. | Compensation
|-- | ------------

In
2008, Formula paid to its directors and officers (nine persons) aggregate direct
remuneration of approximately $804,000. 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 Formula's officers;
| | - | ----------------------------------------------------------------------------

| |  | expenses,
including business travel, professional and business association dues and expenses,
                that Formula reimburses its 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 Formulas outside directors
and Mr. Shlomo Nass. Formula compensates its outside directors in accordance with the
regulations promulgated under the Israeli Companies Law, 1999, referred to as the
Companies Law. Formula compensates Mr. Shlomo Nass in such amounts specified in the
regulations.

Formulas
employee directors do not receive fees for their services as directors. In 2008, Formula
paid an aggregate amount of $26,960 for post-employment benefits for Formulas
executive officers and directors. Under Israeli law, Formula is not required to disclose,
and has not otherwise disclosed, the compensation of its senior management and directors
on an individual basis.

Generally, we enter into written
employment agreements with our executive officers 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 up to 6 months prior 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
December 2008, our chief executive officer, Mr. Guy Bernstein, ceased to serve as a member
of our board of directors. His service agreement with us was terminated and replaced by a
new agreement, the terms of which have been approved by our board of directors, as
required under Israeli law.

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Under
his new service agreement, Mr. Guy Bernstein continues to be entitled to an annual bonus,
previously approved by our audit committee, board of directors and shareholders, in an
amount equal to 3.3% of our net profit (including capital gains) after tax. An advance of
70% of the bonus is paid quarterly, based on our quarterly financial statements, subject
to final adjustment at the end of each year.

Under
his former service agreement, Mr. Bernstein was granted, for his services as a director,
options to purchase 198,000 ordinary shares, each exercisable at an exercise price of NIS
60 per share (not linked to the CPI) (approximately $16.35). In June 2008, Mr. Bernstein
waived his right to receive such options. For information regarding additional options to
purchase ordinary shares granted to Mr. Bernstein, see Item 6.E. Share
Ownership below.

|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, of which the following three have been
determined by the board to be independent within the meaning of the applicable NASDAQ
requirements: Shlomo Nass, Ronnie Vinkler and Ofer Lavie. 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. Directors, Senior Management and
Employees  Compensation.

Companies
trading on The NASDAQ Global Market are generally required to have a majority of their
board members be independent. We are exempt from this requirement under the
controlled company exemption because more than 50% of our voting power is held
by Emblaze.

Under
a recent amendment to the Companies Law, a person who lacks the necessary qualifications
and the ability to devote an appropriate amount of time to the performance of his or her
duties as a director shall not be appointed director of a publicly traded company and
shall not serve as a director of such company. While determining a persons
compliance with such provisions, the companys special requirements and its scope of
business shall be taken into consideration. Where the agenda of a shareholders meeting of
a publicly traded company includes the appointment of directors, each director nominee
should submit a declaration to the company confirming that he or she has the necessary
qualifications and he or she is able to devote an appropriate amount of time to
performance of his duties as a director. In the declaration, the director nominee should
specify his or her qualifications and confirm that the restrictions set out in the
Companies Law, do not apply.

60

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Under
the Companies Law, if a director ceases to comply with any of the requirements provided in
the Companies Law, such director must notify the company immediately about it, and his
term of service shall terminate on the date of the notice.

Outside
Directors under the Companies Law

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, another person to
whom he was directly or indirectly subject, 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.
| | - | ----------------------------

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 the Companies Law, all outside directors must have financial and accounting expertise
or professional qualifications, and at least one outside director must have financial and
accounting expertise. The terms financial and accounting expertise and
professional qualifications are defined in regulations promulgated under the
Companies Law. Our audit committee member, Ronnie Vinkler, is considered to have the
required professional qualifications and Shlomo Nass has financial and accounting
expertise.

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If
an outside director ceases to comply with any of the requirements provided in the
Companies Law with respect to the appointment of outside directors, such outside director
must notify the company immediately about it, and his term of service shall terminate on
the date of the notice.

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 March 2007, Mr. Ronnie Vinkler
and Mr. Ofer Lavie were appointed as our outside directors, each to hold office until
March 2010. In accordance with the Israeli Companies Regulations (Alleviation for Public
Companies Whose Shares are Listed on a Stock Exchange Outside of Israel) 2000, dual listed
companies, like us, may re-appoint an outside director for additional three-year terms,
above the maximum six-year term permitted under the Companies Law, if the audit committee
and the board of directors confirm that due to the expertise and special contribution of
the outside director to the work of the board and its committees, his re-appointment is in
the best interests of the company.

Each
committee of a companys board of directors is required to include at least one
outside director and the audit committee must 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.

Independent
Directors Under the Companies Law

Under
a recent amendment to the Companies Law, a publicly traded company may prescribe in its
articles of association that its board of directors shall include independent directors in
such number or such percentage as to be provided in the articles. An independent
director is defined as a director who meets all of the following:

| |  | the
audit committee confirms that he or she meets the qualifications for being appointed as
an outside director, except for the requirement for financial and accounting expertise or
professional qualifications; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | he
or she has not served as a director of the company for a period exceeding nine
consecutive years. For this purpose, a break of up to two years in the service shall not
be deemed to interrupt the continuation of the service.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
Companies Law provides that if the company has no controlling shareholder or a shareholder
that holds at least 25% of the voting rights in the company, most of the members of the
board shall be independent directors. If the company has a controlling shareholder or a
shareholder that holds at least 25% of the voting rights therein, at least one-third of
the directors shall be independent directors.

As
of the date of this annual report, our articles of association have not yet been amended
to include the new provisions of the Companies Law relating to independent directors.

62

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Qualifications
of Other Directors Under the Companies Law

Under
the Companies Law, the board of directors of a publicly traded company is required to make
a determination as to the minimum number of directors who must have financial and
accounting expertise according to criteria that is defined in regulations promulgated
under the Companies Law, effective as of January 2006. In accordance with the Companies
Law, the determination of the board should be based on, among other things, the type of
the company, its size, the volume and complexity of its activities and the number of
directors. Based on the foregoing considerations, our board determined that the number of
directors with financial and accounting expertise in our company shall not be less than
one.

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.

In
addition, under applicable NASDAQ rules, we are currently required to have at least three
independent directors and to maintain an audit committee, whose members are independent of
management. We have established an audit committee, consisting of our two outside
directors, Ronnie Vinkler andOfer Lavie, as well as Shlomo Nass. Each audit
committee member qualifies as an independent director under the applicable NASDAQ rules
and those of the SEC. The board has determined that Shlomo Nass is an audit
committee financial expert as defined by applicable SEC regulations. See Item
16. 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, subject to shareholder approval as required under Israeli law. In
addition, the audit committee is responsible for assisting the board in monitoring our
financial statements and the effectiveness of our internal controls. We have adopted a
formal audit committee charter that we have implemented, 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
auditor or its representative may not serve as the companys internal auditor.

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Exculpation,
Insurance and Indemnification of Directors and Officers

Under
the Companies Law, an Israeli company may not exempt an office holder from liability with
respect to a breach of his duty of loyalty, but may exempt in advance an office holder
from his liability to the company, in whole or in part, with respect to a breach of his
duty of care, provided, however, that such a breach is not related to a distribution of a
dividend or any other distribution by the company.

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 2008 was
approximately $200,000.

Indemnification
of Office Holders. Our articles of association provide that we may indemnify an office
holder in respect of an obligation or expense imposed on or expended by an office holder
in respect of an act performed in his capacity as an office holder as specified below:

| | (i) | 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;
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (ii) | reasonable
litigation expenses, including attorneys fees, expended by the
               office holder as a result of an investigation or proceeding instituted
against                him by a competent authority, provided that such investigation or
proceeding                concluded without the filing of an indictment against him, and
either (i)                concluded without the imposition of any financial liability in
lieu of criminal                proceedings; or (ii) concluded with the imposition of a
financial liability in                lieu of criminal proceedings but relates to a
criminal offense that does not                require proof of criminal intent; and
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | (iii) | reasonable
litigation expenses, including attorneys fees, expended by the
               office holder or charged to him by a court, in proceedings instituted
against                him by another person, or in a criminal charge from which he was
acquitted or in                any criminal proceedings of a crime which does not require
proof of criminal                intent in which he was convicted.
| | ----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We
may undertake to indemnify an office holder as aforesaid, (a) prospectively, provided that
in respect of (i) above, the undertaking is limited to categories of events that in the
opinion of our board of directors are foreseeable in light of the companys
operations at the time that the undertaking to indemnify is given, and for an amount or
criteria that our board has determined as reasonable under the circumstances, and further
provided that such events and amount or criteria are indicated in the indemnification
undertaking, but in any event no more than 25% of Formulas shareholders equity
according to its most recent financial statements as of the date of the actual payment of
indemnification; and (b) retroactively.

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; any fine
levied against the office holder; or
| | - | -----------------------------------------------------------------------------------------------------------------------------

| |  | a
counterclaim made by the company or in its name in connection with a claim against the
company filed by the office holder.
| | - | ----------------------------------------------------------------------------------------------------------------------------

In
addition, under the Companies Law, indemnification of, and procurement of insurance
coverage for, our office holders must be approved by our audit committee and our board of
directors and, in specified circumstances, by our shareholders.

We
have entered into an undertaking to indemnify our office holders in specified limited
categories of events and in specified amounts, subject to the limitations set by the
Companies Law and our articles of association, as described above. For more information,
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.

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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.

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.

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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 5,500 full-time employees, of whom approximately 4,730 are software
professionals. Most of our employees are located in Israel and the other in the United
States, Europe and other places abroad. In 2007, we had approximately 4,950 full-time
employees, of whom approximately 4,260 were software professionals. In 2006, we had
approximately 5,290 full-time employees, of whom approximately 4,550 were software
professionals. The increase in the number of employees in 2008 compared to 2007 related
primarily to the increase in the number of employees in Matrix and nextSource, which was
offset by a decrease in the number of employees in Magic Software and Sapiens. The
decrease in the number of employees in 2007 compared to 2006 related primarily to the
decrease in the number of employees in Magic Software, Sapiens and ,in particular,
nextSource, which was offset by an increase in the number of employees in Matrix.

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 (i) contributing on an
ongoing basis towards managers insurance funds that combine pension,
insurance and, if applicable, severance pay benefits and (ii) payment of differences, if
applicable. In addition, Israeli employers and employees are required to pay specified
percentages of wages to the National Insurance Institute. 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.

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|E. | Share
Ownership
|-- | ---------------

As
of April 20, 2009, none of our directors and officers had a share ownership in our
company, nor did they hold options to purchase shares, except for Mr. Guy Bernstein, our
chief executive officer , as described below.

Mr.
          Bernstein was granted, for his services as a director, options to purchase
          198,000 ordinary shares, each exercisable at an exercise price of NIS 60 per
          share (approximately $16.35). In June 2008, Mr. Bernstein waived his right to
          receive such options.

In
January 2009, we granted to Mr. Bernstein, in connection with his new service agreement,
options to purchase 396,000 ordinary shares. These options vest over a three-year period,
commencing on December 17, 2008, on a quarterly basis. The exercise price of the options
is NIS 0.01 per share. The options shall expire six years of the date of grant. As of
April 20, 2009, Mr. Bernstein is the beneficial owner of less than 1% of our outstanding
share capital (including options exercisable within 60 days of this annual report).

# Arrangements Involving
the Issue or Grant of Options to Purchase Shares

Formulas
2008 Share Option Plan

In
March 2008, our shareholders approved the adoption of Formulas 2008 Employee and
Office Holders Share Option Plan, referred to as the plan. Pursuant to the plan, we may
grant from time to time to our and our subsidiaries employees and office holders
(which are not Formulas controlling shareholders) options to purchase up to 400,000
ordinary shares of Formula. The plan is administered by our board of directors. The plan
provides that options may be granted, from time to time, to such grantees to be determined
by the board, at an exercise price and under such terms to be determined at their sole and
absolute discretion. Options may be granted under the plan through January 2018.

Of
the options available for grant under the plan, we granted in January 2009, options to
purchase 396,000 ordinary shares to our chief executive officer, each exercisable at an
exercise price of NIS 0.01. For more information, see Item 6.B. Compensation.

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.

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# ITEM 7. MAJOR
SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

|A. | Major
Shareholders
|-- | ------------------

The
following table presents information regarding the ownership of Formulas ordinary
shares at April 20, 2009 by each person known to us to be the beneficial owner of more
than 5% of Formulas ordinary shares based on information provided to us by the
holders or disclosed in public filings with the SEC. None of the holders of the ordinary
shares listed in this table have voting rights different from other holders of
Formulas ordinary shares. Except where indicated otherwise, we believe, based on
information furnished by these owners, that the beneficial owners of Formulas shares
listed below have sole investment and voting power with respect to the shares.

|Name and Address                             | Shares Beneficially
Owned | Percent of
Class(1)
|-------------------------------------------- | ------------------------- | -------------------
|
|
|
|
|Emblaze Ltd.(2)                              |                           |                    
|                                             |                           |                    
|Menora Mivtachim Holdings Ltd. (3)           |                           |                    
|                                             |                           |                    
|Clal Insurance Enterprises Holdings Ltd. (5) |                           |                    

---

|(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 April 20, 2009, 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 April 20, 2009.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | In
November 2006, Emblaze Ltd., referred to as Emblaze, purchased from FIMGold           LP
all of its shareholdings in Formula, i.e. 33.4% of our outstanding           share
capital. Since then and until April 20, 2009, Emblaze purchased additional
          shares of Formula in the open market and in privately negotiated transactions,
          bringing its holdings in Formula to 51.7%. Emblaze is a public company traded
on           the main list of the London Stock Exchange. The major shareholders of
Emblaze,           based on publicly available and other information (i.e.,
persons that           hold 5% or more of the share capital of the Emblaze) are Naftali
Shani, the           chairman of the board of directors of Emblaze (who holds
approximately 13.9% of           the outstanding share capital of Emblaze) and Eli
Reifman, vice-chairman of the           board of directors of Emblaze (who holds
approximately 13.55% of the outstanding           share capital of Emblaze), Fortissimo
Capital Management Ltd. (that holds           approximately 16% of the outstanding share
capital of Emblaze), Schroders Plc           (that holds approximately 15% of the
outstanding share capital of Emblaze) and           Donald Sturm (who holds approximately
8.9% of the outstanding share capital of           Emblaze).
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Menora
Mivtachim Holdings Ltd. is a holding company publicly-traded on the TASE.
          61.86% of Menora Mivtachim Holdings outstanding shares are held, directly
          and indirectly, by Menachem Gurevitch, and 38.14% are publicly held.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Pursuant
to Amendment No. 2 to Schedule 13D filed on March 19, 2009.
|--- | --------------------------------------------------------------------

|(5) | Clal
Insurance Enterprises Holdings Ltd., referred to as Clal Insurance, is           publicly
traded on the TASE. The controlling shareholder of Clal Insurance is           IDB
Development Corporation Ltd. (57.53%) and Bank Hapoalim Ltd. holds a 9.95%
          interest in Clal Insurance.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Pursuant
to Schedule 13G/A filed on February 13, 2009, of the 1,202,967 shares           reported
as beneficially owned by Clal Insurance (i) 1,202,265 shares are held           for
members of the public through, among others, provident funds, mutual funds,
          pension funds and insurance policies, which are managed by subsidiaries of Clal
          Insurance, each of which subsidiaries operates under independent management and
          makes independent voting and investment decisions; and (ii) 702 shares are held
          by third-party client accounts managed by Clal Finance Batucha Investment
          Management Ltd., a wholly owned subsidiary of Clal Finance Ltd., as portfolio
          managers, which operates under independent management and makes investment
          decisions independent of Clal Insurance and Clal Finance.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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As
of April 20, 2009, 13,200,000 ordinary shares were issued and outstanding, excluding
24,780 ordinary shares that we purchased during 2002. On April 20, 2009, we had
approximately 2 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 April 20, 2009, 564,066 ADSs were issued and outstanding pursuant to a depositary
agreement with The Bank of New York, representing 564,066 of our ordinary shares. As of
that date, there were approximately 25 registered holders of ADSs in the United States.

|B. | Related
Party Transactions
|-- | --------------------------

Indemnification
of Office Holders

In
December 2005, the general meeting of shareholders approved the grant of new
indemnification letters to office holders following the amendment of the Companies Law
adopted in March 2005 and the changes in articles of association approved by the general
meeting in December 2005.

The
indemnification letters provide, among other things, that will indemnify each of office
holders to the maximum extent permitted by articles of association. Advance payments for
coverage of legal expenses in criminal proceedings will be required to be repaid by office
holders to the company if such office holder is found guilty of a crime which requires
proof of criminal intent, or if it is determined that the office holder is not lawfully
entitled to such indemnification.

All
of the indemnification letters granted to office holders are identical, including
indemnification letters granted to office holders who are or may be considered
controlling persons under the Companies Law.

The
indemnification is limited to the expenses and matters detailed in the indemnification
letters insofar as they result from the office holders actions which includes, among
other things, the following matters: the offering of securities by us to the public or to
private investors; the offer by us to purchase securities from the public, private
investors or other holders, whether pursuant to a prospectus, agreement, tender or any
other proceeding; occurrences resulting from being a public company, or from the fact that
our securities were offered to the public and traded on the NASDAQ and on the TASE; and
occurrences in connection with investments.

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.

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

| | (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.

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 2008 was
approximately $200,000.

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.

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# ITEM 8. FINANCIAL
INFORMATION

|A. | Consolidated
Statements and Other Financial Information
|-- | -------------------------------------------------------

Financial
Statements

Our
consolidated financial statements and other financial information are incorporated herein
by reference to Item 18. Financial Statements below.

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 legal proceedings which may have, or have had in the recent past, significant
effects on our financial position or profitability.

Dividend
policy

Under
Formulas dividend policy adopted 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. In recent years, Formula has made the following distributions:

In
January 2009, Formula distributed to its shareholders a cash dividend of $2.27 per share,
previously announced in December 2008. The aggregate amount distributed by Formula was
approximately $30 million.

In
April 2008, Formula distributed to its shareholders a cash dividend of approximately $0.76
per share. The aggregate amount distributed by Formula was approximately $10 million.

In
December 2006, Formula distributed to its shareholders a dividend consisting of 36,696,000
shares of Formula Vision held by Formula and representing approximately 57% of the
outstanding share capital of Formula Vision. Formula Vision shares were distributed at a
ratio of 2.78 shares of Formula Vision for every one outstanding ordinary share of
Formula, prior to withholding taxes.

In
June 2005, Formula distributed to its shareholders a cash dividend in the amount of
approximately $4 per ordinary share, or approximately $50.2 million in the aggregate.

|B. | Significant
Changes
|-- | -------------------

There
has been no material change in our financial position since December 31, 2008.

