---

---

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

# FORM 20-F

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

OR

|x | ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
               1934 For the fiscal year ended December 31, 2006;
|- | ------------------------------------------------------------------------------------------------------------------------------------------------

OR

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

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
|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

Securities for which there is a
reporting obligation pursuant to Section 15(d) of the Act:

None

As of December 31, 2006, the
registrant had 13,200,000 outstanding ordinary shares, NIS 1 par value, of which
420,737_were represented by American depositary shares as of such date.



---

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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
financial statement item the registrant has elected to follow.

Item 17 o Item 18 x

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. 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, Formula Vision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.



---

---



# 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                                                    | 20
|ITEM 4A. UNRESOLVED STAFF COMMENTS                                                    | 43
|ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                  | 43
|ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                    | 60
|ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                             | 70
|ITEM 8. FINANCIAL INFORMATION                                                         | 74
|ITEM 9. THE OFFER AND LISTING                                                         | 75
|ITEM 10. ADDITIONAL INFORMATION                                                       | 77
|ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS                  | 92
|ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       | 92
|ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                              | 92
|ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 93
|ITEM 15T. CONTROLS AND PROCEDURES                                                     | 93
|ITEM 16. [RESERVED]                                                                   | 94
|ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT                                            | 94
|ITEM 16B. CODE OF ETHICS                                                              | 94
|ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES                                      | 94
|ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES                  | 95
|ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS      | 95
|ITEM 17. FINANCIAL STATEMENTS                                                         | 96
|ITEM 18. FINANCIAL STATEMENTS                                                         | 96
|ITEM 19. EXHIBITS                                                                     | 96



---

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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, 2004, 2005 and 2006, and the balance
sheet data as at December 31, 2005 and 2006 from our consolidated financial statements
included elsewhere in this annual report. Our consolidated financial statements have been
audited by Ziv Haft registered public accountants (Isr.), a BDO member firm. The
consolidated income statement data for the years ended December 31, 2002 and 2003 and the
consolidated balance sheet data for the years ended December 31, 2002, 2003 and 2004
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 (loss)                       |                        
|Financial income (expenses), net              |                        
|Gain on realization of shareholdings, net     |                        
|Other expenses, net                           |                        
|                                              |                        
|Income (loss) before taxes on income          |                        
|Taxes on income                               |                        
|Equity in gains (losses) of affiliated        |                        
|companies, net                                |                        
|Minority interest inearnings of subsidiaries, |                        
|net                                           |                        
|                                              |                        
|Income from continuing operations             |                        
|                                              |                        
|Income from discontinued operations, net      |                        
|                                              |                        
|Net income (loss)                             |                        
|Earnings per share generated from             |                        
|continuing operations                         |                        
|Basic                                         |                        
|Diluted                                       |                        
|Earnings (losses) per share generated         |                        
|from discontinued operations                  |                        
|Basic                                         |                        
|Diluted                                       |                        
|Earnings (loss) per share:                    |                        
|Basic earnings (loss)                         |                        
|Diluted earnings (loss)                       |                        
|                                              |                        
|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
December 2006, Formula distributed to its shareholders a dividend consisting of 36,696,000
shares of Formula Vision Technology (F.V.T.) Ltd., or 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 are declared and paid in New Israeli Shekels. Dividends are converted into
dollars and paid by the depositary of the ADRs for the benefit of owners of ADRs.

Dividends
paid by an Israeli company to shareholders residing outside Israel are generally subject
to withholding of Israeli income tax at a rate of up to 20%. 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. In addition, the trading price of our ordinary shares could
decline due to any of these risks.

6

---

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Risks Relating to Our
Business

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:

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

| |  | 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.

7

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If capital spending on information
technology, or IT, slows down, our business could be seriously harmed.

We are affected by global economic
changes, in particular trends in capital spending in the IT sector. Changes in purchasing
patterns in the IT industry directly affect our operating results. For example, during
2001 through 2003, the overall business slowdown in the North American and European
markets influenced the purchasing patterns of leading software developers who delayed
their planned orders and caused developers to reduce the amount of their planned license
commitment. Although we believe that during the last three years the IT market has begun
to recover, we cannot know whether the global market recovery will continue in the future,
and how the economic conditions will continue to affect our business. Accordingly, we
cannot assure you that we will be able to increase our revenues or keep our revenues at
the same level as in 2005 and 2006.