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# ITEM 9. THE OFFER AND
LISTING

|A. | Offer
and Listing Details
|-- | -------------------------

Price
Range of Ordinary Shares

The
following table sets forth 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 April
20, 2009 was NIS 4.207 = $1.00.

|Period                   | Closing Price Per Share
|------------------------ | -----------------------
|
|
|
|
|2004                     |                        
|2005                     |                        
|2006                     |                        
|2007                     |                        
|First Quarter            |                        
|Second Quarter           |                        
|Third Quarter            |                        
|Fourth Quarter           |                        
|2008                     |                        
|First Quarter            |                        
|Second Quarter           |                        
|Third Quarter            |                        
|Fourth Quarter           |                        
|October                  |                        
|November                 |                        
|December                 |                        
|2009                     |                        
|First Quarter            |                        
|January                  |                        
|February                 |                        
|March                    |                        
|April (through April 20) |                        
|                         |                        

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Price
Range of American Depositary Shares

The
following table sets forth, for the periods indicated, the high and low closing sale
prices for the ADSs, as reported by the NASDAQ Global Market.

|Period                   | Closing Price Per Share
|------------------------ | -----------------------
|
|
|
|
|2005                     |                        
|2006                     |                        
|2007                     |                        
|First Quarter            |                        
|Second Quarter           |                        
|Third Quarter            |                        
|Fourth Quarter           |                        
|2008                     |                        
|First Quarter            |                        
|Second Quarter           |                        
|Third Quarter            |                        
|Fourth Quarter           |                        
|October                  |                        
|November                 |                        
|December                 |                        
|2009                     |                        
|First Quarter            |                        
|January                  |                        
|February                 |                        
|March                    |                        
|April (through April 20) |                        
|                         |                        

|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 under the symbol FORT. No U.S. trading market exists for the ordinary
shares. Since October 1997, our ADSs have been traded on the NASDAQ Global Market, under
the symbol FORTY.

Pursuant
to NASDAQ Marketplace Rule 4350(a), we notified NASDAQ that with respect to the quorum for
shareholders meetings, we follow Israeli law and practice and accordingly do not follow
NASDAQ rules. The quorum for a shareholders meeting, as stipulated in our articles of
association, complies with the provisions of the Israeli law, and requires the presence,
in person or by proxy of holders of 25% of our outstanding ordinary shares, in lieu of the
requirement specified in NASDAQ Marketplace Rule 4350(e) pursuant to which the quorum for
any shareholders meeting shall not be less than 33?% of the outstanding voting shares of
the company.

|D. | Selling
Shareholders
|-- | --------------------

Not applicable.

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|E. | Dilution
|-- | --------

Not applicable.

|F. | Expenses
of the Issue
|-- | ---------------------

Not applicable.

# ITEM 10. ADDITIONAL
INFORMATION

|A. | Share
Capital
|-- | -------------

Not applicable.

|B. | Memorandum
and Articles of Association
|-- | --------------------------------------

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s 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.

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Dividend
and Liquidation Rights

Our
board of directors is authorized to declare dividends, subject to the provisions of the
Companies Law. Dividends on our ordinary shares may be paid only out of profits and other
surplus, as defined in the Companies Law, as of the end date of the most recent financial
statements or as accrued over a period of two years, whichever is higher. Alternatively,
if we do not have sufficient profits or other surplus, then permission to effect a
distribution can be granted by order of an Israeli court. In any event, our board of
directors is authorized to declare dividends, provided there is no reasonable concern that
the dividend will prevent us from satisfying our existing and foreseeable obligations as
they become due. Dividends may be paid in cash or in kind. 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.

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. Under the Companies Law, shares held by the company are
not entitled to any rights so long as they are held by the company.

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.

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Shareholder
Duties

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 rules pertaining to a breach
of contract apply to a breach of the duty to act in fairness, mutatis mutandis, bringing
into account the shareholders position in the company. The Companies Law does not
describe the substance of this duty.

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.

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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.

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 20% 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.

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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.

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 sale of our shareholdings of BluePhoenix as a material contract. For more
information about this transaction, see Item 4. Information on the
CompanyHistory and DevelopmentCapital Expenditures and Divestitures.

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|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,
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 wer pay them in NIS. See Item 3. Key
Information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 a description of material tax consequences regarding the ownership and
disposition of our ordinary shares and ADSs under 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.

Tax
Consequences Regarding Disposition of Our ADSs or Ordinary Shares

In
general, Israel imposes capital gains tax on the sale of capital assets, including shares
of Israeli companies by both Israeli residents and non-Israeli resident shareholders,
unless a specific exemption is available or unless a tax treaty between Israel and the
shareholders country of residence provide otherwise. Shareholders that are not
Israeli residents are generally exempt from Israeli capital gains tax on any gain derived
from the sale of our ADSs or ordinary shares, provided that (i) such shareholders did
not acquire the shares prior to our initial public offering; and (ii) such gains did
not derive from a permanent establishment of such shareholders in Israel. However,
non-Israeli corporations will not be entitled to the foregoing exemption if an Israeli
resident (a) has a controlling interest of 25% or more in such non-Israeli
corporation; or (b) is the beneficiary of or is entitled to 25% or more of the
revenues or profits of such non-Israeli corporation, whether directly or indirectly.

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In
certain instances where our non-Israeli shareholders may be liable to Israeli tax on the
sale of our ADSs or ordinary shares, the payment of the consideration may be subject to
Israeli withholding tax.

In
addition, in the case when the sale, exchange or disposition of our ADSs or ordinary
shares by shareholders who are U.S. residents (within the meaning of the U.S.-Israel
Tax Treaty) holding the ADSs or ordinary shares as a capital asset will be also exempt
from Israeli capital gains tax under the U.S.-Israel Tax Treaty, unless, either
(i) the shareholders hold, directly or indirectly, shares representing 10% or more of
our voting shares during any part of the 12-month period preceding such sale, exchange or
disposition; or (ii) the capital gains arising from such sale, exchange or
disposition are attributable to a permanent establishment of the shareholders located in
Israel. In such case, the shareholders would be subject to Israeli capital gains tax, to
the extent applicable, as mentioned above. However, under the U.S.-Israel Tax Treaty, the
U.S. resident would be permitted to claim a credit for such taxes against the
U.S. federal income tax imposed on the sale, exchange or disposition, subject to the
limitation in the U.S. law applicable to foreign tax credits. The U.S.-Israel Tax
Treaty does not relate to U.S. state or local taxes.

Taxes
Applicable to Dividends

Nonresidents
of Israel are generally subject to Israeli income tax on the receipt of dividends paid on
our ADSs or ordinary shares at the rate of 20%, or 15% for dividends or income generated
by an approved enterprise, which tax will be withheld at source, unless a different rate
is provided in a treaty between Israel and the shareholders country of residence.

However,
the tax rate on dividends paid to a substantial shareholder (which is someone
who alone, or together with another person, holds, directly or indirectly, at least 10% in
one or all of any of the means of control in the corporation) is 25%.

Under
Israeli tax law, a distribution of dividends from income attributable to an Approved
Enterprise will be subject to tax in Israel at the rate of 15%, which is withheld and paid
by the company paying the dividend, if the dividend is distributed during the benefits
period or within the following 12 years (but the 12-year limitation does not apply to a
Foreign Investors Company). Any distribution of dividends from income that is not
attributable to an Approved Enterprise after January 1, 2006, will be subject to tax in
Israel at the rate of 20%.

Under
the U.S.-Israel Tax Treaty, the maximum rate of tax withheld in Israel on dividends paid
to a holder of our ADSs or ordinary shares who is a U.S. resident (within the meaning
of the U.S.-Israel Tax Treaty) is 25%. However, dividends paid from income derived from
our Approved Enterprise are subject to withholding at the rate of 15%, although we cannot
assure you that we will designate the profits that are being distributed in a way that
will reduce shareholders tax liability according to the U.S.-Israel Tax Treaty.
Furthermore, the maximum rate of withholding tax on dividends not generated by our
Approved Enterprise, that are paid to a U.S. corporation holding 10% or more of our
outstanding voting capital during the part of the tax year that precedes the date of the
payment of the dividend and during the whole of its prior tax year, is 12.5%. This reduced
rate will not apply if more than 25% of our gross income consists of interest or
dividends, other than dividends or interest received from a subsidiary corporation, 50% or
more of the outstanding voting shares of which are owned by the company.

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A
nonresident of Israel who receives dividends with respect of which tax was fully paid, is
generally exempt from the duty to file returns in Israel in respect of such income,
provided such income was not derived from a business conducted in Israel by the taxpayer
and the taxpayer has no other taxable sources of income in Israel.

United
States Federal Income Tax Considerations

Subject
to the limitations described herein, this discussion summarizes certain 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 who is a citizen or resident of the United States for United States federal
                  income tax purposes;
| | - | --------------------------------------------------------------------------------------------------------------------------------

| |  | 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, any political
subdivision thereof, or the District of Columbia;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 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 (a non-United States
holder) and considers only United States holders that will own the ordinary shares
or ADSs as capital assets (generally, for investment).

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This
discussion is based on current provisions of the Internal Revenue Code of 1986, as amended
(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 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, insurance companies, tax-exempt organizations, financial institutions,
financial service entities, ,real estate investment trusts, regulated
investment companies, grantor trusts, individual retirement and tax-deferred accounts, 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, United States holders who acquired their shares upon the
exercise of employee stock options or otherwise as compensation, certain former citizens
or long-term residents of the United States and United States holders 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 laws.

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

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Taxation of Distributions
on the Ordinary Shares or ADSs

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. 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 non-U.S.
taxes withheld from such distribution. 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% through taxable years beginning on or
before December 31, 2010), provided that such dividends meet the requirements of
qualified dividend income. For this purpose, qualified dividend income
generally includes dividends paid by a non-U.S. corporation if certain holding period and
other requirements are met and either (a) the stock of the non-U.S. corporation with
respect to which the dividends are paid is readily tradable on an established
securities market in the United States (e.g., the NASDAQ Global Market) or (b) the
non-U.S. corporation is eligible for benefits of a comprehensive income tax treaty with
the United States which includes an information exchange program and is determined to be
satisfactory by the United States Secretary of the Treasury. The United States Internal
Revenue Service (IRS) has determined that the United States-Israel income tax
treaty is satisfactory for this purpose. 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 (as such term is defined in the Code), or PFIC, for
any taxable year, dividends paid on our ordinary shares or ADSs in such year or in the
following taxable year would not be qualified dividends. See the discussion below
regarding our PFIC status under Tax Consequences if We Are a Passive Foreign
Investment Company. 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
so; in such case the dividend income 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.

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Dividends
paid by us in NIS generally will be included in the income of United States holders at the
dollar amount of the dividend (including any non-U.S. taxes withheld therefrom), based
upon the spot rate of exchange in effect on the date the distribution is received. United
States holders will have a tax basis in NIS for United States federal income tax purposes
equal to that dollar value. A United States holder that converts a dividend paid in NIS
into United States dollars subsequent to receipt may have foreign exchange gain or loss
arising from exchange rate fluctuations, which will generally be taxable as United States
source ordinary income or loss.

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 non-U.S. 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 generally will be foreign source passive income for U.S. foreign
tax credit purposes. United States holders that do not elect to claim a foreign tax credit
may instead claim a deduction for the non-U.S. 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 non-U.S. 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 31-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 of the
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 and
non-corporate United States holders may be eligible for a reduced rate of taxation
(currently a maximum rate of 15% for taxable years beginning on or before December 31,
2010). Capital gain from the sale, exchange or other disposition of ordinary shares or
ADSs held for one year or less is short-term capital gain and taxed as ordinary income.
Gain or loss recognized by a United States holder on a sale, exchange or other disposition
of ordinary shares or ADSs generally will be treated as U.S. source income or loss for
United States foreign tax credit purposes. The deductibility of capital losses is subject
to certain limitations.

85

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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 that uses the accrual method 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) may 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.

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) the average
percentage (by value determined on a quarterly basis) in a taxable year of our assets that
produce, or are held for the production of, passive income is at least 50%. 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.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

86

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| | 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 IRS. The QEF election is made by attaching a
completed IRS 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 IRS 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 marketable stock (e.g., regularly
traded on the NASDAQ Global Market). Pursuant to this regime, an electing United
States holders ordinary shares or ADSs are marked-to-market for each taxable year
that we are a PFIC 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the mark-to-market election, in a taxable year that we are a PFIC, 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 (losses in excess of
net mark-to-market gain previously included are generally capital losses). The
mark-to-market election applies to the taxable year for which the election is made and
all later taxable years, unless the ordinary shares or ADSs cease to be marketable or the
IRS 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) 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).
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

87

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| | 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 person who inherits shares or ADSs in a non-U.S. corporation
that was a PFIC in the hands of the decedent is generally denied the otherwise available
step-up in the tax basis of such shares or ADSs. Instead, such United States holders
basis would be equal to the lessor of the decedents basis or the fair market value
of the ordinary shares or ADSs.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We
believe that in 2008 we were not a PFIC and currently we expect that we will not be a PFIC
in 2009. 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, the amount and type
of our gross income and the market value of our ordinary shares. Therefore, there can be
no assurance that we will not become a PFIC for the current taxable year ending December
31, 2009 or in a future taxable 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 (currently at rate of up to 28% through 2010) with respect to dividend
payments on, or 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, or if a United States holder provides a correct
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 IRS.

88

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Non-United States holders
of Ordinary Shares or ADSs

Except
as provided below, a non-United States holder of ordinary shares or ADSs 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, in the case of
United States federal income taxes, 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 upon the disposition of our ordinary
shares or ADSs 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
certain other conditions are met.

Non-United
States holders generally will not be subject to information reporting or backup
withholding with respect to the payment of dividends on, or the proceeds from the
disposition of, ordinary shares or ADSs, provided that the non-United States holder
provides its taxpayer identification number, certifies to its foreign status, or otherwise
establishes an exemption.

|F. | Dividends
and Paying Agents
|-- | ---------------------------

Not applicable.

|G. | Statement
by Experts
|-- | --------------------

Not applicable.

|H. | Documents
on Display
|-- | --------------------

Formula
is subject to the reporting requirements of the Exchange Act that are applicable to a
foreign private issuer. In accordance with the Exchange Act, we file with the SEC reports,
including annual reports on Form 20-F by June 30 each year. In addition, we furnish
interim financial information on Form 6-K on a quarterly basis. We also furnish to the SEC
under cover of Form 6-K certain other material information required to be made public in
Israel, filed with and made public by any stock exchange or distributed by us to our
shareholders. You may inspect without charge and copy at prescribed rates such material at
the public reference facilities maintained by the SEC, at 100 F Street, N.E., 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, 100 F Street, N.E., 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 site 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.

89

---

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Formulas
ADSs are quoted on the NASDAQ Global Market. You may inspect reports and other information
concerning Formula at the offices of the National Association of Securities Dealers, Inc.,
9513 Key West Avenue, Rockville, Maryland 20850. You may also find our reports filed with
the ISA on the Magna site whose address is http://www.magna.isa.gov.il.

Our
Internet address is http://www.formulasystems.com. A copy of each report submitted
in accordance with applicable United States law is available for public review at our
principal executive offices.

|I. | Subsidiary
Information
|-- | ----------------------

Not applicable.

# ITEM 11. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

# Currency Exchange Rate
Fluctuations and Impact of Inflation

In
light of the nature of our activities, we invest our cash and cash equivalents primarily
in short-term and long-term deposits. As of December 31, 2008, we invested substantially
all of the cash we held in dollar accounts bearing interest based on LIBOR, euro accounts
and NIS accounts bearing interest based on the Israeli prime rate.

An
increase in value of the NIS against the dollar or euro may have a negative impact on our
operating results and financial condition. 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 or euro 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 Global Market and the
TASE. These companies include Magic Software, Matrix and Sapiens. 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.

90

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# 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.Based on managements evaluation (with the participation
of our chief executive officer and chief financial officer), as of December 31, 2008, our
chief executive officer and chief financial officer concluded that our disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act)
were effective to provide reasonable assurance that information required to be disclosed
by us in reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in Commission rules and forms,
and is accumulated and communicated to management, including our chief executive officer
and chief financial officer, as appropriate to allow timely decisions regarding required
disclosure.

(b) Managements
Annual Report on Internal Control over Financial Reporting.Our board of directors and
audit committee are responsible for establishing and maintaining adequate internal control
over financial reporting. Formulas internal control system was designed to provide
reasonable assurance regarding the reliability of financial reporting and the preparation
and fair presentation of our consolidated financial statements.

Our
chief executive officer and chief financial officer assessed the effectiveness of
Formulas internal control over financial reporting as of December 31, 2008. In
making this assessment, they used the criteria established in Internal Control 
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on this assessment, our chief executive officer and chief financial
officer have concluded that, as of December 31, 2008, Formulas internal control over
financial reporting is effective based on those criteria.

91

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Notwithstanding
the foregoing, all internal control systems no matter how well designed have inherent
limitations. Therefore, even those systems determined to be effective may not prevent or
detect misstatements and can provide only reasonable assurance with respect to financial
statement preparation and presentation. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.

(c)
Attestation Report of the Registered Public Accounting Firm. This annual
          report includes an attestation report of our registered public accountant
          assessing our internal control over financial reporting.

(d) Changes
in Internal Control Over Financial Reporting.During the period           covered by
this report, there were no changes in Formulas internal           controls over
financial reporting that have materially affected, or are           reasonably likely to
materially affect, Formulas internal control over           financial reporting.

# ITEM 16. [RESERVED]

# ITEM 16A. AUDIT
COMMITTEE FINANCIAL EXPERT

Our
board of directors has determined that 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: Chief Financial Officer.
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 independent registered public accounting firm, 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 independent registered public accounting firm, 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.

92

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Principal Accountant Fees
and Services

We
paid the following fees for professional services rendered by Ziv Haft independent
registered public accounting firm, BDO member firm, for the years ended December 31:

|                   | 2008 | 2007
|------------------ | ---- | ----
|
|
|
|
|Audit Fees         |      |     
|Audit-Related Fees |      |     
|Tax Fees           |      |     
|All Other Fees     |      |     
|                   |      |     
|Total              |      |     
|                   |      |     
|                   |      |     

The
Audit Fees for the years ended December 31, 2008 and 2007 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.

The
audit-related fees for the years ended December 31, 2008 and 2007 were primarily related
to internal control review.

Tax
Fees for the years ended December 31, 2008 and 2007 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.

# ITEM 16F. CHANGE IN
REGISTRANT CERTIFYING ACCOUNTANT

Not applicable.

93

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# ITEM 16G. CORPORATE GOVERNANCE

The
NASDAQ Global Market requires companies with listed shares to comply with its corporate
governance standards. As a foreign private issuer, we are not required to comply with all
of the rules that apply to listed U.S. companies. However, except for certain instances
described below, we have generally chosen to comply with the NASDAQ Global Markets
corporate governance rules as though we were a U.S. company. Accordingly, except for such
difference described below, we do not believe there are any significant differences
between our corporate governance practices and those that would typically apply to a U.S.
domestic issuer under the NASDAQ Global Market corporate governance rules.