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

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

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

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

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

8

---

---



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

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

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

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

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

9

---

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

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, may materially and adversely affect our business, operating
results and financial condition.

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

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

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

10

---

---



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 2005 and 2006, we received approximately 45% of our total revenues from
customers located outside of Israel. The expansion of our existing operations and entry
into additional international markets will require significant management attention and
financial resources. We are subject to a number of risks customary for international
operations, including:

| |  | changing
product and service requirements in response to the formation of               economic
and marketing unions, including the European Union;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------

| |  | economic
or political changes in international markets;
| | - | -------------------------------------------------------

| |  | greater
difficulty in accounts receivable collection and longer collection periods;
| | - | -----------------------------------------------------------------------------------

| |  | unexpected
changes in regulatory requirements;
| | - | ----------------------------------------------

| |  | difficulties
and costs of staffing and managing foreign operations;
| | - | -------------------------------------------------------------------

| |  | the
uncertainty of protection for intellectual property rights in some countries;
| | - | ---------------------------------------------------------------------------------

| |  | multiple
and possibly overlapping tax structures; and
| | - | -----------------------------------------------------

| |  | currency
and exchange rate fluctuations.
| | - | ----------------------------------------

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

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

11

---

---



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.

12

---

---



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.

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

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

13

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

Substantial
litigation over intellectual property rights exists in the software industry. We expect
that software products may be increasingly subject to third-party infringement claims as
the functionality of products in different industry segments overlaps. Although our
products and services have never been the subject of an infringement proceeding, we cannot
predict whether third parties will assert claims of infringement against us. In addition,
our employees and contractors have access to software licensed by us from third parties. A
breach of the non-disclosure undertakings by any of our employees or contractors may lead
to a claim of infringement against us. Any 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.

14

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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 50.1% 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.

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

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

| | that
the inflation  rate in Israel will exceed the NIS  devaluation  rate against the dollar
or the        euro;
|- | ----------------------------------------------------------------------------------------------------------------

| | that
the devaluation process will lag behind the NIS inflation timing; or
|- | -------------------------------------------------------------------------

| | that
the euro experiences devaluation against the dollar.
|- | ---------------------------------------------------------

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

15

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

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

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., Matrix IT Ltd. and Sapiens International Corporation N.V. 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.

We will be exposed to risks
relating to evaluations of controls required by Section 404 of the Sarbanes-Oxley Act of
2002.

Under
the current rules of the Securities and Exchange Commission, or SEC, we are required to
comply with the management assessment of internal controls over financial reporting
requirement of Section 404 of the Sarbanes-Oxley Act of 2002 for our fiscal year ending
December 31, 2006 and with the auditor attestation requirement of Section 404 for our
fiscal year ending December 31, 2007. We are in the process of evaluating our internal
controls systems to allow management to report on, and our independent auditors to audit,
our internal controls over financial reporting. We will be performing the system and
process evaluation and testing (and any necessary remediation) required to comply with the
management assessment and auditor attestation requirements of Section 404. However, we
cannot be certain as to the timing of completion of our evaluation, testing and
remediation actions or the impact of the same on our operations. Furthermore, upon
completion of this process, we may identify control deficiencies of varying degrees of
severity under applicable SEC and Public Company Accounting Oversight Board rules and
regulations that remain unremediated. We will be required to report, among other things,
control deficiencies that constitute a material weakness or changes in
internal controls that, or are reasonably likely to, materially affect internal controls
over financial reporting. A material weakness is a control deficiency, or
combination of control deficiencies that results in more than a remote likelihood that a
material misstatement of the annual or interim financial statements will not be prevented
or detected. If we fail to implement the requirements of Section 404 in a timely manner,
we might be subject to sanctions or investigation by regulatory authorities such as the
SEC or by Nasdaq. Additionally, failure to comply with Section 404 or the report by us of
a material weakness may cause investors to lose confidence in our financial statements and
our share price may be adversely affected. If we fail to remedy any material weakness, our
financial statements may be inaccurate, we may not have access to the capital markets, and
our share price may be adversely affected.

16

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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. The market prices of securities of technology companies have been extremely
volatile, and have experienced fluctuations that have often been unrelated or
disproportionate to the operating performance of those companies. These broad market
fluctuations could adversely affect the market price of our ordinary shares and American
Depositary Shares, or ADSs.