Pursuant
to NASDAQ Marketplace Rule 4350(a), we notified NASDAQ that with respect to the quorum for
shareholders meetings, we follow Israeli law and practice and accordingly do not follow
NASDAQ rules. The quorum for a shareholders meeting, as stipulated in our articles of
association, complies with the provisions of the Israeli law, and requires the presence,
in person or by proxy of holders of 25% of our outstanding ordinary shares, in lieu of the
requirement specified in NASDAQ Marketplace Rule 4350(e) pursuant to which the quorum for
any shareholders meeting shall not be less than 33?% of the outstanding voting shares of
the company.

94

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# P A R T  III

# ITEM 17. FINANCIAL
STATEMENTS

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

# ITEM 18. FINANCIAL
STATEMENTS

Our
consolidated financial statements and the reports of independent registered public
accounting firm in connection therewith are filed as part of this annual report, as noted
on the pages below:

|                                                                                                                |     
|--------------------------------------------------------------------------------------------------------------- | ----
|
|
|
|
|Report of Independent Registered Public Accounting Firm                                                         | F-1 
|Consolidated Balance Sheets at December 31, 2008 and 2007                                                       | F-5 
|Consolidated Statements of Operations for theYears Ended December 31, 2008, 2007 and 2006                       | F-7 
|Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2008, 2007 and 2006 | F-8 
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006                      | F-9 
|Notes to Consolidated Financial Statements                                                                      | F-14
|                                                                                                                |     

# ITEM 19. EXHIBITS

# Exhibit No.

|1.1 |  | Memorandum
of Association (1)
|--- |  | -----------------------------

|1.2 |  | Articles
of Association as amended on December 28, 2005 (2)
|--- |  | -----------------------------------------------------------

|4.1 |  | Form
of Letter of Indemnification, dated December 28, 2005 (2)
|--- |  | --------------------------------------------------------------

|4.2 |  | International
Securities Purchase Agreement dated June 15, 2007 between the Registrant and each of the
purchasers identified on the signature pages of the agreement (3)
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 |  | English
translation of Formula Systems (1985) Ltd. Employees and Office Holders Share Option
                       Plan (2008)*
|--- |  | --------------------------------------------------------------------------------------------------------------------------------

95

---

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# Exhibit No.

|8 |  | List
of Subsidiaries*
|- |  | ---------------------

|12.1 |  | Certification
of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
                       of 2002*
|---- |  | ------------------------------------------------------------------------------------------------------------------------------

|12.2 |  | Certification
of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
                       of 2002*
|---- |  | ------------------------------------------------------------------------------------------------------------------------------

|13.1 |  | Certification
of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
                       Act of 2002*
|---- |  | ------------------------------------------------------------------------------------------------------------------------------

|13.2 |  | Certification
of the Chief Financial Officer pursuant to Section. 906 of the Sarbanes-Oxley
                       Act of 2002*
|---- |  | -------------------------------------------------------------------------------------------------------------------------------

|15.1 |  | Consent
of Ziv Haft registered certified public accountants (Isr.) BDO member firm*
|---- |  | -----------------------------------------------------------------------------------

|15.2 |  | Consent
of Levy Cohen and Co.*
|---- |  | ------------------------------

|15.3 |  | Consent
of Levy Cohen and Co.*
|---- |  | ------------------------------

|15.4 |  | Consent
of Kost, Forer, Gabbay & Kaiserer*
|---- |  | ------------------------------------------

|15.5 |  | Consent
of Kost, Forer, Gabbay & Kaiserer*
|---- |  | ------------------------------------------

|15.6 |  | Consent
of Verstegen accountants en belastingadviseurs*
|---- |  | -------------------------------------------------------

|15.7 |  | Consent
of KDA Audit Corporation*
|---- |  | ---------------------------------

|15.8 |  | Consent
of Maria Negyessy*
|---- |  | --------------------------

---

|*Filed
herewith.
|----------------

(1)    
          Incorporated by reference to the Registration Statement on Form F-1 (File No.
          333-8858). (2)    
          Incorporated by reference to the Annual Report on Form 20-F filed with the
          Securities and Exchange Commission on June 29, 2006. (3)    
          Incorporated by reference to the Annual Report on Form 20-F filed with the
          Securities and Exchange Commission on June 29, 2007.

96

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# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
corporation)

# 2008 Annual Report



---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# 2008 CONSOLIDATED FINANCIAL
STATEMENTS

# TABLE OF CONTENTS

|                                                          | Page     
|--------------------------------------------------------- | ---------
|
|
|
|
|REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM: | F-1-F-3  
|CONSOLIDATED FINANCIAL STATEMENTS:                       
|Balance Sheets                                            | F-4-F-5  
|Statements of Operations                                  | F-6      
|Statements of Changes in Shareholders' Equity             | F-7      
|Statements of Cash Flows                                  | F-8-F-12 
|Notes to Financial Statements                             | F-13-F-67

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



---

---

|           |  |                                              |  |                                                                                                                                                                                        
|---------- |  | -------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(BDO LOGO) |  | ZIV HAFT
Certified Public Accountants (Isr.) |  | Head
  Office: Amot Bituach House Building B
  46-48
  Menachem Begin Road, Tel-Aviv 66184
  Tel: +972 3 638 6868, Fax: +972 3 639 4320
  E-mail:
  zivhaft@bdo.co.il     www.bdo.co.il

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

We have audited the accompanying
consolidated balance sheets of Formula Systems (1985) Ltd. and its subsidiaries (the
Company) as of December 31, 2008 and 2007 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, 2008. 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 21%
and 22% of total consolidated assets as of December 31, 2008 and 2007, respectively, and
whose consolidated revenues constitute approximately 18%, 20% and 23% of total
consolidated revenues for the years ended December 31, 2008, 2007 and 2006, respectively.
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. 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 referred to
above present fairly, in all material respects, the consolidated financial position of the
Company and its subsidiaries as of December 31, 2008 and 2007, and the related
consolidated results of their operations and cash flows for each of the three years in the
period ended December 31, 2008, in conformity with accounting principles generally
accepted in the United States of America.

We also have audited, in accordance
with the standards of the Public Company Accounting Oversight Board (United States), the
Companys internal control over financial reporting as of December 31, 2008, based on
criteria established in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Tread way Commission (COSO) and our report dated April 27,
2009 expressed an unqualified opinion thereon.

Tel Aviv, Israel
April 27, 2009

| |  | Ziv HaftCertified Public Accountants (Isr.)
BDO Member Firm
| |  | -----------------------------------------------------------

|                                                                                 |  |                                                                                          |  |            
|-------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------- |  | -----------
|Haifa Tel: 04-8680600, Fax: 04-8620866Jerusalem Tel: 02-6546200, Fax: 02-6526633 |  | Kiryat Shmona Tel: 04-6951389, Fax:04-6951360Beer Sheva Tel: 08-6654432, Fax: 08-6270008 |  | (BVQI LOGO)

F - 1

---

---

|           |  |                                              |  |                                                                                                                                                                                        
|---------- |  | -------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(BDO LOGO) |  | ZIV HAFT
Certified Public Accountants (Isr.) |  | Head
  Office: Amot Bituach House Building B
  46-48
  Menachem Begin Road, Tel-Aviv 66184
  Tel: +972 3 638 6868, Fax: +972 3 639 4320
  E-mail:
  zivhaft@bdo.co.il     www.bdo.co.il

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

We have audited Formula Systems
(1985) Ltd. (the Company) internal control over financial reporting as of
December 31, 2008, based on criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Tread way Commission (the
COSO criteria). The Companys management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting, included in the accompanying
Item 15b Management Report Over Financial Reporting. Our responsibility is to
express an opinion on the Companys internal control over financial reporting 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 effective internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and evaluating
the design and operating effectiveness of internal control based on the assessed risk. Our
audit also included performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our opinion.

A companys internal control
over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and (3)
provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a material
effect on the financial statements.

|                                                                                 |  |                                                                                          |  |            
|-------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------- |  | -----------
|Haifa Tel: 04-8680600, Fax: 04-8620866Jerusalem Tel: 02-6546200, Fax: 02-6526633 |  | Kiryat Shmona Tel: 04-6951389, Fax:04-6951360Beer Sheva Tel: 08-6654432, Fax: 08-6270008 |  | (BVQI LOGO)

F - 2

---

---

|           |  |                                              |  |                                                                                                                                                                                        
|---------- |  | -------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(BDO LOGO) |  | ZIV HAFT
Certified Public Accountants (Isr.) |  | Head
  Office: Amot Bituach House Building B
  46-48
  Menachem Begin Road, Tel-Aviv 66184
  Tel: +972 3 638 6868, Fax: +972 3 639 4320
  E-mail:
  zivhaft@bdo.co.il     www.bdo.co.il

Because of its inherent limitations,
internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.

In our opinion, the Company
maintained in all material respects, effective internal control over financial reporting
as of December 31, 2008, based on the COSO criteria.

We also have audited, in accordance
with the standards of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of the Company and subsidiaries as of December 31, 2007 and
2008, 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, 2008
and our report dated April 27, 2009 expressed an unqualified opinion thereon.

Tel Aviv, Israel

April 27, 2009

| |  | Ziv HaftCertified Public Accountants (Isr.)
BDO Member Firm
| |  | -----------------------------------------------------------

|                                                                                 |  |                                                                                          |  |            
|-------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------- |  | -----------
|Haifa Tel: 04-8680600, Fax: 04-8620866Jerusalem Tel: 02-6546200, Fax: 02-6526633 |  | Kiryat Shmona Tel: 04-6951389, Fax:04-6951360Beer Sheva Tel: 08-6654432, Fax: 08-6270008 |  | (BVQI LOGO)

F - 3

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# CONSOLIDATED BALANCE
SHEETS

|                                                                  | December 31,
|----------------------------------------------------------------- | ------------
|
|
|
|
|ASSETS                                                            |             
|CURRENT ASSETS:                                                   |             
|Cash and cash equivalents                                         |             
|Short-term investments (Note 3)                                   |             
|Trade receivables (net of allowances for doubtful debts of $4,326 |             
|and $4,678 as of December 31, 2008 and 2007, respectively)        |             
|Other current assets (Note 17A)                                   |             
|Inventories                                                       |             
|Total assets attributed to discontinued operations                |             
|                                                                  |             
|                                                                  |             
|                                                                  |             
|                                                                  |             
|LONG-TERM INVESTMENTS, LOANS AND RECEIVABLES:                     |             
|Loans and other investments (Note 5)                              |             
|Investments in affiliates (Note 6)                                |             
|                                                                  |             
|                                                                  |             
|                                                                  |             
|                                                                  |             
|SEVERANCE PAY FUND                                                |             
|                                                                  |             
|                                                                  |             
|PROPERTY AND EQUIPMENT, NET (Note 7)                              |             
|                                                                  |             
|                                                                  |             
|GOODWILL (Note 1J and Note 8)                                     |             
|                                                                  |             
|                                                                  |             
|OTHER ASSETS, NET (Note 9)                                        |             
|                                                                  |             
|                                                                  |             
|                                                                  |             
|                                                                  |             

F - 4

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

|                                                                     | December 31,
|-------------------------------------------------------------------- | ------------
|
|
|
|
|LIABILITIES AND SHAREHOLDERS' EQUITY                                 |             
|CURRENT LIABILITIES:                                                 |             
|Liabilities to banks and others (Notes 17B and 11B)                  |             
|Trade payables                                                       |             
|Other accounts payable (Note 17C)                                    |             
|Dividend payable                                                     |             
|Liability in respect of the acquisition of subsidiaries (Note 10)    |             
|Debentures (Note 12)                                                 |             
|Total liabilities attributed to discontinued operations              |             
|                                                                     |             
|                                                                     |             
|                                                                     |             
|                                                                     |             
|LONG-TERM LIABILITIES:                                               |             
|Debentures (Note 12)                                                 |             
|Deferred taxes                                                       |             
|Customer advances                                                    |             
|Liabilities to banks and others (Note 11)                            |             
|Liability in respect of the acquisition of activity                  |             
|Accrued severance pay                                                |             
|                                                                     |             
|                                                                     |             
|                                                                     |             
|                                                                     |             
|MINORITY INTEREST                                                    |             
|                                                                     |             
|                                                                     |             
|COMMITMENTS AND CONTINGENCIES (Note 14)                              |             
|                                                                     |             
|SHAREHOLDERS' EQUITY (Note 15):                                      |             
|Share capital - ordinary shares of NIS 1 par value                   |             
|(authorized - December 31, 2008 and 2007 - 25,000,000 shares;        |             
|issued: December 31, 2008 - 13,224,780 and 2007 - 13,224,780 shares) |             
|Additional paid-in capital                                           |             
|Retained earnings                                                    |             
|Other accumulated comprehensive loss                                 |             
|                                                                     |             
|                                                                     |             
|Cost of 24,780 treasury shares                                       |             
|                                                                     |             
|TOTAL SHAREHOLDERS' EQUITY                                           |             
|                                                                     |             
|                                                                     |             
|                                                                     |             
|                                                                     |             

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

F - 5

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# CONSOLIDATED
STATEMENTS OF OPERATIONS

|                                                                   | Year Ended December 31,
|------------------------------------------------------------------ | -----------------------
|
|
|
|
|Revenues (Note 17H)                                                |                        
|Proprietary software products                                      |                        
|                                                                   |                        
|Software services                                                  |                        
|                                                                   |                        
|Total revenues                                                     |                        
|Cost of revenues                                                   |                        
|Proprietary software products                                      |                        
|Software services                                                  |                        
|                                                                   |                        
|Total cost of revenues                                             |                        
|                                                                   |                        
|Gross profit                                                       |                        
|Research and development costs, net                                |                        
|Selling, general and administrative expenses                       |                        
|Restructuring and non-recurring costs (Note 17D)                   |                        
|                                                                   |                        
|Operating income                                                   |                        
|Financial expenses, net (Note 17E)                                 |                        
|Gain (losses) on realization of shareholdings, net (Note 17G)      |                        
|Other expenses (Note 17F)                                          |                        
|                                                                   |                        
|Income before taxes on income                                      |                        
|Taxes on income (Note 16)                                          |                        
|                                                                   |                        
|                                                                   |                        
|Equity in gains (losses) of affiliated companies, net              |                        
|Minority interest in earnings of subsidiaries, net                 |                        
|                                                                   |                        
|Income (loss) from continuing operation                            |                        
|Income from discontinued operation, net (Note 18)                  |                        
|                                                                   |                        
|Net income                                                         |                        
|                                                                   |                        
|                                                                   |                        
|Earnings (losses) per share generated from continuing operation:   |                        
|Basic                                                              |                        
|                                                                   |                        
|Diluted                                                            |                        
|                                                                   |                        
|                                                                   |                        
|Earnings (losses) per share generated from discontinued operation: |                        
|Basic                                                              |                        
|                                                                   |                        
|Diluted                                                            |                        
|                                                                   |                        
|                                                                   |                        
|Total earnings per share:                                          |                        
|Basic                                                              |                        
|                                                                   |                        
|Diluted                                                            |                        
|                                                                   |                        
|                                                                   |                        
|Weighted average number                                            |                        
|of shares outstanding in thousands (Note 17J):                     |                        
|Basic                                                              |                        
|                                                                   |                        
|Diluted                                                            |                        
|                                                                   |                        

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

F - 6

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

|                                                                         | Share Capital |  |  |            |  | 
|------------------------------------------------------------------------ | ------------- |  |  | ---------- |  | 
|
|
|
|
|Balance as of January 1, 2006                                            |               |  |  | 13,200,000 |  | 
|Changes during 2006:                                                     |               | 
|Net Income                                                               |               |  |  |            |  | 
|Unrealized loss from available-for-sale securities, net                  |               |  |  |            |  | 
|Currency translation adjustments                                         |               |  |  | -          |  | 
|                                                                         |               |  |  |            |  | 
|Total comprehensive income                                               |               |  |  | -          |  | 
|Employee stock options exercised                                         |               |  |  | -          |  | 
|Spin off                                                                 |               |  |  | -          |  | 
|                                                                         |               |  |  |            |  | 
|Balance as of December 31, 2006                                          |               |  |  | 13,200,000 |  | 
|Changes during 2007:                                                     |               | 
|Net Income                                                               |               |  |  | -          |  | 
|Unrealized gain from available - for-sale securities, net                |               |  |  | -          |  | 
|Currency translation adjustments                                         |               |  |  | -          |  | 
|                                                                         |               |  |  |            |  | 
|Total comprehensive income                                               |               |  |  | -          |  | 
|Implementation of FSP EITF 00-19-2                                       |               |  |  | -          |  | 
|Cumulative  impact of change in accounting  for                          |               | 
|uncertainties  in income taxes (FIN 48)                                  |               |  |  | -          |  | 
|                                                                         |               |  |  |            |  | 
|Balance as of December 31, 2007                                          |               |  |  | 13,200,000 |  | 
|Changes during 2008:                                                     |               | 
|Net Income                                                               |               |  |  | -          |  | 
|Unrealized and realized gain from available - for-sale securities, net   |               |  |  | -          |  | 
|Other than temporary impairment on marketable securities                 |               |  |  | -          |  | 
|Currency translation adjustments                                         |               |  |  | -          |  | 
|                                                                         |               |  |  |            |  | 
|Total comprehensive income                                               |               |  |  | -          |  | 
|Gain from issuance of shares to third party in  development stage entity |               |  |  | -          |  | 
|Dividend to shareholders                                                 |               |  |  | -          |  | 
|                                                                         |               |  |  |            |  | 
|Balance as of December 31, 2008                                          |               |  |  | 13,200,000 |  | 
|                                                                         |               | 
|Accumulated unrealized loss from available - for-sale securities         |               |  |  |            |  | 
|Accumulated currency translation adjustments                             |               |  |  |            |  | 
|                                                                         |               |  |  |            |  | 
|Accumulated other comprehensive loss                                     |               |  |  |            |  | 
|                                                                         |               |  |  |            |  | 

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

|                                                                            | Year ended December 31,
|--------------------------------------------------------------------------- | -----------------------
|
|
|
|
|CASH FLOWS FROM OPERATING ACTIVITIES:                                       |                        
|Net income                                                                  |                        
|Adjustments to reconcile net income  to net cash provided                   |                        
|by operating activities:                                                    |                        
|Impairment and write down of other investments  and fixed assets            |                        
|Impairment of available for sale marketable securities                      |                        
|Minority interest in earnings  of consolidated subsidiaries                 |                        
|Equity in losses (gains) of affiliated companies, net                       |                        
|Depreciation and amortization                                               |                        
|Increase  in accrued severance pay, net                                     |                        
|Gain from sale of subsidiaries                                              |                        
|Loss (gain) from sale of operation                                          |                        
|Loss (gain) from sale of property and equipment                             |                        
|Loss( gain) on realization of shareholdings                                 |                        
|Stock based employ compensation                                             |                        
|Increase in value and  accrued interest                                     |                        
|on debentures and changes in embedded derivative                            |                        
|Gain from repurchase of convertible debt, net                               |                        
|Changes in value of long term loans and deposits, net                       |                        
|Deferred taxes                                                              |                        
|Change in liability in respect of acquisition                               |                        
|Changes in value of PUT option                                              |                        
|Changes in Derivatives                                                      |                        
|Loss ( gain ) from sale and decrease (increase)                             |                        
|in value of marketable securities, net                                      |                        
|Changes in operating assets and liabilities:                                |                        
|Decrease (increase) in inventories                                          |                        
|Increase in trade receivables                                               |                        
|Decrease (increase) in other accounts receivable                            |                        
|Increase in trade payables                                                  |                        
|Increase (decrease) in other accounts payable                               |                        
|and restructuring accrual                                                   |                        
|Increase (decrease) in deferred revenue & customer advances, net of work in |                        
|progress                                                                    |                        
|                                                                            |                        
|Net cash provided by operating activities                                   |                        
|                                                                            |                        

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

|                                                                        | Year ended December 31,
|----------------------------------------------------------------------- | -----------------------
|
|
|
|
|CASH FLOWS FROM INVESTING ACTIVITIES:                                   |                        
|Acquisition of newly-consolidated subsidiaries (Appendix C)             |                        
|Proceeds from realization of investment                                 |                        
|in previously-consolidated subsidiaries (Appendix D)                    |                        
|Proceeds from sale of activity in a consolidated company                |                        
|Proceeds from sale of associated company                                |                        
|Proceeds from sale of subsidiary's operation                            |                        
|Restricted short term deposit, net                                      |                        
|Restricted long term deposit, net                                       |                        
|Purchase of property and equipment                                      |                        
|Purchase (proceeds) of short term investment , net                      |                        
|Proceeds from sale of property and equipment                            |                        
|Investment in and loans to affiliated and other companies               |                        
|Other investments                                                       |                        
|Payments to formally  stockholders of consolidated company on behalf of |                        
|purchase liability                                                      |                        
|Proceeds from sale of investments in                                    |                        
|and loans to affiliated companies                                       |                        
|Changes in short term deposits, net                                     |                        
|Purchase of intangible assets by consolidated companies                 |                        
|Proceeds from long term bank deposits                                   |                        
|Capitalization of software development and other costs                  |                        
|Purchase of minority interest in subsidiaries                           |                        
|Proceeds from maturity of marketable securities                         |                        
|Proceeds from realization of investment in subsidiaries                 |                        
|Proceeds from investments in short term bank deposits, net              |                        
|                                                                        |                        
|Net cash provided (used) in investing activities                        |                        
|                                                                        |                        

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

F - 9

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# CONSOLIDATED
STATEMENTS OF CASH FLOWS

|                                                                   | Year ended December 31,
|------------------------------------------------------------------ | -----------------------
|
|
|
|
|CASH FLOWS FROM FINANCING ACTIVITIES:                              |                        
|Spin-off consolidated company (Appendix D)                         |                        
|Issuance of debentures (net from issuance expense)                 |                        
|Issuance of convertible debt                                       |                        
|Exercise of share options in subsidiaries                          |                        
|Dividend to minority shareholders of subsidiary                    |                        
|Dividend to shareholders                                           |                        
|Short-term bank credit, net                                        |                        
|Repayment of long-term loans                                       |                        
|Receipt of long-term loans                                         |                        
|Issuance in a subsidiary to minority shareholders, net             |                        
|Convertible debt issuance expenses in a subsidiary                 |                        
|Deposit for SWAP deal                                              |                        
|Repayment and repurchase of debenture                              |                        
|Proceeds from sale of treasury stock of subsidiary                 |                        
|Purchase of treasury stock in a subsidiary by a subsidiary thereof |                        
|                                                                   |                        
|Net cash provided (used) by financing activities                   |                        
|                                                                   |                        
|Effect of exchange rate changes on cash and cash equivalents       |                        
|                                                                   |                        
|NET INCREASE (DECREASE)                                            |                        
|IN CASH AND CASH EQUIVALENTS                                       |                        
|CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR(*)                  |                        
|                                                                   |                        
|CASH AND CASH EQUIVALENTS AT END OF YEAR (*)                       |                        
|                                                                   |                        

(*) Includes cash and cash
equivalents of discontinued operations.

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

F - 10

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# CONSOLIDATED
STATEMENTS OF CASH FLOWS

# Appendix A 
Supplemental cash flow information:

|                                         | Year ended December 31,
|---------------------------------------- | -----------------------
|
|
|
|
|Cash paid during the year in respect of: |                        
|Interest                                 |                        
|                                         |                        
|Income tax                               |                        
|                                         |                        

# Appendix B  Non-cash
activities:

|                                                               | Year ended December 31,
|-------------------------------------------------------------- | -----------------------
|
|
|
|
|Purchase of fixed assets against trade payables                |                        
|                                                               |                        
|Investment in a consolidated company against issuance of share |                        
|capital to minority shareholders of consolidated company       |                        
|                                                               |                        
|                                                               |                        
|Investment in a consolidated company against account payable   |                        
|                                                               |                        
|                                                               |                        
|Dividend to shareholders                                       |                        
|                                                               |                        
|                                                               |                        
|Investments in available marketable securities,                |                        
|against accounts payable                                       |                        
|                                                               |                        
|                                                               |                        
|Fin 48 provision                                               |                        
|                                                               |                        

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

F - 11

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# CONSOLIDATED
STATEMENTS OF CASH FLOWS

# Appendix C 
Acquisition of newly-consolidated subsidiaries:

|                                                             | Year ended December 31,
|------------------------------------------------------------ | -----------------------
|
|
|
|
|Assets and liabilities of subsidiaries consolidated          |                        
|as of acquisition date:                                      |                        
|Working capital (other than cash and cash equivalents)       |                        
|Investment in affiliates and loans                           |                        
|Property and equipment                                       |                        
|Other assets and deferred expenses*                          |                        
|Other assets  arising upon acquisition                       |                        
|Long-term liabilities                                        |                        
|Other long term assets                                       |                        
|Long term deferred tax liability                             |                        
|Liability to formally  stockholders of  consolidated company |                        
|on behalf of purchase                                        |                        
|Minority interest at acquisition date                        |                        
|                                                             |                        
|Total                                                        |                        
|                                                             |                        

# * Mainly goodwill

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

|                                                            | Year ended December 31,
|----------------------------------------------------------- | -----------------------
|
|
|
|
|Assets and liabilities of consolidated subsidiaries         |                        
|as of date of realization                                   |                        
|Working capital (other than cash and cash equivalents)      |                        
|Debtors from sale of subsidiaries                           |                        
|Investments and loans in subsidiaries                       |                        
|Accrued severance pay, net                                  |                        
|Investment in affiliate (including loans)                   |                        
|Property and equipment                                      |                        
|Other assets, deferred expenses and long term payables      |                        
|Provision for losses                                        |                        
|Long term deposits                                          |                        
|Goodwill                                                    |                        
|Other comprehensive (loss) gain                             |                        
|Long-term liabilities                                       |                        
|Gain (loss) from realization of investments in subsidiaries |                        
|Retained earnings                                           |                        
|Minority interest                                           |                        
|                                                            |                        
|Total                                                       |                        
|                                                            |                        

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

F - 12

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS

# Note 1  Summary of
Significant Accounting Policies:

# General:

Formula Systems (1985) Ltd.
(Formula) was incorporated in Israel in 1985. Since 1991, Formula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 Global Market in the United States. Each ADS represents one ordinary share of
Formula.

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 reportable 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:

|Name of subsidiary:                                | Percentage of ownership and control
|-------------------------------------------------- | -----------------------------------
|
|
|
|
|Matrix IT Ltd. ("Matrix")                          |                                    
|Magic Software Enterprises Ltd. ("Magic")          |                                    
|NextSource Inc.                                    |                                    
|Sapiens International Corporation N.V. ("Sapiens") |                                    

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

# Accounting Principles

The consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
(GAAP) as applied in the United States.

F - 13

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS

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

|A. | Functional
and Reporting Currency:
|-- | ----------------------------------

| | Beginning
in 2007, the Company changed its functional currency from NIS to the United States dollar
(dollar). This was done according to a change in economic and circumstance
factors for the Company, as mentioned in financial accounting standards board statement
No. 52 foreign currency translation. Prior to 2007, Formula operated
primarily in the economic environment of the New Israeli Shekel (NIS) and its functional
currency was the NIS. The functional currencies of Formulas subsidiaries are the
NIS and the dollar. Formula has elected to use the dollar as its reporting currency for
all years presented.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Formula
translates the financial statements of its subsidiaries whose functional currency is
the NIS, into dollars, 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. Formula presents
differences resulting from translation under shareholders equity in the item
accumulating other comprehensive income (loss).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
comparative figures for 2006 have been measured under the assumption that formulas
functional currency was the NIS.
| | ------------------------------------------------------------------------------------------------------------------------

| | The
financial statements of prior years 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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|B. | 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.
| | ---------------------------------------------------

F - 14

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS

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

|C. | 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. Acquisition of
subsidiaries is accounted for under the purchase method. All inter-company balances and
transactions have been eliminated upon consolidation.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|D. | 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|E. | 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). 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 shareholders 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 other-than-temporary impairment in value
has occurred, in which case the investment is written down to its fair value, through the
income statements. In accordance with the Companys policy and FASB Staff Position
(FSP) Nos. SFAS 115-1 (FSP 115-1) and SAB Topic 5M, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments, the
Company recognizes an impairment charge when a decline in the fair value of its
investments below the cost basis is judged to be other-than-temporary. The Company
considers various factors in determining whether to recognize an impairment charge,
including the Companys intent and ability to hold the investment for a period of
time sufficient to allow for any anticipated recovery in market value, the length of time
and extent to which the fair value has been less than the cost basis, the credit ratings
of the securities and the financial condition and near-term prospects of the issuers.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS

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

|F. | 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|G. | 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 for hardware.
| | ------------------------------------------------------------------------------------------------------------------------------

|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 |  
| | Motor vehicles          |  
| | Buildings               |  
| | Leasehold improvements  |  

| | *
Over the shorter of the term of the lease or the estimated useful life of the asset.
| | --------------------------------------------------------------------------------------

|J. | Goodwill:
|-- | ---------

| | The
Company applies 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. 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 16

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS

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

|J. | Goodwill
(cont.):
|-- | -----------------

| | The Company has selected December
31st as the date on which it will perform its annual goodwill impairment test. As required
by SFAS 142, the impairment test is accomplished using a two- step approach. The first
step of the goodwill impairment test compares the fair value of a reporting unit with its
carrying amount, including goodwill. At December 31, 2008, the market capitalization
of two reporting unit was below their carrying value, the company determined the fair
value of these reporting units using the Income Approach, which utilizes a discounted cash
flow model, as it believes that this approach best approximates their fair value. The
company measured the fair values using the Market Approach By using judgments and
assumptions related to revenue, gross profit, operating expenses, future short-term and
long-term growth rates, weighted average cost of capital, interest, capital expenditures,
cash flows, and market conditions that are inherent in developing the discounted cash flow
model. Additionally, the company evaluated the reasonableness of the estimated fair value
of the reporting units by reconciling to their market capitalization. The ability to
reconcile the gap between the market capitalization and the aggregate fair value depends
on various factors; very low volumes in the shares, analysis of independent analysts,
growth in future estimated revenues, large amounts of cash reserves and a control premium.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Goodwill
related to equity method investees is not amortized (as of January 1, 2002 and
thereafter) but the investment is tested for impairment under the provisions of APB 18.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2008, 2007 and 2006, no impairment was required.
| | -------------------------------------------------------------------

|K. | Software
Development Costs:
|-- | ---------------------------

| | Development
costs of software, which is intended for sales that are incurred after the establishment
of technological feasibility of the relevant product, 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Software
development costs incurred before technological feasibility has been established are
charged to the statement of operations as incurred, net of participation of the Office of
the Chief Scientist of the Israeli Ministry of Industry and Trade (the OCS).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 17

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS

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

|K. | Software
Development Costs (cont.):
|-- | -----------------------------------

| | 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
3-5 years. During the year ended December 31, 2008, consolidated subsidiaries capitalized
software development costs aggregating $6.7 million (2007  $6.2 million, 2006  $8.5
million) and amortized capitalized software development costs aggregating $7.2 million
(2007  $6.4 million, 2006  $8.9 million).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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. As of
December 31, 2008, no impairment was recorded.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|L. | Other
Intangible Assets:
|-- | ------------------------

| | Other
intangible assets are comprised of customers related intangible assets 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. Amortization is computed using the straight-line method as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                      |           
| | ---------------------------------------------------- | ----------
|
|
|
|
| | Prepaid royalties                                    | 15 years  
| | Distribution rights                                  | 5-7 years 
| | Technology, usage rights and other intangible assets | 4-15 years

| | The
company evaluate every year the remaining useful life of the intangible assets.
| | -----------------------------------------------------------------------------------

| | During
2006, 2007 and 2008, no impairment losses have been identified.
| | ----------------------------------------------------------------------

F - 18

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# NOTES TO THE
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, 2006 and 2008 no impairment losses have
been identified. During 2007, impairment loss in the amount of $137 thousand has 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 policies 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 Law, 1963 (Section 14), certain
employees of the Company who are subjected to 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, 2008, 2007 and 2006
were $7.4 million, $9.3 million and $5.6 million, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 19

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS

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

|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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, there are certain arrangements involving multiple elements such as software
product, maintenance and support.
| | --------------------------------------------------------------------------------------------------------------------------

| | 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 criteria are met. Under the residual method,
any discount in the arrangement is allocated to the delivered elements.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
VSOE of undelivered elements-PCS (post contract support) is based on the price charged on
PCS sold separately or renewed.
| | -----------------------------------------------------------------------------------------------------------------------------

| | 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.
| | ----------------------------------------------------------------------------------------------------

| | 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
VSOE for consulting services in multiple element arrangements is established based on the
price charged when the consulting services sold separately based on a time and material
basis.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS

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

|O. | Revenue
Recognition (cont.):
|-- | ----------------------------

| | Revenue
from fixed fee contracts 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. These revenues are included in the
proprietary software products segment.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
Company generally does not grant a right of return to its customers. When a right of
return exists, revenue is deferred until the right of return expires, at which time
revenue is recognized provided that all other revenue recognition criteria are met.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Deferred
revenue includes unearned amounts received under maintenance contracts and amounts
received from customers but not yet recognized as revenues. Payments for maintenance fees
are generally made in advance and are nonrefundable.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Tax
collected from customers and remitted to governments authorities (including VAT) are
presented in income statement on a net basis.
| | --------------------------------------------------------------------------------------------------------------------------------------

|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 past experience, Formula and its subsidiaries do not record any provision for
warranties in respect of their products and services.
| | -----------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS

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

|R. | Advertising
Costs:
|-- | ------------------

| | The
Company records advertising expenses as incurred. Advertising costs were recorded at the
amount of $5.6 million, $5.1 million, and $2.4 million in the years 2008, 2007, 2006
respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 such results to the statement of operations,
provided that the conditions stipulated by SAB 51 for such recognition have been met.
When conditions are not met gain is recognized as part of APIC.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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, in
future years.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
September 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty
in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48). FIN 48
contains a two-step approach to recognizing and measuring uncertain tax positions
accounted for in accordance with SFAS No. 109. The first step is to evaluate the tax
position taken or expected to be taken in a tax return by determining if the weight of
available evidence indicates that it is more likely than not that, on an evaluation of
the technical merits, the tax position will be sustained on audit, including resolution
of any related appeals or litigation processes. The second step is to measure the tax
benefit as the largest amount that is more than 50% likely to be realized upon ultimate
settlement. This interpretation is effective for fiscal years beginning after December
15, 2006. The company adopted FIN 48 since January 1, 2007.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS

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

|U. | Earnings
(Loss) Per Share:
|-- | --------------------------

| | Earnings
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 per share are calculated on the basis of the weighted average number of
common shares outstanding during each year. The diluted earnings 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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, 2008 and 2007 were deposited in Israeli, U.S. and European banks. The Company is of
the opinion that the credit risk in respect of these balances is remote.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Groups trade receivables are derived from sales to large firm organizations located
mainly in 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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | SFAS
No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities (SFAS No. 140),establishes a standard for determining when a
transfer of financial assets should be accounted for as a sale. The underlying conditions
are met for the transfer of financial assets to qualify for accounting as a sale. The
transfers of financial assets are typically performed by the sale of receivables to a
financial institution. There are no sales of receivables in 2008.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---

# FORMULA SYSTEMS (1985)
LTD.

# (An Israeli
Corporation)

# NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS

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

|W. | Concentration
of Credit Risks  Allowance for Doubtful Accounts (cont.):
|-- | ------------------------------------------------------------------------

| | The
agreements, pursuant to which the Company sells its trade receivables, are structured
such that the Company (i) transfers the proprietary rights in the receivable from the
Company to the financial institution; (ii) legally isolates the receivable from the
Companys other assets, and presumptively puts the receivable beyond the legal reach
of the Company and its creditors, even in bankruptcy or other receivership; (iii) confers
on the financial institution the right to pledge or exchange the receivable; and (vi)
eliminates the Companys effective control over the receivable, in the sense that
the Company is not entitled and shall not be obligated to repurchase the receivable other
than in case of failure by the Company to fulfill its commercial obligation.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
net change in the provision for doubtful accounts charged to general and administrative
expenses amounted to $0.783 million, $0.58 million and $1.3 million in the years 2008,
2007 and 2006, respectively, and was determined for specific debts where doubt existed as
to their collectability.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|X. | Options
Granted to Employees:
|-- | -----------------------------

| | On
January 1, 2006, the Company adopted the provisions of Statement of Financial
Accounting Standard No. 123 (revised 2004) (FAS 123R), Share-Based
Payment, and Staff Accounting Bulletin No. 107 (SAB 107), which
was issued in March 2005 by the SEC. FAS 123R addresses the accounting for share-based
payment transactions in which the Company obtains employee services in exchange for
equity instruments of the Company. This statement requires that employee equity awards be
accounted for using the grant-date fair value method. SAB 107 provides supplemental
implementation guidance on FAS 123R, including guidance on valuation methods,
classification of compensation expense, income statement effects, disclosures and other
issues.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | FAS
123R supersedes the Companys previous accounting for its employee stock option
plans using the intrinsic value-based method of accounting prescribed under Accounting
Principles Board Opinion No. 25 (APB 25) and related
interpretations. The Company elected to adopt the modified prospective transition method
permitted by FAS 123R. Under such transition method, the new standard has been
implemented from January 1, 2006, with no restatement of prior periods to reflect
the fair value method of expensing share-based compensation.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 24