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
|---- | ------------------------- | -----------
|
|
|
|
|2006 |                           |            
|2005 |                           |            
|2004 |                           |            

The
market price of the ordinary shares and the ADSs may fluctuate substantially due to a
variety of factors, including:

| |  | any
actual or anticipated fluctuations in our or our competitors' quarterly revenues and
              operating results;
| | - | -------------------------------------------------------------------------------------------------------------------------

| |  | shortfalls
in our operating results from levels forecast by securities analysts;
| | - | --------------------------------------------------------------------------------

| |  | public
announcements concerning us or our competitors;
| | - | ------------------------------------------------------

| |  | results
of integrating investments and acquisitions;
| | - | ----------------------------------------------------

| |  | the
introduction or market acceptance of new service offerings by us or our competitors;
| | - | ----------------------------------------------------------------------------------------

| |  | changes
in product pricing policies by us or our competitors;
| | - | -------------------------------------------------------------

| |  | changes
in security analysts' financial estimates;
| | - | --------------------------------------------------

| |  | changes
in accounting principles;
| | - | ---------------------------------

| |  | sales
of our shares by existing shareholders; and
| | - | -------------------------------------------------

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| |  | the
loss of any of our key personnel.
| | - | -------------------------------------

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

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

As
of June 20, 2007, we had 13,200,000 ordinary shares outstanding, of which 390,446 were
represented by ADSs. Of the 13,200,000 shares outstanding, 6,613,200 shares are held by
Emblaze, our controlling shareholder. If a large number of our ordinary shares is sold in
a short period, the price of our ordinary shares would likely decrease.

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 2006, we cannot assure you that we will not be treated
as a passive foreign investment company in 2007 or in future years. We would be a passive
foreign investment company if 75% or more of our gross income in a taxable year is passive
income. We would also be a passive foreign investment company if at least 50% of our
assets in a taxable year produce, or are held for the production of, passive income.
Passive income includes interest, dividends, royalties, rents and annuities. If we are or
become a passive foreign investment company, many of you will be subject to adverse tax
consequences, including having gain realized on the sale of our ordinary shares or ADSs
being treated as ordinary income, as opposed to capital gain income, and having
potentially punitive interest charges apply to such sale proceeds. A decline in the value
of our ordinary shares or ADSs may result in our being a PFIC. United States shareholders
should consult with their own tax advisors with respect to the United States tax
consequences of investing in our ordinary shares.

18

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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 45% of our revenues in 2006 from international
markets, we are, nonetheless, directly influenced by the political, economic and military
conditions affecting Israel. Major hostilities involving Israel, including as a result of
the military conflicts between the Fatah and Hamas in Gaza Strip, Judea and Samaria, or
the interruption or curtailment of trade between Israel and its present trading partners
could have a material adverse effect on our business, operating results and financial
condition. Furthermore, several countries restrict business with Israeli companies. In
addition, nonexempt male adult citizens of Israel, including some of our officers and
employees, are obligated to perform military reserve duty until the age of 40 or 45
depending on their function in the army, and are subject to being called for active duty
under emergency circumstances. While we have operated effectively under these requirements
since our incorporation, we cannot predict the full impact of such conditions on 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.

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

Certain
of our subsidiaries received grants in the past and receive tax benefits under Israeli
government programs, particularly as a result of the Approved Enterprise
status of certain operations in Israel. Approved Enterprise status is granted
by the Israeli Investment Center of the Ministry of Industry and Trade and entitles the
grantee to a variety of tax incentives. The incentives awarded to certain of our
subsidiaries include reduced tax rates and a tax holiday. Certain of our subsidiaries were
granted a two year tax exemption, followed by a five year tax reduced tax rate of 25%
instead of 29% on income derived from Approved Enterprise investment programs.
In order to qualify for these incentives, the Approved Enterprise is required
to provide minimum paid-in-capital (30% of the investment), to show an increase in its
export activities, and to meet other general investing criteria. As of June 20, 2007, our
subsidiaries have met those criteria and received tax benefits from their Approved
Enterprise programs, as presented in Note 15 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.

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

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.