---

---

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

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

|X. | Options
Granted to Employees (cont.):
|-- | -------------------------------------

| | The
Company has expensed compensation costs, applying the accelerated vesting method, based
on the grant-date fair value estimated in accordance with the original provisions of FAS
123, and previously presented in the pro forma footnote disclosures. Results for prior
periods have not been restated as explained above. For the year ended December 31,
2008, the Companys subsidiaries recorded stock-based compensation costs in the
amount of $1.5 million. The total unrecognized compensation cost on employee stock
options amounted to $1.9 million on December 31, 2008, and is expected to be
recognized up to 4 years.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Certain
public subsidiaries granted options to their employees to purchase shares.
| | ----------------------------------------------------------------------------------

| | Some
subsidiaries use the Black-Scholes option-pricing model which requires a number of
assumptions, of which the most significant are, expected stock price volatility, and the
expected option term. Expected volatility was calculated based upon actual historical
stock price movements over the most recent periods ending on the grant date, equal to the
expected option term. The expected option term represents the period that the Companys
stock options are expected to be outstanding and was determined based on historical
experience of similar options, giving consideration to the contractual terms of the stock
options.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | One
of the companys subsidiaries, Magic, used the Black-Scholes option-pricing model
through December 31, 2006 and the Cox, Ross and Rubinsteins Binomial model for
options granted thereafter. The Binomial model considers characteristics of fair value
option pricing that are not available under the Black-Scholes model. Similar to the
Black-Scholes model, the Binominal model takes into account variables such as volatility,
dividend yield rate and risk free interest rate. However, in addition, the Binomial model
considers specific terms and conditions of the options, such as the contractual term of
the option, the probability that the option will be exercised prior to the end of its
contractual life and the probability of termination of the option holder in computing the
value of the option. For these reasons, Magic believes that the Binominal model provides
a fair value that is more representative of actual experience and future expected
experience than that calculated using the Black-Scholes model.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 25

---

---

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

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

|Y. | Derivatives
and Hedging:
|-- | ------------------------

| | The
Company accounts for derivatives 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 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Put
options which were granted to minority interest during 2007 in a subsidiary have been
measured in fair value pursuant to EITF 00-06 Accounting for Freestanding
Derivative Financial Instruments Indexed to, and Potentially Settled in, the Stock of a
Consolidated Subsidiary. Changes in the fair value are reflected in the
consolidated statements of operations as financial income or expense.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, during 2007 the Companys subsidiary engaged in Swap deal to exchange
interest which was linked to the CPI. This Swap deal did not qualify as hedging
instrument under SFAS 133. Changes in the fair value are reflected in the consolidated
statements of operation as financial income or expense.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Z. | Fair
Value of Financial Instruments:
|-- | ------------------------------------

| | The
carrying amounts of our financial instruments, including cash and cash equivalents,
accounts receivable, accounts payable and accrued liabilities, approximate fair value
because of their generally short maturities.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Effective
January 1, 2008, the Company adopted SFAS 157, Fair Value Measurementsand,
effective October 10, 2008, adopted FSP No. SFAS 157-3, Determining the Fair
Value of a Financial Asset When the Market for That Asset Is Not Active, except as
it applies to the nonfinancial assets and nonfinancial liabilities subject to FSP 157-2.
SFAS 157 clarifies that fair value is an exit price, representing the amount that would
be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants. As such, fair value is a market-based measurement that
should be determined based on assumptions that market participants would use in pricing
an asset or a liability. As a basis for considering such assumptions, SFAS 157
establishes a three-tier value hierarchy, which prioritizes the inputs used in the
valuation methodologies in measuring fair value:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Level
1  Observable inputs that reflect quoted prices (unadjusted) for identical assets
or liabilities in active markets.
| | --------------------------------------------------------------------------------------------------------------------------

| | Level
2  Include other inputs that are directly or indirectly observable in the
marketplace.
| | ---------------------------------------------------------------------------------------------

| | Level
3- Unobservable inputs which are supported by little or no market activity. The fair
value hierarchy also requires an entity to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair value
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 26

---

---

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

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

|AA. | Spin-off
of the Investment in Formula Vision
|--- | --------------------------------------------

| | In
December 2006, the company spun-off its investment in Formula Vision to its shareholders.
Formula Visions shares were distributed to the Companys shareholders at a
pro-rata basis. According to APB 29 the spin off was accounted as a decrease in the
Companys retained earnings and measured according to the book value of the
investment as of the spin-off date (see also note 2E).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|AB. | Discontinued
operations:
|--- | ------------------------

| | Under
SFAS 144, when a component of an entity, as defined in SFAS 144, has been disposed of or
is classified as held for sale, the results of its operations, including the gain or loss
on its disposal should be classified as discontinued operations and the assets and
liabilities of such component should be classified as assets and liabilities attributed
to discontinued operations. The operations, assets and liabilities of the component have
been reclassified to discontinued operation from the Companys consolidated
operations and the Company will no longer have any significant continuing involvement in
the operations of the component.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|AC. | Reclassifications:
|--- | ------------------

| | Certain
comparative figures have been reclassified to conform to the current year presentation.
| | -----------------------------------------------------------------------------------------------

|AD. | Recently
Issued Accounting Pronouncements:
|--- | ------------------------------------------

| | In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No. 157).
This statement provides a single definition of fair value, a framework for measuring fair
value, and expanded disclosures concerning fair value. Previously, different definitions
of fair value were contained in various accounting pronouncements creating
inconsistencies in measurement and disclosures. SFAS No. 157 applies under those
previously issued pronouncements that prescribe fair value as the relevant measure of
value, except SFAS No. 123(R) and related interpretations. The statements does not apply
to accounting standard that require or permit measurement similar to fair value but are
not intended to measure fair value. This pronouncement is effective for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal years. The
company adopted SFAS 157 as of 1.1.2008.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
February 12, 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of
FASB Statement No. 157 (the FSP). The FSP amends FASB Statement No. 157, Fair Value
Measurements (Statement 157), to delay the effective date of Statement 157 for
nonfinancial assets and nonfinancial liabilities, except for items that are recognized or
disclosed at fair value in the financial statements on a recurring basis (that is, at
least annually). For items within its scope, the FSP defers the effective date of
Statement 157 to fiscal years beginning after November 15, 2008, and interim periods
within those fiscal years.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---

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

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

|AC. | Recently
Issued Accounting Pronouncements:
|--- | ------------------------------------------

| | In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations (SFAS 141R). SFAS 141R establishes principles
and requirements for how an acquirer recognizes and measures in its financial statements
the identifiable assets acquired, the liabilities assumed, any non controlling interest
in the acquire and the goodwill acquired. SFAS 141R also establishes disclosure
requirements to enable the evaluation of the nature and financial effects of the business
combination. Change in deferred tax asset valuation allowances and acquired income tax
uncertainties in a business combination after the measurement period will impact income
tax expense. SFAS 141R is effective for fiscal years beginning after December 15,
2008. Earlier adoption is prohibited. The impact of SFAS 141R on the Companys
consolidated results of operations and financial condition will depend on the nature and
size of acquisitions, if any, subsequent to the effective date.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51". SFAS No. 160
establishes accounting and reporting standards that require that the ownership interests
in subsidiaries held by parties other than the parent be clearly identified, labeled, and
presented in the consolidated statement of financial position within equity, but separate
from the parents equity; the amount of consolidated net income attributable to the
parent and to the noncontrolling interest be clearly identified and presented on the face
of the consolidated statement of income; and changes in a parents ownership
interest while the parent retains its controlling financial interest in its subsidiary be
accounted for consistently. SFAS No. 160 is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008. The
Company does not expect the adoption of SFAS No. 160 will have significant impact on its
consolidated financial statement, except for reclassification of minority interest to
equity.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 28

---

---

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

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

|AC. | Recently
Issued Accounting Pronouncements (cont.):
|--- | --------------------------------------------------

| | In
March 2008, the FASB issued Statement 161 Disclosures about Derivative Instruments
and Hedging Activities (SFAS 161) an amendment to FASB No. 133.  This
statement changes the disclosure requirements for derivative instruments and hedging
activities.  Entities are required to provide enhanced disclosures about (a)
how and why and entity uses derivative instruments, (b) how derivative instruments and
related hedged items are accounted for under Statement 133 and its related
interpretations, and (c) how derivative instruments and related hedged items affect an
entitys financial position, financial performance, and cash flows.  This
statement is effective for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008.  Early application is encouraged.  The
Company does not expect the adoption of SFAS 161 to have a material impact on its
financial position, results of operations or cash flows.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 29

---

---

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

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

|AC. | Recently
Issued Accounting Pronouncements (cont.):
|--- | --------------------------------------------------

| | In
April 2008, the FASB issued FSP 142-3, Determination of the Useful Life of
Intangible Assets (FSP 142-3). FSP 142-3 amends the factors that should be
considered in developing renewal or extension assumptions used to determine the useful
life of a recognized intangible asset under SFAS No. 142, Goodwill and Other
Intangible Assets. FSP 142-3 is effective for fiscal years beginning after December
15, 2008. The Company does not expect the adoption of FSP 142-3 will have a material
impact on the Companys consolidated financial position, results of operations and
cash flows.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | EITF
Issue No. 08-6, Equity-Method Investment Accounting(EITF 08-6)
concludes that the cost basis of a new equity-method investment would be determined using
a cost-accumulation model, which would continue the practice of including transaction
costs in the cost of investment and would exclude the value of contingent consideration.
Equity-method investment should be subject to other-than-temporary impairment analysis.
It also requires that a gain or loss to be recognized on the portion of the investors
ownership sold. EITF 08-6 will be effective for the reporting period beginning after
December 15, 2008. The Company does not expect a material impact on its consolidated
financial statements from adoption of EITF 08-6.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles. SFAS 162 identifies the sources of accounting principles and
the framework for selecting the principles to be used in the preparation of financial
statements of nongovernmental entities that are presented in conformity with generally
accepted accounting principles in the United States. It is effective 60 days following
the SECs approval of the Public Company Accounting Oversight Board amendments to AU
Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted
Accounting Principles. The Company is currently evaluating the impact of SFAS No.
162 on its financial statements, and the adoption of this statement is not expected to
have a material effect on the Companys financial statements.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
May 2008, the FASB issued FSP Accounting Principles Board (APB) 14-1 Accounting
for Convertible Debt instruments That May Be Settled in Cash upon Conversion (Including
Partial Cash Settlement) (FSP APB 14-1). FSP APB 14-1 requires the
issuer of certain convertible debt instruments that may be settled in cash (or other
assets) on conversion to separately account for the liability (debt) and equity
(conversion option) components of the instrument in a manner that reflects the issuers
non-convertible debt borrowing rate. FSP APB 14-1 is effective for fiscal years beginning
after December 15, 2008 on a retroactive basis. The Company does not believe the adoption
of FSP APB 14-1 will have significant effect on its consolidated results of operations
and financial condition
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 30

---

---

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

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

|AC. | Recently
Issued Accounting Pronouncements (cont.):
|--- | --------------------------------------------------

| | In
June 2008, the FASB issued FSP EITF No. 03-6-1, Determining Whether
Instruments Granted in Share-Based Payment Transactions Are Participating Securities.
Under the FSP, unvested share-based payment awards that contain rights to receive
non-forfeitable dividends (whether paid or unpaid) are participating securities, and
should be included in the two-class method of computing EPS. The FSP is effective for
fiscal years beginning after December 15, 2008, and interim periods within those
years, and is not expected to have a significant impact on our consolidated financial
statement.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Note 2  Certain Transactions:

| | A. | In
June 2007 the company sold its entire holdings in BluePhoenix, for
          consideration of approximately $64 million. The company recognized
approximately           $18 million in capital gains upon completion of the sale of
ordinary shares.            This gain is presented in the income statement as income
from discontinued           operation.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | On
December 30, 2007, the Companys subsidiary, Magic, sold its           wholly-owned
subsidiary, Advanced Answers on Demand Holding Corporation, or           AAOD, a Florida
corporation that develops and markets application software           targeted at the
long-term care industry, to Fortissimo Capital for $17 million.           Fortissimo paid
Magic $1 million of the sale price in December 2007 and the           remaining $16
million in March 2008. As a result of this sale, the Company           recorded a net
gain of approximately $9.3 million; this gain is presented in the           income
statement as an income of discontinued operation.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, as part of the transaction, Magic entered into a three years license agreement
with AAOD according to which AAOD will continue to sell Magics products, as an OEM
partner, in consideration for $3 million, to be paid quarterly over three years starting
in 2008.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | On
August 19, 2007, the Companys subsidiary, Matrix, completed an offering
          of non-convertible debentures in an aggregate principal amount of approximately
          $ 62 million (NIS 250 million). The debentures were sold to institutional and
          other investors in Israel. The debentures bear an interest at an annual rate of
          5.15%. The principal will be paid in four equal annual installments on December
          31 of each of the years 2010 through 2013. The principal and interest are
linked           to the Israeli consumer price index. On February 21, 2008, Matrix listed
the           debentures for trading on the TASE.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 31

---

---

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

Note 2  Certain Transactions
(Cont.):

| | D. | In
June 2007, the Companys subsidiary, Sapiens, entered into a private
          placement investment transaction with several institutional investors, private
          investors and Formula for an aggregate gross investment amount of $20 million
          (excluding finders fees and out of pocket expenses), $6.5 million of
which           was by Formula.  Sapiens issued to the investors an aggregate of
6,666,667           common shares (of which 2,166,666 common shares were issued to
Formula), at a           price per share of $3.00 which reflected a premium of
approximately 25% above           the trading price of Sapiens common shares (as of
the date Sapiens          board of directors approved the investment).
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. | In
December 2006, the Company spun-off Formula Vision. Therefore, Formula Vision
          is no longer a subsidiary of the Company. The spin-off was affected by way of
          distributing the 36,696,000 Formula Vision shares owned by Formula (then
          representing approximately 57% of the outstanding Formula Vision shares) to
          Formulas shareholders on a pro-rata basis. The Formula Vision shares were
          distributed at a ratio of 2.78 Formula Vision shares for each outstanding
          Ordinary Share held at the close of the trade on December 14, 2006, the record
          date, subject to withholding taxes.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. | In 2008 Matrix purchased all the shares of TACT Computers and Systems Ltd. for
          an aggregate consideration of $12.5 million. The acquisition was done as part of
          Matrix policys to increase its market share. The sellers are entitled to
          an additional consideration to be calculated as per the difference between the
          calculations of TACTs value in 2008 as per the formula agreed upon (based
          on the agreed upon multiplication of the operating profit), subject to the
          execution of agreed upon adjustments and calculations, to the consideration paid
          on the date of completion. At this time a commitment has been incurred for an
          additional contingent consideration of approximately $6.5 million. All
          additional consideration will be allocated as goodwill. TACT is consolidated
          starting June 30,2008.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 32

---

---

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

Note 2  Certain Transactions
(Cont.):

| | a. | The
following table summarizes the fair values of assets acquired and
               liabilities assumed as of the date of purchase:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------

| |                                               | (in thousands)
| | --------------------------------------------- | --------------
|
|
|
|
| | Current assets                                |               
| | Property and equipment                        |               
| | Goodwill                                      |               
| | Customer related intangible asset             |               
| |                                               |               
| |                                               |               
| | Total tangible and intangible assets acquired |               
| |                                               |               
| | Current liabilities                           |               
| |                                               |               
| | Other long-term liabilities                   |               
| |                                               |               
| | Total liabilities assumed                     |               
| |                                               |               
| | Net assets acquired                           |               
| |                                               |               
| |                                               |               
| | Cash paid                                     |               
| |                                               |               

| | b. | The
following unaudited pro forma summary presents information as if the
               acquisition of TACT Computers and Systems Ltd. Had occurred as of January
1,                2008 and as of January 1,2007.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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, not is it necessarily indicative of future results of operations of the
consolidated entity.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 33

---

---

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

# Note 2  Certain
Transactions (Cont.):

|b. | (Cont.):
|-- | --------

| |                                  | Year ended December 31.
| | -------------------------------- | -----------------------
|
|
|
|
| | Revenues                         |                        
| | Income from continuing operation |                        
| | Earning per share - basic        |                        
| | Earning per share - diluted      |                        
| |                                  |                        

# Note 3  Short-term
Investments:

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

| |                               | Interest rate |  | 
| | ----------------------------- | ------------- |  | 
|
|
|
|
| | Trading securities            |               |  | 
| | Available-for-sale securities |               |  | 
| | Short-term deposits           |               |  | 
| |                               |               |  | 
| | Total                         |               |  | 
| |                               |               |  | 
| |                               |               |  | 

F - 34

---

---

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

# Note 3  Short-term Investments
(Cont.):

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

|                                               | December 31,
|---------------------------------------------- | ------------
|
|
|
|
|
|Available-for-sale:                            |             
|Government debentures                          |             
|Marketable securities                          |             
|Commercial debentures                          |             
|Equity funds                                   |             
|                                               |             
|Total available-for-sale marketable securities |             
|                                               |             
|                                               |             

| | In
2008 and 2007, the Company recorded proceeds from sales of marketable securities on the
amount of $1,809 thousand and $721 thousand respectively and related gains of $80
thousand and $17 thousand in financial income, net respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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, 2008. In addition, these securities have been in a continuous
unrealized losses position for a period not more than 12 months.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
2008 and 2007, the Company recorded impairment charges in the amount of $ 130 thousand
and $1.7 million respectively.
| | ------------------------------------------------------------------------------------------------------------------------

| | The
estimated fair value of available-for-sale investments as of December 31, 2008 and as of
December 31, 2007 by contractual maturity, are as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                     | December 31,
| | ----------------------------------- | ------------
|
|
|
|
| | Available-for-sale debt securities: |             
| | Matures in one year                 |             
| | Matures in one to five years        |             
| | Matures in more than five years     |             
| |                                     |             
| |                                     |             
| |                                     |             
| |                                     |             