# 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 National Market.

20

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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 2005 and 2006, see Item
5. Operating and Financial Review and ProspectsLiquidity and Capital
Resources.

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.

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 issued to
Formula 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 holds does 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). For more information, see Item 5.  Operating and Financial
Review and ProspectsLiquidity and Capital ResourcesRelated Party
TransactionsTransactions between Us and Formula Vision.

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Private
Placement to FIMGold. In March 2005, we completed a private placement of 2,400,000
Formula shares for a net aggregate consideration of $33.0 million. The shares were issued
to FIMGold LP, an entity owned in equal shares by Dan Goldstein and FIMI Opportunity Fund.
Concurrently with the closing of the private placement, Dan Goldstein sold to FIMGold LP
all of his holdings in Formula and in Formula Vision. Following these transactions,
FIMGold LP held a 33.3% controlling interest in Formula and approximately 24% interest in
Formula Vision.

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 currently deliver our solutions in over 50
countries worldwide to customers with complex IT services needs, including a number of
Fortune 1000 companies. We operate in two principal business areas, IT
services and proprietary software solutions. Following is a description of our business
areas:

IT
Services

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

Proprietary
Software Solutions

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

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The
Formula Group

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

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

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| |  | 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., or Matrix, is one of Israels leading integration and information technology
services companies, based on Duns 100 Israel Largest Enterprises 2006.
Matrix employs over 2,700 software, hardware, integration and training personnel, which
provide advanced IT services to more than 500 customers in the Israeli market. Matrix also
markets in Israel software and hardware products manufactured by a broad range of
international manufacturers.

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

Areas
of Operation

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

Software
solutions and services.Matrix provides software services, software
development projects, outsourcing, integration of software systems and services  all
in accordance with its customers specific needs. Matrix also provides upgrading and
expansion of existing software systems. Matrix software solutions include the following
components: (i) development of dedicated customer software; (ii) customization of software
developed by Matrix or by third parties to provide a response to customers
requirements; (iii) systems assimilation; 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 the marketing
and assimilation of software products in various categories, mainly customer relationship
management (CRM) software products, 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.

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Infrastructure
solutions and hardware products.These include: (i) supply of infrastructure solutions
for computer and communication systems; (ii) sale and marketing of PCs, laptops, Intel
servers, peripheral equipment, operating systems, servers and workstations operating on
Unix and 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): communications and security, banking and finance, industry and trade, and
the public sector.

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

| |        
A
technology center providing development services, which include mainly cross-sector
applications (applications which can be used in more than one business sector), as well
as the development of applications that require specialist resources and professional
know-how; and
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |        
A
strategic consulting center that provides customers with diverse consultation services on
topics such as organization, strategy, business development and technological
development.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Customers

Matrixs
customers include large enterprises in Israel, including commercial banks(such
asBank 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),
credit card companies (Visa Cal, Isracard and Leumicard), leasing companies, insurance
companies (such as Harel Hamishmar, Phoenix, Clal, Migdal), security agencies, cellular
operators(Cellcom, Orange and Pelephone), satellite operators (YES), hi-tech
companies(such as Comverse, Motorola and Amdocs), the Israeli Defense Force and
government ministries and public agencies such as Israel Electric Company, Social
Security, Mekorot, Amidar, and media and publishing entities.

25

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Magic

Magic
Software Enterprises Ltd., or Magic, develops, markets and supports composite application
development and deployment platforms with a service-oriented architecture, or SOA,
including application integration and business process management, or BPM, with existing
and legacy systems. Magics products and services are available through a global
network of subsidiaries, distributors and software solution providers in approximately 50
countries. Users of Magics solutions and technology include a broad community of
independent software vendors, system integrators and corporations worldwide, supported by
an extensive global services organization. In addition to technology, Magic provides its
customers with maintenance and technical services, as well as professional services and
training.

Magic
Core Technology

Magic
embeds at its core a rule based technology, abstracting repetitive and mundane programming
chores, and enabling a high degree of agility and flexibility for solutions implemented
with Magics products.

Magics
technology solutions include a comprehensive set of resources and services, offering
compliance with the leading architectures and environments. Magics products provide
platform independence and interoperability.

With
20 years of experience and millions of users, Magic offers leading composite applications
development and deployment tool suites. Using Magics technology, customers can
implement and migrate to a service oriented architecture, leveraging existing IT assets
within new business processes and composite applications, and maximize the return on past
and new IT investments.

Magic
delivers the following two complementary products that address the wide spectrum of SOA
and composite applications:

     iBOLT
Business Integration Suite  a flow oriented composite applications toolset,
delivering a comprehensive, business-driven integration framework that empowers
enterprises to improve business performance. iBOLT enables customers to easily design,
develop and deploy automated business processes, including BPM and business activity
monitoring. Increasing the usability and life span of existing legacy and other IT
systems, iBOLT allows fast application integration (EAI), development and customization
of diverse applications, systems and databases, assuring rapid return on investment and
time-to-market, increased profitability, and customer satisfaction.

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     eDeveloper  an
interactive composite applications toolset, delivering a productive, state-of-the-art
technology for developing and deploying Web and client/server applications across and
beyond the enterprise. eDeveloper automates the mundane repetitive tasks of the software
development cycle  significantly shortening the process; reducing project risk; and
minimizing human errors.

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

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

Enabling
Business

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

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

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

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

Professional
Services

Magic,
together with Magics partners, offers customers application integration and
development services that assist customers to maximize their development investments.
These services include project management, technical support, installation services,
application development, integration, consulting and training. All projects are subject to
a rigorous standard for project management and quality assurance. Nevertheless,
Magics goal is to provide such activities as a complementary service to customers
and partners as part of its focus on license sales.

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Strategic
Alliances

Magic
forms strategic alliances to help deliver complete solutions to customers. These solutions
encompass application integration, development, vertical domain expertise and hardware
implementation. Magic maintains strategic alliances with leading vendors, like SAP, IBM,
Iway, IDS Scheer and Pervasive Software. Magics partnership with SAP, entered into
in 2004, focuses on providing a special edition of iBOLT which extends the value of SAP
implementations with capabilities such as extended workflows, composite applications,
multi-channel access, unlimited interoperability and integration with other systems and
platforms, as well as business activity and performance monitoring. In addition, Magic has
alliances with system integrators, software and hardware vendors and consulting
organizations. These partnerships enable Magic to better serve its customers worldwide.

Vertical
Solutions

Magic
also develops, markets, and supports, through its subsidiaries and affiliates, vertical
applications, including long-term care, cargo handling and inventory control solutions.

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

 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.

 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.

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Markets
and Customers

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

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

BluePhoenix

Until
recently, we held a controlling interest in BluePhoenix. On June 20, 2007 we completed the
sale of our entire holdings in BluePhoenix, to international institutional investors.
BluePhoenix (formerly known as Crystal Systems Solutions Ltd.) develops and markets unique
enterprise IT modernization solutions that enable companies to automate the process of
modernizing and upgrading their mainframe and distributed IT infrastructure and to
effectively compete in todays environment. The combination of BluePhoenixs
comprehensive tools and services with its unique methodology provides an efficient and
cost-effective process for extending the return on investment of existing enterprise IT
assets. BluePhoenixs complete modernization solutions consist of a combination of
automated technologies and services that minimize the risk through the whole life cycle of
the process. Its solutions are based on technologies for Understanding, Migration,
Remediation, and Redevelopment, which allow companies to fully leverage their
current systems and applications, speed up and reduce the cost of the renewal process, and
effectively update their systems in order to adapt to new business demands. In addition,
by using BluePhoenixs technologies, organizations gain the added value of extending
their systems to be ready for future demands, such as SOA.

BluePhoenixs
solution portfolio includes software products, software tools and services that address
the most pressing challenges organizations and companies face today. BluePhoenixs
modernization solutions are offered to customers in all business market sectors,
particularly financial services, banking, insurance and automotive. With 12 offices in 10
countries, five full service delivery centers, and representatives, BluePhoenix provides
its products and services worldwide.

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

BluePhoenix
provides its modernization solutions directly and through its strategic partners, such as
IBM, EDS, NCS, Matrix, and TACT. Additionally, from time to time, other IT services
companies license BluePhoenix technologies for use in modernization projects in various
markets. BluePhoenixs partners are usually system integrators who assist it in
increasing its penetration and exposure in the market. BluePoenix provides solutions to
its partners customers in collaboration with the system integrators team. In
most cases, the partners provide related services to the customers. BluePhoenixs
arrangements with its partners vary. It may enter into distribution agreements with its
partners under which it grants license rights to its partners or to the partners
customers, provides related services, or a combination of both. Alternatively, BluePhoenix
may enter into subcontractor relationships with its strategic partners.