F - 35

---

---

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

# NOTE 4:- FAIR VALUE
MEASURMENTS

| | Effective
January 1, 2007, we adopted SFAS 157 and effective October 10, 2008, we adopted
FSP No. SFAS 157-3, Determining the Fair Value of a Financial Asset When the Market
forThat Asset Is Not Active, except as it applies to the nonfinancial assets
and nonfinancial liabilities subject to FSP 157-2. SFAS 157 clarifies that fair value is
an exit price, representing the amount that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants. As such, fair
value is a market-based measurement that should be determined based on assumptions that
market participants would use in pricing an asset or a liability. As a basis for
considering such assumptions, SFAS 157 establishes a three-tier value hierarchy, which
prioritizes the inputs used in the valuation methodologies in measuring fair value:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Level 1 -
Observable inputs that reflect quoted prices (unadjusted) for identical assets or
liabilities in active markets.
| | --------------------------------------------------------------------------------------------------------------------------

| | Level 2 -
Includes other inputs that are directly or indirectly observable in the marketplace.
| | ----------------------------------------------------------------------------------------------

| | Level 3 -
Unobservable inputs which are supported by little or no market activity.
| | ----------------------------------------------------------------------------------

| | In
accordance with SFAS 157, the Company measures its cash equivalents, short-term deposits,
and marketable securities at fair value. Cash equivalents, short-term deposits and
marketable securities, are classified within Level. This is because these assets are
valued using quoted market prices
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys financial assets measured at fair value on a recurring basis, excluding
accrued interest components; consisted of the following types of instruments as of
December 31, 2008:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                       | Fair value measurements using input type
| | ------------------------------------- | ----------------------------------------
|
|
|
|
| | Cash equivalents                      |                                         
| | Short-term deposits                   |                                         
| | Marketable securities:                |                                         
| | Trustee funds                         |                                         
| | Shares                                |                                         
| | Government and corporate debentures - |                                         
| | Derivative                            |                                         
| | Equity Fund                           |                                         
| |                                       |                                         
| | Total Financials Assets               |                                         
| |                                       |                                         
| | Embedded derivatives                  |                                         
| |                                       |                                         
| | Total Financials Liabilities          |                                         
| |                                       |                                         

F - 36

---

---

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

# Note 5  Loans and
Other Investments:

# Comprise:

| |                            |  |  | December 31,
| | -------------------------- |  |  | ------------
|
|
|
|
| | Cost of shares (1)         |  |  |             
| |                            |  |  |             
| | Long-term prepaid expenses |  |  |             
| |                            |  |  |             
| |                            |  | 
| | Restricted deposit         |  |  |             
| | Restricted deposit         |  |  |             
| | Deposit                    |  |  |             
| | Deposit                    |  |  |             
| | Deposit                    |  |  |             
| |                            |  |  |             
| |                            |  |  |             
| |                            |  |  |             
| | Total                      |  |  |             
| |                            |  |  |             

|(1) | In
2008 impairment losses on cost investments have been identified in the amount
               of $502 thousand. In 2007 impairment losses on cost investments have been
               identified in the amount of $512 thousand.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 6 
Investments in Affiliates:

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

| |                                                                 | December 31,
| | --------------------------------------------------------------- | ------------
|
|
|
|
| | Investment in shares:                                           |             
| | Cost                                                            |             
| | Goodwill and allocated original excess cost *                   |             
| |                                                                 |             
| | Net asset value as of acquisition date                          |             
| | Equity in post-acquisition undistributed retained earnings, net |             
| |                                                                 |             
| | Net asset value as of the balance sheet date                    |             
| | Balance of goodwill                                             |             
| |                                                                 |             
| | Total                                                           |             
| |                                                                 |             

| | * | Beginning
on 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 1J).
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 37

---

---

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

# Note 6 
Investments in Affiliates (cont.):

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

| |                   | December 31,
| | ----------------- | ------------
|
|
|
|
| | Total assets      |             
| |                   |             
| | Total liabilities |             
| |                   |             
| | Net (loss) income |             
| |                   |             

# Note 7  Property
and Equipment, net:

# Comprise:

|                          | December 31,
|------------------------- | ------------
|
|
|
|
|Cost:                     |             
|Computers and equipment   |             
|Motor vehicles            |             
|Buildings                 |             
|Leasehold improvements    |             
|                          |             
|                          |             
|                          |             
|Accumulated Depreciation: |             
|Computers and equipment   |             
|Motor vehicles            |             
|Buildings                 |             
|Leasehold improvements    |             
|                          |             
|                          |             
|                          |             
|Depreciated balance       |             
|                          |             

Depreciation expenses totaled $4.7
million, $4.3 million and $4.7 million for the years ended December 31, 2008, 2007 and
2006, respectively.

See Note 14B with respect to pledges.

F - 38

---

---

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

# Note 8  Goodwill:

The changes in the carrying amount of
goodwill for the year ended December 31, 2007 and 2006 are as follows:

|                                                    | U.S. $ in
thousands
|--------------------------------------------------- | -------------------
|
|
|
|
|Balance as of January 1,2007                        |                    
|Acquisition of additional interest in subsidiaries  |                    
|Realization and decrease in shareholding percentage |                    
|Acquisition of newly-consolidated subsidiaries      |                    
|Foreign currency translation adjustments            |                    
|                                                    |                    
|Balance as of December 31, 2007                     |                    
|Acquisition of additional interest in subsidiaries  |                    
|Realization and decrease in shareholding percentage |                    
|Acquisition of newly-consolidated subsidiaries      |                    
|Foreign currency translation adjustments            |                    
|                                                    |                    
|Balance as of December 31, 2008                     |                    
|                                                    |                    

Note 9 - Other Assets, Net:

Comprised as follows:

|   |                                        | December 31,
|-- | -------------------------------------- | ------------
|
|
|
|
|A. | Original amounts:                      |             
|   | Capitalized software development costs |             
|   | Deferred expenses and others           |             
|   | Deferred tax asset                     |             
|   |                                        |             
|   |                                        |             
|   |                                        |             
|   | Accumulated amortization:              |             
|   | Capitalized software development costs |             
|   | Deferred expenses and others           |             
|   |                                        |             
|   |                                        |             
|   |                                        |             
|   | Total                                  |             
|   |                                        |             

|B. | Amortized
expenses totaled $ 8.3 million, $7.7 million and $9.9 million for the
               years ended December 31, 2008, 2007 and 2006, respectively.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
for impairments of software development cost, see Note 1K.
| | -------------------------------------------------------------

F - 39

---

---

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

# Note 9  Other
Assets, Net (Cont.):

|C. | Estimated
deferred expenses and other intangible assets amortization for the           years ended:
|-- | ---------------------------------------------------------------------------------------------------

| | December 31,        | (U.S. $ in
thousands)
| | ------------------- | ---------------------
|
|
|
|
| | 2009                |                      
| | 2010                |                      
| | 2011                |                      
| | 2012                |                      
| | 2013                |                      
| | 2014 and thereafter |                      
| |                     |                      
| | Total               |                      
| |                     |                      

# Note 10  Liability in
respect of the acquisition of activity

In 2008 Matrix purchased all the
shares of TACT Computers and Systems Ltd. for an aggregate consideration of $12.5 million.
The sellers are entitled to an additional consideration to be calculated as per the
difference between the calculations of TACTs value in 2008 as per the formula agreed
upon (based on the agreed upon multiplication of the operating profit), subject to the
execution of agreed upon adjustments and calculations, to the consideration paid on the
date of completion. At this time a commitment has been incurred for an additional
Contingent consideration of approximately $6.5 million.

F - 40

---

---

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

Note 11  Liabilities to Banks
and Others:

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

|      | December 31,
2008 | Linkage basis | Long-term
liabilities | Current
maturities | Total long-term
liabilities net of
current maturities | Total long-term
liabilities net of
current maturities
|----- | ----------------- | ------------- | --------------------- | ------------------ | ----------------------------------------------------- | -----------------------------------------------------
|
|
|
|
|      |                   |               |                       | 6.1-6.6            |                                                       |                                                      
|      |                   |               |                       | 5.5-6.5            |                                                       |                                                      
|      |                   |               |                       | 2.2-5.7            |                                                       |                                                      
|      |                   |               |                       | -                  |                                                       |                                                      
|      |                   |               |                       | -                  |                                                       |                                                      
|      |                   |               |                       | -                  |                                                       |                                                      
|      |                   |               |                       |                    |                                                       |                                                      
|Total |                   |               |                       |                    |                                                       |                                                      
|      |                   |               |                       |                    |                                                       |                                                      

|* | One
of our subsidiary has two contracts, one lasts until the year of 2010 and the other until
the year of 2013. Even though it is a hedging of the cash flow, the subsidiary does not
apply hedge accounting. The agreements:
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In December 2008 the subsidiary
entered into a swap deal with Bank Leumi for NIS 200,000 thousand (approximately
$52,604 thousand). According to the agreement which lasts until December 2010, the
subsidiary has committed to exchange CPI for a basic rate of 1.712% for the whole period.
As of December 31, 2008, the fair value of the derivative is a $260 thousand
liability.

In December 2007 the subsidiary
entered into a swap agreement with Deutche Bank AG. London (Deutche Bank) for
NIS 50,000 thousand (approximately $13,151 thousand) (The principal of the swap
agreement). According to the agreement which lasts until December 31, 2013,
Deutche Bank has committed to pay the subsidiary payments which resemble by amount, rate
and time to the subsidiarys liability to pay principal and interest according to the
bonds terms after listing, for $13,151.

The subsidiary has committed to pay
Deutche Bank the principal of the swap agreement plus indexation of 2% per year, and
interest on the rest of the principal of the swap agreement, for the majority of the swap
agreement period, at a rate derived from a unique index used by Deutche Bank (which is an
index calculated according to the markets expectations of the short-term interest).

As of December 31, 2008, the
fair value of the derivative was $266 thousand.

During March 2009, both parties has
agreed to terminate the agreement with no additional costs to any of the parties.

F - 41

---

---

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

# Note 11 
Liabilities to Banks and Others (cont.):

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

|                                | December 31,
|------------------------------- | ------------
|
|
|
|
|First year (current maturities) |             
|Second year                     |             
|Third year                      |             
|Fourth year                     |             
|Fifth year                      |             
|                                |             
|Total                           |             
|                                |             

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

F - 42

---

---

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

# Note 12 
Debentures:

# Comprised as follows:

|                                        |  |  | December 31,
|--------------------------------------- |  |  | ------------
|
|
|
|
|Debentures                              |  |  |             
|                                        |  |  |             
|Convertible debenture:                  |  | 
|Par value                               |  |  |             
|Embedded derivatives, net *)            |  |  |             
|Deemed discount, net *)                 |  |  |             
|                                        |  |  |             
|                                        |  |  |             
|                                        |  |  |             
|Less - debentures purchased by one      |  | 
|of the Company's subsidiaries           |  |  |             
|Less - current maturities of debentures |  |  |             
|                                        |  |  |             
|                                        |  |  |             
|                                        |  |  |             

|*) | Amortization
of the deemed discount and the changes in the fair value of                embedded
derivatives charged to expenses were $308 thousand and $911 thousand                for
2008 and 2007, respectively.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys subsidiary Sapiens convertible debentures, warrants and options are
traded only in the TASE. Any Common shares issued upon conversion of the Debentures
(Series A) or exercise of the Warrants (Series 1) will be traded on both TASE and NASDAQ.
The offering was made to the public in Israel only in accordance with Israeli securities
laws. It was not open to persons residing in the United States or to other U.S. persons
(other than distributors). The securities offered have not been registered under the
Securities Act of 1933, as amended, and may not be offered or sold in the United States
absent registration under such Act or an applicable exemption from registration. 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 (EITF 00-19), Sapiens has classified all the above derivative
financial instruments issued in connection with issuance of the convertible debentures,
Warrants and Options as liabilities.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 43

---

---

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

# Note 12 
Debentures (cont.):

The conversion features and the floor
rate to the dollar payments were evaluated under FAS 133, Accounting for Derivative
Instruments and Hedging Activities (FAS 133), and EITF 00-19, and were
determined under EITF 00-19 to have characteristics of liabilities and therefore
derivative liabilities under FAS 133. Each reporting period these derivatives liabilities
are marked to market with the non cash gain or loss recorded in the period. At December
31, 2008 and 2007,, the aggregate derivatives liabilities were $900 and $1,143
respectively . The valuation of the embedded derivatives is determined by the Black and
Scholes model and the Lattice model.

Amounts allocated to the Options
(Series A) and the Warrants (Series 1) are accounted for as liabilities, in accordance
with EITF 00-19, and are marked to market, based on their fair values in the TASE at each
reporting date, against financial income (expense).

In August 2006 Sapiens modified the
terms of the first payment of the Debentures (Series A) that was due in December, 2006 as
follows: (a) 50% of the first payment amount, approximately $2.4 million, will be deferred
to December 5, 2009 (the last day of payment of the principal on the debentures), and (b)
with respect to other 50% of the first payment amount, Sapiens can choose from the
following alternatives, in its sole discretion: (1) to convert such amount on December 5,
2006 into Sapienss Common shares, at a conversion price per share of $1.28, which
reflects the average closing price for the 10 day period prior to July 17, 2006, or (2) to
pay the approximately $2.4 million amount to the debenture holders.

On December 5, 2006, an amount of
approximately $2.4 million was paid to the debenture holders.

The modification of the terms of the
first payment of the Debentures (Series A) was accounted for in accordance with FAS 15
Accounting by Debtors and Creditors for Troubled Debt Restructurings.
Accordingly, Sapiens calculated the new effective borrowing rate of the debt, which
affected the amortization rate of the unamortized discount and unamortized issuance
expenses as of the date of the restructuring.

In June 2007, Sapiens re-purchased an
aggregate amount of NIS 15 millions nominal value, representing approximately $3.5 million
of the outstanding debentures that were retired and removed from circulation on the TASE.

On December 5, 2007, an amount of
approximately $4.4 million was paid to the debenture holders, representing the second
payment of the Debentures (Series A).

In January and February 2008, Sapiens re-purchased an aggregate amount of NIS 7,600 nominal value, representing $2,090
of the outstanding debentures (series A) that were retired and removed from circulation on
the TASE. Sapiens recorded 300$ thousand as loss from repurchase of debentures.

F - 44

---

---

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

# Note 12 
Debentures (cont.):

On December 5, 2008, an amount of
$3,500 was paid to the debenture holders, representing the third payment of the principal
of the debentures (series A).

Subsequent to balance sheet date in
January 2009, Sapiens re-purchased an aggregate amount of NIS 1,600 nominal value
representing $ 400 thousands of the outstanding debentures (series A) that were retrieved and
removed from circulation on TASE.

On November 2008, The Companys
subsidiary Matrix re-purchased part of its debentures in an aggregate amount of
$12.6 million. Matrix recorded $500 thousand as gain from repurchase of debentures.

# Note 13  Employee
Option Plans in Subsidiaries:

|A. | Certain public subsidiaries granted options to their employees to purchase
               shares in the respective companies.
|-- | -----------------------------------------------------------------------------------------------------------------------------

| | The options were mainly granted during the years 1999-2008. In general, the options are
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 benefit mentioned above. For further
information with respect to expenses relating to the benefit to the employees, and
additional disclosure required by FAS 123R, see Note 1.X.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 45

---

---

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

# Note 13  Employee
Option Plans in Subsidiaries (cont.):

|B. | The
following table is a summary of the status of option plans in Magic as of
               December 31, 2008, 2007 and 2006:
|-- | ------------------------------------------------------------------------------------------------------------------------------

|                       | Year endedDecember 31, 2008 | Year endedDecember 31, 2007 | Year endedDecember 31, 2006
|---------------------- | --------------------------- | --------------------------- | ---------------------------
|
|
|
|
|Options outstanding at |                             |                             |                            
|the beginning of the   |                             |                            
|year                   |                             |                             |                            
|Granted                |                             |                             |                            
|Exercised              |                             |                             |                            
|Forfeited              |                             |                             |                            
|                       |                             |                             |                            
|Outstanding at the     |                             |                            
|end of the year        |                             |                             |                            
|                       |                             |                             |                            
|                       |                             |                            
|Vested and expected to |                             |                            
|vest at the end of the |                             |                            
|year                   |                             |                             |                            
|                       |                             |                             |                            
|Exercisable at the     |                             |                            
|end of the year        |                             |                             |                            
|                       |                             |                             |                            
|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 binomial
model for the years 2007-2008 and the Black-Scholes Option Valuation Model for the year
2006 (see note 1.X.) with the following weighted-average assumptions for each of the
three years in the period ended December 31, 2008, 2007 and 2006: expected volatility of
56-65%, 51-73%, and 64%, respectively; risk-free interest rates of 1.83%, 3.46%-5.05% and
4.7% respectively; dividend yields of 0% for each year, and a weighted average expected
life of the option of 2.48-3 years, 2.48-3 years and 5 years, respectively.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The weighted-average grant-date fair
value of options granted during the twelve months period ended December 31, 2006, 2007 and
2008 were $ 0.98, $ 1.31 and $ 0.68, respectively. The aggregate intrinsic value
in the table above represents the total intrinsic value that would have been received by
the option holders had all option holders exercised their options on December 31,
2008. This amount is changed based on the fair market value of the Companys shares.
Total intrinsic value of options exercised for the twelve months ended December 31, 2006,
2007 and 2008 were $ 161, $ 168 and $ 383 thousands respectively. As of
December 31, 2008, there was $ 218 thousands of total unrecognized compensation cost
related to non-vested share-based compensation arrangements granted under the
Companys stock option plans. This cost is expected to be recognized over a period of
approximately 3 years.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 46

---

---

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

# Note 13  Employee
Option Plans in Subsidiaries (cont.):

|C. | The
following is a summary of the status of option plans in Matrix as of
               December 31, 2008, 2007 and 2006 and changes during the years then ended:
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|                       | Year endedDecember 31, 2008 | Year endedDecember 31, 2007 | Year endedDecember 31, 2006
|---------------------- | --------------------------- | --------------------------- | ---------------------------
|
|
|
|
|Options outstanding at |                             |                             |                            
|the beginning of the   |                             |                            
|year                   |                             |                             |                            
|Granted                |                             |                             |                            
|Exercised              |                             |                             |                            
|Forfeited              |                             |                             |                            
|                       |                             |                             |                            
|Outstanding at the     |                             |                            
|end of the year        |                             |                             |                            
|                       |                             |                             |                            
|Vested and expected    |                             |                            
|to vest at the end of  |                             |                            
|the year               |                             |                             |                            
|                       |                             |                             |                            
|Exercisable at the     |                             |                            
|end of the year        |                             |                             |                            
|                       |                             |                             |                            
|Weighted average fair  |                             |                            
|value of  options      |                             |                            
|granted  during        |                             |                            
|the year *             |                             |                             |                            
|                       |                             |                             |                            

| | * | The
fair value of options granted is estimated on the date of grant using the Black-Scholes
option-pricing model, with the following weighted average assumptions used for grants:
expected volatility: 2008 -24%-31%; 2007- 24%-25%; risk-free interest rate (in NIS terms)
of 2008  4.3%-5.3%; 2007  5.3%-5.5% and expected life: 3-3.5 years. The
aggregate intrinsic value of the vested and expected to vest options for December 31,
2008, 2007 and 2006 were $ 27, $ 3,045 and $ 3,562 thousands, respectively. Total
intrinsic value of options exercised for the twelve months ended December 31, 2008, 2007
and 2006 were $ 477, $ 2,508 and $ 2,275 thousands, respectively.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 47

---

---

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

# Note 13  Employee
Option Plans in Subsidiaries (cont.):

|D. | The
following is a summary of the status of options plans in Sapiens as of           December
31, 2008, 2007 and 2006 and changes during the years then ended:
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         | Year endedDecember 31, 2008 | Year endedDecember 31, 2007 | Year endedDecember 31, 2006
|------------------------ | --------------------------- | --------------------------- | ---------------------------
|
|
|
|
|
|Options outstanding at   |                             |                             |                            
|the beginning of         |                             |                            
|the year                 |                             |                             |                            
|Changes during the year: |                             |                            
|Granted                  |                             |                             |                            
|Exercised                |                             |                             |                            
|Forfeited                |                             |                             |                            
|                         |                             |                             |                            
|Options                  |                             |                            
|outstanding at           |                             |                            
|the end of the           |                             |                            
|year                     |                             |                             |                            
|                         |                             |                             |                            
|Vested and expected to   |                             |                            
|vest at the end of the   |                             |                            
|year                     |                             |                             |                            
|                         |                             |                             |                            
|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 assumption:
Dividend yield of 0% for all years; expected volatility: 2008  78%, 2007  89%,
2006  67%, risk-free interest rate 2008  2.95%, 2007  4.2%, 2006  6%
and expected life: 2008  4.25 years, 2007  6.25 year and 2006  6.25
years. The aggregate intrinsic value is the difference between the Companys closing
stock price on the last trading day of the fiscal year 2008 and the exercise price,
multiplied by the number of in-the-money options that would have been received by the
option holders had all option holders exercised their options on December 31, 2008.
This aggregate intrinsic value changes based on the fair market value of the Companys
shares.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The total intrinsic value of options
exercised during the years ended December 31, 2006, 2007 and 2008 was $0, $17,666 and
$96,500, respectively. Compensation expense recognized amounted to $32, $115 and $165
thousands for the years ended December 31, 2006, 2007 and 2008, respectively. As of
December 31, 2008, there was $505 thousands of total unrecognized compensation cost
related to non-vested options granted under the Plan and the Special Plan, which is
expected to be recognized over a period of up to four years.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 48

---

---

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

# Note 14 
Commitments and Contingencies:

|A. | Commitments:
|-- | ------------

| | Some
of the Companys subsidiaries have commitments to the Chief Scientist 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
$6.4 million as of December 31, 2008.
| | -----------------------------------------------------------------------------------------------------------------------------------

|B. | Liens:
|-- | ------

| | 1. | Some
of the subsidiaries have liens on leased vehicles, leased equipment and
               other assets in favor of the leasing companies.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Some
of the subsidiaries have given floating charges in favor of banks and other
               financial institutions.
| | -- | -----------------------------------------------------------------------------------------------------------------------

|C. | Guarantees:
|-- | -----------

| | 1. | Subsidiaries
have provided bank guarantees in the amount of approximately $13.6                million
as security for the performance of various contracts with customers. If
               the subsidiaries were to breach certain terms of such contracts, the
customers                could demand that the banks providing the guarantees pay amounts
claimed to be                due.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Subsidiaries
have provided bank guarantees in the amount of $2.2 million as                security
for rent to be paid for their offices. If the subsidiaries were to                breach
certain terms of their lease, the leaser could demand that the banks
               providing the guarantees pay amounts claimed to be due.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|D. | Others:
|-- | -------

| | In
connection with credit facilities of subsidiaries, these subsidiaries have entered into
agreements with various banks. Accordingly, the subsidiaries committed, among other
things:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | To
maintain certain financial ratios.
| | -- | -------------------------------------

| | b. | Not
to grant a security interest in all or substantially all of their respective
          assets.
| | -- | --------------------------------------------------------------------------------------------------

F - 49

---

---

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

# Note 14 
Commitments and Contingencies (cont.):

|E. | Legal
Proceedings:
|-- | ------------------

| | Lawsuits
have been submitted against certain subsidiaries in the ordinary course of business. The
subsidiaries followed SFAS No. 5, and recorded provision where it was appropriate.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|F. | Lease
Commitments:
|-- | ------------------

| | The
following are details of the future minimum lease commitments of office equipment, office
space and motor vehicles under non-cancelable operating leases as of December 31, 2008:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                     | U.S. $ in
thousands
| | ------------------- | -------------------
|
|
|
|
| | 2009                |                    
| | 2010                |                    
| | 2011                |                    
| | 2012                |                    
| | 2013 and thereafter |                    
| |                     |                    
| |                     |                    
| |                     |                    

| | Rent
expenses for the years ended December 31, 2008, 2007 and 2006, were approximately $16
million, $24 million and $20 million, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------

| | Most
of the building leases will expire by 2013.
| | ------------------------------------------------

F - 50

---

---

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

# Note 15  Shareholders Equity:

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

|                             | December 31, 2008 | December 31, 2007
|---------------------------- | ----------------- | -----------------
|
|
|
|
|Ordinary  shares,  NIS 1 par |                   |                  
|value each                   |                   |                  
|                             |                   |                  

| | 1. | Formulas
shares are traded in the TASE and through ADSs, each representing                one
ordinary share of NIS 1 par value, quoted on the NASDAQ Global Market
               in the United States.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
2002, Formula repurchased 324,780 of its ordinary shares in the open market           for
an aggregate of $3.4 million. In 2003, Formula sold 300,000 of its ordinary
          shares for an aggregate of $4.8 million.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3 | In
April 2008, the Company distributed a cash dividend of approximately $0.76 per share to
its shareholders. The aggregate amount distributed by the company was approximately $10
million.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | In
March 2008, the Companys shareholders approved the adoption of
               Formulas 2008 Employee and Office Holders Share Option Plan,
referred to                as the plan. Pursuant to the plan, the company may
grant from time                to time to the company and its subsidiaries employees
and office holders                (which are not Formulas controlling shareholders)
options to purchase up                to 400,000 ordinary shares of Formula. The plan is
administered by the                Companys board of directors or by an option
committee to be appointed by                the board. The plan provides that options may
be granted, from time to time, to                such grantees to be determined by the
board or the option committee, at an                exercise price and under such terms
to be determined at their sole and absolute                discretion. Options may be
granted under the plan through January 2018.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
his former service agreement, Mr. Bernstein was granted, for his services as a director,
options to purchase 198,000 ordinary shares, each exercisable at an exercise price of NIS
60 per share (not linked to the CPI) (approximately $16.35). In June 2008, Mr. Bernstein
waived his right to receive such options
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | In
December 2008, the company announced that the board of directors approved
               distribution of a cash dividend payable on January 29, 2009 with respect
to each                outstanding Formula ordinary share held as of the close of
business day on                January 12, 2009. The cash distribution was on the amount
of $2.27 per share or                approximately $30 million in the aggregate.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 51

---

---



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

# 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 the status of an Approved
Enterprise which was granted under the Law before April 1, 2005. According to the
provisions of the Law, the subsidiaries have elected the alternative benefitsprogram
and as such are entitled to tax exemption of two to four years and to a reduced tax rate
of 10%-25% ( depending on the level of foreign investment in Technologies). The benefits
commence with the date on which taxable income is first earned. The period of tax
benefits detailed above is subject to a limit of the earlier of 12 years from the
commencement of production or 14 years from receiving the approval.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
entitlement to the above benefits is conditional upon the Company fulfilling the
conditions stipulated by the above Law, regulations published thereafter and the
certificates of approval for the specific investments in an Approved Enterprise.
In the event of failure to comply with these conditions, the benefits may be canceled and
the subsidiary may be required to refund the amount of the benefits, in whole or in part,
including interest.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
tax-exempt income attributable to an Approved Enterprise can be distributed
to shareholders without subjecting the Company to taxes only upon the complete
liquidation of the Company. If this net retained tax-exempt income is distributed the
company, would be taxed at the corporate tax rate applicable to such profits as if the
Company had not elected the alternative tax benefits (currently 25% of the gross
dividend).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
subsidiary does not anticipate paying dividends in the foreseeable future. Accordingly,
no deferred tax liabilities have been provided on income attributable to the Companys
Approved Enterprises.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 52

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO THE 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.):
| | -- | ------------------------------------------------------------------------------------------------------------------------------------

| | Income
from sources other than the Approved Enterprise during the period of benefits
will be taxable at regular corporate tax rates. On April 1, 2005, an amendment to the
Investment Law came into effect (the Amendment) and has significantly changed
the provisions of the Investment Law. The Amendment limits the scope of enterprises which
may be beneficial by the Investment Center by setting criteria for the approval of a
facility as an Approved Enterprise, such as provisions generally requiring that at least
25% of the beneficial Enterprises income will be derived from export. Additionally,
the Amendment enacted major changes in the manner in which tax benefits are awarded under
the Investment Law so that companies no longer require Investment Center approval in
order to qualify for tax benefits
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 qualify as an Industrial Company as defined by this
law, and as such are 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | Tax
Rates Applicable to Income in Israel:
| | -- | -----------------------------------------

| | Taxable
income of Israeli companies is subject to tax at the rate of 31% in 2006, 29% in 2007,
27% in 2008, 26% in 2009 and 25% in 2010 and thereafter.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

F - 53

---

---



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

# Note 16  Taxes on
Income (Cont.):

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

| | 5. | Changes
in the tax laws applicable to the Company:
| | -- | --------------------------------------------------

| | In
February 2008, the Knesset (Israeli parliament) passed an amendment to the
Income Tax (Inflationary Adjustments) Law, 1985, which limits the scope of the law
starting 2008 and thereafter. Starting 2008, the results for tax purposes will be
measured in nominal values, excluding certain adjustments for changes in the Consumer
Price Index carried out in the period up to December 31, 2007. The amended law includes,
inter alia, the elimination of the inflationary additions and deductions and the
additional deduction for depreciation starting 2008.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 and its subsidiaries have cumulative losses for tax purposes as of December 31,
2008 totaling approximately $216.2 million, of which $173.7 million is in respect of
Companies in Israel (December 31, 2007  $193.3 million), and approximately $42.5
million in respect of companies abroad (December 31, 2007  $28.7 million). The
likelihood of the utilization of most of these losses in the future is low inter alia,
due to the fact that the companys capital losses can be deductible only against
capital gains which are not predictable by their nature. Based on its experience, the
company can not support a more likely than not utilization of its capital accumulated
losses. Therefore, the Company recorded a valuation allowance against the deferred taxes
attributed to these losses carried forward.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|D. | Income
Tax Assessments:
|-- | -----------------------

| | In
2007, Formula paid approximately $250 thousand, as taxes for the years 2001-2004, after
reaching an agreement with the Israeli tax authorities for those years.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 54

---

---



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

# Note 16  Taxes on
Income (cont.):

|E. | Deferred
Taxes:
|-- | ---------------

| | 1. | Composition:
| | -- | ------------

| |                                         | December 31,
| | --------------------------------------- | ------------
|
|
|
|
| | Net operating losses carried forward    |             
| | Software development costs              |             
| | Allowances and reserves                 |             
| | Adjustments to cash basis in subsidiary |             
| |                                         |             
| |                                         |             
| | Valuation allowance                     |             
| |                                         |             
| | Total                                   |             
| |                                         |             

| | Most
of the valuation allowances for which the Company and its subsidiaries were provided, are
against the deferred tax assets in respect of tax losses carry forward. As a result, most
of the valuation allowance is long-term.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |                                    | December 31,
| | ---------------------------------- | ------------
|
|
|
|
| | Stated in current assets           |             
| | Stated in other assets             |             
| | Stated in long term liabilities    |             
| |                                    |             
| | Total (included in balance sheets) |             
| |                                    |             

|F. | Income
before Taxes on Income:
|-- | ------------------------------

| |          | Year ended December 31,
| | -------- | -----------------------
|
|
|
|
| | Domestic |                        
| | Foreign  |                        
| |          |                        
| | Total    |                        
| |          |                        

F - 55

---

---



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

# Note 16  Taxes on
Income (cont.):

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

| |                                           | Year ended December 31,
| | ----------------------------------------- | -----------------------
|
|
|
|
| | Current taxes:                            |                        
| | In Israel                                 |                        
| | Abroad                                    |                        
| |                                           |                        
| |                                           |                        
| |                                           |                        
| | Taxes in Israel in respect of prior years |                        
| | Deferred taxes,  net                      |                        
| |                                           |                        
| | Total                                     |                        
| |                                           |                        

|H. | Theoretical
Tax:
|-- | ----------------

| | The
following is 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,
| | ----------------------------------------------------- | -----------------------
|
|
|
|
| | Income before taxes on income, as per the statement   |                        
| | of continuing  operations                             |                        
| | Statutory tax rate in Israel                          |                        
| |                                                       |                        
| | Theoretical tax expense                               |                        
| | Additional tax (tax savings) in respect of:           |                        
| | Non-deductible expenses                               |                        
| | Tax-exempt income ,change in tax rate and reduced tax |                        
| | rates in companies which have approved enterprises    |                        
| | Losses (utilization of losses) and temporary          |                        
| | differences for which deferred taxes were not         |                        
| | recorded, net                                         |                        
| | Write off of deferred taxes and tax advances          |                        
| | Taxes in respect of previous years                    |                        
| | Effect of the Inflationary Adjustments Law            |                        
| | Other                                                 |                        
| |                                                       |                        
| | Taxes on income as per                                |                        
| | the statement of operations                           |                        
| |                                                       |                        
| | Effective tax rate - in %                             |                        
| |                                                       |                        

F - 56

---

---



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

# Note 16  Taxes on
Income (cont.):

|I. | Uncertain
tax positions:
|-- | ------------------------

| | The
Company and its subsidiaries adopted the provisions of FASB Interpretation No. 48, Accounting
for Uncertainty in Income Taxes (FIN 48) on January 1, 2007. This Interpretation
clarifies the accounting for uncertainty in income taxes recognized in an enterprises
financial statements in accordance with SFAS No. 109 and prescribes a recognition
threshold of more-likely-than-not to be sustained upon examination.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A
reconciliation of the beginning and ending amount of total unrecognized tax benefits in
the Companys subsidiaries, is as follows:
| | ------------------------------------------------------------------------------------------------------------------------------------

| |                                                 | (U.S. $ in thousands)
| | ----------------------------------------------- | ---------------------
|
|
|
|
| | Balance as of January 1, 2007                   |                      
| | Increases related to current year tax positions |                      
| | Settlements                                     |                      
| |                                                 |                      
| | Balance as of December 31, 2007                 |                      
| | Increases related to current year tax positions |                      
| | Increase related to prior tax positions         |                      
| |                                                 |                      
| | Balance as of December 31, 2008                 |                      
| |                                                 |                      

# Note 17 
Supplementary Financial Statement Information:

# Balance Sheet:

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

| | Composition:
| | ------------

| |                                            | December 31,
| | ------------------------------------------ | ------------
|
|
|
|
| | Government departments                     |             
| | Employees (1)                              |             
| | Prepaid expenses and advances to suppliers |             
| | Deferred taxes                             |             
| | Debtors from a sale of subsidiary          |             
| | Other                                      |             
| |                                            |             
| | Total                                      |             
| |                                            |             

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

F - 57

---

---



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

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

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

| | Composition:
| | ------------

| |                            | December 31,
2008 |  | December 31,
| | -------------------------- | ----------------- |  | ------------
|
|
|
|
|
| | Bank overdraft             |                   |  |             
| | Short-term bank loans      |                   |  |             
| | Short-term bank loans      |                   |  |             
| | Short-term bank loans      |                   |  |             
| | Short-term bank loans      |                   |  |             
| |                            |                   |  |             
| | Current maturities of      |                   | 
| | long-term loans from banks |                   |  |             
| |                            |                   |  |             
| | Total                      |                   |  |             
| |                            |                   |  |             

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

| | Composition:
| | ------------

| |                                                         | December 31,
| | ------------------------------------------------------- | ------------
|
|
|
|
| | Employees and other wage and salary related liabilities |             
| | Government departments                                  |             
| | Prepaid income and customer advances                    |             
| | Accrued expenses and other current liabilities          |             
| |                                                         |             
| | Total                                                   |             
| |                                                         |             

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

| |                                          | Year ended December 31,
| | ---------------------------------------- | -----------------------
|
|
|
|
| | Wages and related expenses               |                        
| | Expenses relating to closing of branches |                        
| |                                          |                        
| | Total                                    |                        
| |                                          |                        

| | Restructuring
expenses were recorded by consolidated companies and relate to the proprietary software
products segment. These companies announced the adoption of a restructuring plan in order
to reduce expenses and improve organizational and business efficiency.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 58

---

---



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

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

|E. | Financial
Expenses, Net:
|-- | ------------------------

| | Composition:
| | ------------

| |                                                         | Year ended December 31,
| | ------------------------------------------------------- | -----------------------
|
|
|
|
| | Financing income                                        |                        
| | Financing costs related to long-term credit             |                        
| | Financing costs related to short-term credit and others |                        
| | Gain (loss) from marketable securities, net.*           |                        
| |                                                         |                        
| | Total                                                   |                        
| |                                                         |                        

| | * | Includes
gains (losses) from trading securities still held by the company for the years ended
December 31, 2008, 2007 and 2006 in the amounts of (1,530), (202) and 3 thousands respectively.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Composition:
| | ------------

| |                                              | Year ended December 31,
| | -------------------------------------------- | -----------------------
|
|
|
|
| | Gain on sale of fixed assets, net            |                        
| | Impairment of fixed assets                   |                        
| | Impairment in value of cost based investment |                        
| | Other                                        |                        
| |                                              |                        
| | Total                                        |                        
| |                                              |                        

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

| | Composition:
| | ------------

| |                                                    | Year ended December 31,
| | -------------------------------------------------- | -----------------------
|
|
|
|
| | Loss from sale and decrease                        |                        
| | in shareholding percentage in Magic                |                        
| | Gain (loss) from sale and decrease in shareholding |                        
| | percentage in Matrix                               |                        
| | Gain from sale and decrease in shareholding        |                        
| | percentage in Tiltan                               |                        
| | Capital gain (loss) from realization of Matrix One |                        
| | Gain from sale and decrease in shareholding        |                        
| | percentage in Sapians                              |                        
| | Gain (loss) on realization of other investments    |                        
| |                                                    |                        
| | Total                                              |                        
| |                                                    |                        

F - 59

---

---



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

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

|H. | Operating
Segments:
|-- | -------------------

| | The
Company operates in two reportable 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 solutions for the insurance industry.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 were earned.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following is a list of the companies included in each operating segment, as of December
31, 2007:
| | -----------------------------------------------------------------------------------------------------

| | Software Services:
| | ------------------

| | Matrix IT Ltd.     NextSource Inc.
| | ----------------------------------

| | Proprietary Software Products:
| | ------------------------------

| | Magic Software Enterprises Ltd.          Sapiens International Corporation N.V.
| | -------------------------------------------------------------------------------

F - 60

---

---



FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO THE 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 and finance expenses are
allocated proportionally between the segments:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Software
Services        | Proprietary
Software
Products | Total
| |  | ------------------------ | ----------------------------- | -----
|
|
|
|
| |  | Revenues:                |                               |      
| |  |                          |                              
| |  | 2008                     |                               |      
| |  | 2007                     |                               |      
| |  | 2006                     |                               |      
| |  |                          |                              
| |  | Inter-segment sales:     |                               |      
| |  |                          |                              
| |  | 2008                     |                               |      
| |  | 2007                     |                               |      
| |  | 2006                     |                               |      
| |  |                          |                              
| |  | Operating income (loss): |                               |      
| |  |                          |                              
| |  | 2008                     |                               |      
| |  | 2007                     |                               |      
| |  | 2006                     |                               |      
| |  |                          |                              
| |  | Financial expenses:      |                               |      
| |  |                          |                              
| |  | 2008                     |                               |      
| |  | 2007                     |                               |      
| |  | 2006                     |                               |      
| |  |                          |                              
| |  | Net income (loss):       |                               |      
| |  |                          |                              
| |  | 2008                     |                               |      
| |  | 2007                     |                               |      
| |  | 2006                     |                               |      

F - 61

---

---



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

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

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

| |                                         | Software
Services | Proprietary
Software
Products | Total
| | --------------------------------------- | ----------------- | ----------------------------- | -----
|
|
|
|
| | Identifiable assets including goodwill: |                   |                               |      
| |                                         |                   |                              
| | 2008                                    |                   |                               |      
| | 2007                                    |                   |                               |      
| |                                         |                   |                              
| | Identifiable liabilities:               |                   |                              
| |                                         |                   |                              
| | 2008                                    |                   |                               |      
| | 2007                                    |                   |                               |      
| |                                         |                   |                              
| | Depreciation and amortization:          |                   |                               |      
| |                                         |                   |                              
| | 2008                                    |                   |                               |      
| | 2007                                    |                   |                               |      
| | 2006                                    |                   |                               |      
| |                                         |                   |                              
| | Investments in segment assets:          |                   |                               |      
| |                                         |                   |                              
| | 2008                                    |                   |                               |      
| | 2007                                    |                   |                               |      
| | 2006                                    |                   |                               |      

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

| |                                         | 2008 | 2007 | 2006
| | --------------------------------------- | ---- | ---- | ----
|
|
|
|
| | Revenues:                               |      |      |     
| |                                         |      |     
| | Revenues as above                       |      |      |     
| | Less inter-segment transactions         |      |      |     
| |                                         |      |      |     
| | Revenues as per statement of operations |      |      |     
| |                                         |      |      |     

F - 62

---

---



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

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

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

| |                                                      | 2008 | 2007
| | ---------------------------------------------------- | ---- | ----
|
|
|
|
| | Identifiable assets:                                 |      |     
| | Total assets of operating segments                   |      |     
| | Assets not identifiable to a particular segment      |      |     
| | Elimination of inter-segment assets and other        |      |     
| |                                                      |      |     
| | Total assets from continuing operation               |      |     
| | as per consolidated balance sheet                    |      |     
| |                                                      |      |     
| | Identifiable liabilities:                            |      |     
| | Total liabilities of operating segments              |      |     
| | Liabilities not identifiable to a particular segment |      |     
| | Elimination of inter-segment liabilities and other   |      |     
| |                                                      |      |     
| | Total liabilities from continuing operation          |      |     
| | as per consolidated balance sheet                    |      |     
| |                                                      |      |     

|I. | Geographical
Information:
|-- | -------------------------

| | 1. | The
Companys Long-Lived Assets are as follows:
| | -- | -----------------------------------------------

| |               | December 31,
| | ------------- | ------------
|
|
|
|
| | Israel        |             
| | United States |             
| | Other         |             
| |               |             
| | Total         |             
| |               |             

| | 2. | Revenues:
| | -- | ---------

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

| |                | Year ended December 31,
| | -------------- | -----------------------
|
|
|
|
| | Israel         |                        
| | International: |                        
| | United States  |                        
| | Other          |                        
| |                |                        
| | Total          |                        
| |                |                        

| | Classification
was based on the location of the customers.
| | ----------------------------------------------------------

F - 63

---

---



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

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

|J. | Earnings
Per Share:
|-- | -------------------

| | The
following table presents the computation of basic and diluted net earnings per share of
continuing operation:
| | -----------------------------------------------------------------------------------------------------------------

| |                                                | Year ended December 31,
| | ---------------------------------------------- | -----------------------
|
|
|
|
| | Amount for basic earnings (loss) per share -   |                        
| | income available to shareholders               |                        
| | Effect of dilutive securities of subsidiaries  |                        
| |                                                |                        
| | Amount for diluted earnings (loss) per share - |                        
| | income available to shareholders               |                        
| |                                                |                        
| | Weighted average shares outstanding            |                        
| | Denominator for basic net earnings per share   |                        
| | Effect of dilutive securities                  |                        
| |                                                |                        
| | Denominator for diluted net earnings per share |                        
| |                                                |                        
| | Basic net earnings (loss) per share            |                        
| | of continuing operation                        |                        
| |                                                |                        
| | Diluted net earnings (loss) per share          |                        
| | of continuing operation                        |                        
| |                                                |                        

| | *) | Anti
dilutive
| | -- | -------------

# Note 18 
Discontinued operations:

|A. | In
December, 2006, the Company spun-off Formula Vision. Therefore, Formula           Vision
is no longer a subsidiary of the Company. The spin-off was affected by           way of
distributing the 36,696,000 Formula Vision shares owned by Formula (then
          representing approximately 57% of the outstanding Formula Vision shares) to
          Formulas shareholders on a pro-rata basis.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Formula
Visions shares were distributed at a ratio of 2.78 Formula Vision shares for each
outstanding ordinary share held at the close of the trade on December 14, 2006, the record
date, subject to withholding taxes. Formula Vision met the definition of a component under
SFAS 144. Accordingly, the results of operations of Formula Vision have been classified as
discontinued operations in the statement of operations of prior periods results. The
Company followed EITF No. 87-24 and allocated interest on debt that is to be assumed by
the buyer and is connected with the discontinued operation. The expenses allocated for the
years 2006 were $9 million.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 64

---

---



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

# Note 18 
Discontinued operations (Cont.):

|B. | On
June 20, 2007, the company completed the sale of its entire shareholding in
          BluePhoenix. BluePhoenix met the definition of a component under SFAS 144.
          Accordingly, the results of operations of BluePhoenix have been classified as
          discontinued operations in the statement of operations and prior periods
results           have been reclassified accordingly. In addition comparative data of the
assets           and liabilities attributed to the discontinued operations have been
reclassified           in the balance sheet.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|C. | In
2007, Magic disposed of two of its subsidiaries (AAOD and Magic Italy).           Both
subsidiaries met the definition of a component under SFAS 144. Accordingly,           the
results of operations of these subsidiaries and businesses and the gain
          resulting from the disposals have been classified as discontinued operations in
          the statement of operations and prior periods results have been reclassified
          accordingly. In addition, comparative data of the assets and liabilities
          attributed to the discontinued operations have been reclassified in the balance
          sheet.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 65

---

---



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

# Note 18 
Discontinued operations (Cont.):

|D. | The
following is the composition from discontinued operations (includes           capital
gain fromrealization):
|-- | ----------------------------------------------------------------------------------------------------------------

| |                                                       | Year Ended December 31,
| | ----------------------------------------------------- | -----------------------
|
|
|
|
| | Revenues                                              |                        
| | Cost of revenues                                      |                        
| |                                                       |                        
| | Gross profit                                          |                        
| | Research and development costs, net                   |                        
| | Selling, general and administrative expenses          |                        
| | Restructuring and non-recurring costs                 |                        
| |                                                       |                        
| | Operating income                                      |                        
| | Financial expenses, net                               |                        
| | Gain on realization of shareholdings, net *,**        |                        
| | Other expenses (income) ,net                          |                        
| |                                                       |                        
| | Income before taxes on income                         |                        
| | Taxes on income (benefit)                             |                        
| |                                                       |                        
| |                                                       |                        
| | Equity in gains (losses) of affiliated companies, net |                        
| | Minority interest in earnings of subsidiaries, net    |                        
| |                                                       |                        
| | Net income (loss)                                     |                        
| |                                                       |                        

| | * | In
November 2006, Formula Vision signed an agreement for effectively selling half of its
holdings in Giga to an American investment company in consideration of $11.2 million.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Upon
the completion of the transaction, Formula Vision held 24.58% of Gigas outstanding
shares. The gain from realization totaled $ 10.6 million.
| | --------------------------------------------------------------------------------------------------------------------------------------------------

| | ** | In
December 2006, Formula Vision engaged in an agreement with Karden Technologies Ltd.
(henceforth: Karden), by which Karden acquires rights in a limited
partnership held by Formula Vision to which Formula Visions investments in 5 of its
portfolio companies were transferred in consideration of $21 million. The gain from
realization totaled $ 13.6 million.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 66

---

---



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

# Note 19 
Subsequent events:

|A. | In
December 2008, the company announced that the board of directors approved
          distribution of a cash dividend payable on January 29, 2009 with respect to
each           outstanding Formula ordinary share held as of the close of business day on
          January 12, 2009. The cash distribution was on the amount of $2.27 per share or
          approximately $30 million in the aggregate.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|B. | In
January 2009, the company granted to Mr. Bernstein, in connection with           his new
service agreement, options to purchase 396,000 ordinary shares. These           options
vest over a three-year period, commencing on December 17, 2008, on a           quarterly
basis. The exercise price of the options is NIS 0.01 per share. The           options
shall expire six years of the date of grant.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 67

---

---



| |                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------
| | Kost Forer Gabbay & Kasierer3 Aminadav St.
Tel-Aviv 67067, Israel
Tel: 972 (3)6232525
Fax: 972 (3)5622555
www.ey.com/il

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

# To the Board of
Directors and 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, 2008
and 2007 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, 2008. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements
based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. We were not engaged to perform an audit of the Companys
internal control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Companys internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, 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, 2008 and 2007 and the
consolidated results of their operations and their cash flows for each of the three years
in the period ended December 31, 2008, in conformity with U.S. generally accepted
accounting principles.

|                 |                                 
|---------------- | --------------------------------
|
|
|
|
|                 |                                 
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER    
|April 26, 2009   | A Member of Ernst & Young Global



---

---

| | 
| | 
| | 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and the Board of Directors 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, 2007 and 2008, 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, 2008. 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 15% and 15% as of December 31, 2007 and 2008, respectively, and total revenues of 37%, 36%
and 39% for each of the three years in the period ended December 31, 2008 of the related consolidated
totals. 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.

As discussed in Note
2 to the consolidated financial statements, in 2007 the Company adopted FASB interpretation No. 48
Accounting for Uncertainty in Income Taxes - An Interpretation of FASB No. 109, effective
January 1, 2007.

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, 2007 and 2008, and the related
consolidated results of their operations and their cash flows for each of the three years in the
period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.

|                 |                                 
|---------------- | --------------------------------
|                 |                                 
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER    
|April 2, 2009    | A Member of Ernst & Young Global



---

---

|                                    
|------------------------------------
|Levy  Cohen & Co.                   
|                                    
|R e g i s t e r e d  A u d i t o r s
|                                    

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

| | To the Board of Directors and Shareholders of 
Magic Software Enterprises (UK) Limited                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | We have audited the accompanying balance sheet of Magic Software Enterprises (UK) Limited as of December 31, 2008 and 2007, and the related statements of operations, changes in shareholders equity for each of the three years in the period ended December 31, 2008. 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 audit.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | 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, the financial statements referred to above present fairly, in all material respects, the financial position of the Company at December 31, 2008 and 2007, and the related statements of operations, changes in shareholders equity for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

|                             |                
|---------------------------- | ---------------
|                             |                
|                             |                
|LEVY COHEN & CO.             |                
|Certified Public Accountants | 21 January 2009
|                             |                
|                             |                

|                     
|---------------------
|J. Cohen C.P.A. (ISR)
|R. Shahmoon ACA      
|                     



---

---

|                                    
|------------------------------------
|Levy  Cohen & Co.                   
|                                    
|R e g i s t e r e d  A u d i t o r s
|                                    

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

| | To the Board of Directors and Shareholders of 
Hermes Logistics Technologies Limited                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | We have audited the accompanying balance sheet of Hermes Logistics Technologies Limited as of December 31, 2008 and 2007, and the related statements of operations, changes in shareholders equity for each of the three years in the period ended December 31, 2008. 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 audit.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | 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, the financial statements referred to above present fairly, in all material respects, the financial position of the Company at December 31, 2008 and 2007, and the related statements of operations, changes in shareholders equity for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

|                             |                  
|---------------------------- | -----------------
|                             |                  
|                             |                  
|LEVY COHEN & CO.             |                  
|Certified Public Accountants | 11 February  2009
|                             |                  
|                             |                  

|                     
|---------------------
|J. Cohen C.P.A. (ISR)
|R. Shahmoon ACA      
|                     



---

---

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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

We have audited the accompanying balance sheets of Magic Software Japan K.K. (the Company) as of December 31, 2008, 2007 and 2006, and the related statements of operations and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Companys internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide 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 the Company as of December 31, 2008, 2007 and 2006, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America.

|                 |                      
|---------------- | ---------------------
|                 |                      
|Tokyo, Japan     |                      
|January 30, 2009 | KDA Audit Corporation



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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Magic Benelux B.V.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Auditors report                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Report on the financial statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | We have audited the accompanying balance sheets as at December 31, 2008 and 2007 and the related statements of operations for each of the three years in the period ended December 31, 2008 of Magic Benelux B.V., Houten.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Managements responsibility                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Management is responsible for the preparation and fair presentation of the financial statements and for the preparation of the management board report, both in conformity with U.S. generally accepted accounting principles. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of the financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances.                                                                                                                                                                                                                                                                                              
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Auditors responsibility                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Our responsibility is to express an opinion on the financial statements based on our audit. We conducted our audit in accordance with Dutch law. This law requires that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditors judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entitys preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entitys internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 



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| |                                                                                                                                                                                                                                                                                                                                     
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |                                                                                                                                                                                                                                                                                                                                     
| |                                                                                                                                                                                                                                                                                                                                     
| | Magic Benelux B.V.                                                                                                                                                                                                                                                                                                                  
| |                                                                                                                                                                                                                                                                                                                                     
| | Opinion                                                                                                                                                                                                                                                                                                                             
| |                                                                                                                                                                                                                                                                                                                                     
| | In our opinion, the financial statements give a true and fair view of the financial position of Magic Benelux B.V. as at December 31, 2008 and 2007, and of its related statements of operations for each of the three years in the period ended December 31, 2008 in conformity with U.S. generally accepted accounting principles.
| |                                                                                                                                                                                                                                                                                                                                     
| | Dordrecht, January 30, 2009                                                                                                                                                                                                                                                                                                         
| |                                                                                                                                                                                                                                                                                                                                     
| | Verstegen accountants en adviseurs                                                                                                                                                                                                                                                                                                  
| |                                                                                                                                                                                                                                                                                                                                     
| | Drs. L.K. Hoogendoorn RA MGA                                                                                                                                                                                                                                                                                                        



---

---

To the Board of Directors and Shareholders of 
  Magic (Onyx) Magyarország Szoftverház Kft.

We have audited the accompanying balance sheet of Magic (Onyx) Szoftverház Kft. (the Company) as of December 31, 2008 and 2007, and the related statements of operations, changes in shareholders equity and cash flows for each of the three years in the period ended December 31, 2008. 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 audit.

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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and at December 31, 2008 and 2007, and the related statements of operations, changes in shareholders equity and cash flows for each of the three years in the period ended December 31, 2008 in conformity with U.S. generally accepted accounting principles.

|                   |               
|------------------ | --------------
|                   |               
|February 25,  2009 | Maria Negyessy
|                   | Reg. Auditor  
|                   |               



---

---

# 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/ Guy Bernstein
Guy BernsteinChief Executive Officer |  | April 27, 2009
 Date
|------------------------------------------------------------------------ |  | ----------------------------------



---

---

# EXHIBIT INDEX

# Exhibit No.

|1.1 |  | Memorandum
of Association (1)
|--- |  | -----------------------------

|1.2 |  | Articles
of Association as amended on December 28, 2005 (2)
|--- |  | -----------------------------------------------------------

|4.1 |  | Form
of Letter of Indemnification, dated December 28, 2005 (2)
|--- |  | --------------------------------------------------------------

|4.2 |  | International
Securities Purchase Agreement dated June 15, 2007 between the Registrant and each of the
purchasers identified on the signature pages of the agreement (3)
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 |  | Formula
Systems (1985) Ltd. Employees and Office Holders Share Option Plan (2008)*
|--- |  | ----------------------------------------------------------------------------------

|8 |  | List
of Subsidiaries*
|- |  | ---------------------

|12.1 |  | Certification
of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
                       of 2002*
|---- |  | ------------------------------------------------------------------------------------------------------------------------------

|12.2 |  | Certification
of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
                       of 2002*
|---- |  | ------------------------------------------------------------------------------------------------------------------------------

|13.1 |  | Certification
of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
                       Act of 2002*
|---- |  | ------------------------------------------------------------------------------------------------------------------------------

|13.2 |  | Certification
of the Chief Financial Officer pursuant to Section. 906 of the Sarbanes-Oxley
                       Act of 2002*
|---- |  | -------------------------------------------------------------------------------------------------------------------------------

|15.1 |  | Consent
of Ziv Haft registered certified public accountants (Isr.) BDO member firm*
|---- |  | -----------------------------------------------------------------------------------

|15.2 |  | Consent
of Levy Cohen and Co.*
|---- |  | ------------------------------

|15.3 |  | Consent
of Levy Cohen and Co.*
|---- |  | ------------------------------

|15.4 |  | Consent
of Kost, Forer, Gabbay & Kaiserer*
|---- |  | ------------------------------------------

|15.5 |  | Consent
of Kost, Forer, Gabbay & Kaiserer*
|---- |  | ------------------------------------------

|15.6 |  | Consent
of Verstegen accountants en belastingadviseurs*
|---- |  | -------------------------------------------------------



---

---

# Exhibit No.

|15.7 |  | Consent
of KDA Audit Corporation*
|---- |  | ---------------------------------

|15.8 |  | Consent
of Maria Negyessy*
|---- |  | --------------------------

---

|*Filed
herewith.
|----------------

(1)    
          Incorporated by reference to the Registration Statement on Form F-1 (File No.
          333-8858). (2)    
          Incorporated by reference to the Annual Report on Form 20-F filed with the
          Securities and Exchange Commission on June 29, 2006. (3)    
          Incorporated by reference to the Annual Report on Form 20-F filed with the
          Securities and Exchange Commission on June 29, 2007.



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