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

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

Enterprise
IT UnderstandingThese solutions enable companies to make informed strategic
decisions regarding the future of their IT systems by automatically capturing multiple
levels of operational and development information into a consolidated metadata warehouse.
BluePhoenix tools facilitate global assessments and impact analyses of application assets,
thus helping reduce costs, streamline working processes, and increase efficiency.
Enterprise IT understanding solutions include the following:

| |         BluePhoenix IT DiscoveryThis
solution provides fast and convenient access to application inventory, dependency, and
operational information. This tool performs the complete audit necessary to enable
companies to define and analyze all application assets in order to make informed
decisions about ongoing modernization activities.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |         BluePhoenix LogicMinerThis
recovery solution mines COBOL and extracts business rules from the legacy code, thus
providing IT departments with the ability to begin a modernization process based on
techniques that preserve the functionality of legacy code. LogicMiner increases a systems
manageability, while eliminating rules that no longer apply to current business
procedures.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Enterprise
IT MigrationThese solutions enable companies to consolidate and eliminate a wide
range of legacy hardware and software through automated migration of applications,
databases, platforms, programming languages, and data. These tools help to reduce costs
and resources, and minimize reliance on proprietary technology, sunset products, and
dwindling skill sets. The SOA-ready solution is provided as a post-migration service,
allowing customers to extend their development environment by providing access to
mainframe systems through Web services protocols, making legacy systems appear as modern
systems. Enterprise IT Migration solutions include the following:

| |         BluePhoenix DBMSMigratorAn
automated migration tool that converts applications from nonrelational databases, such as
IDMS, ADABAS, IMS, and VSAM, to relational databases, such as DB2, Oracle, and SQL
Server. The tool performs automated conversions that provide companies with fully
functional compliance for source and target applications and minimal application,
functional, and logical program flow changes.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |         BluePhoenix PlatformMigratorAn
automated migration tool that converts a range of platforms, including VSE, MVS, and Bull
GCOS, and can be customized to fit the unique IT configuration and business rules of each
customer site. The tool converts platforms to a pure, native installation so that
programs are not required to run under emulation or through translation techniques.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |         BluePhoenix RehostingOrganizations
implement mainframe rehosting in order to reduce the ongoing costs of existing legacy
CICS and batch applications. Rehosting leverages the strength and investment of older
COBOL applications while taking advantage of new, cost-efficient hardware and open
operating system environments such as Linux, Unix, Windows, J2EE, and .NET.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |         BluePhoenix LanguageMigratorAn
automated migration tool for converting COBOL and 4GLs (fourth generation languages) such
as ADSO, Natural, ALLFusion Gen (formerly COOL:Gen), Mantis, and PowerBuilder to COBOL
and Java/J2EE. This reliable, time-efficient, and comprehensive solution enables
site-wide installation, simultaneous testing, and implementation of batch programs.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |         BluePhoenix DataMigratorA
Windows-based tool for migrating data between various data system environments. Coupled
with a step-by-step proven methodology, the tool provides a fully structured but still
versatile automated data migration process. DataMigrator enables full control of source
and target data definitions resulting in consistent, accurate, highest quality target
data with no data loss, and efficient utilization of available resources.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |         BluePhoenixSOA-Ready
EnalementThis post-migration service extends the useful life of valuable legacy
applications that run on historic mainframe platforms by allowing them to be easily
reused in a modern Web-centric environment. This comprehensive solution provides Web
services and Web customers for legacy applications.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Enterprise
IT RemediationThese solutions enable companies to extend the life of their
existing IT systems by quickly adapting to new regulatory changes and business
requirements. These automated tools can be easily customized to fit any IT environment
and corporate need, including data field adjustment, IT standardization, and system
consolidation. Enterprise IT remediation solutions include the following:

| |         BluePhoenix FieldEnablerNew
business decisions or regulatory requirements often require companies to make changes
that impact a wide range of system components. These include field adjustments that
involve changes in the type, length, and structure of a database or program field, such
as expanding a dealer code. FieldEnabler is a rule-based tool that enables a
step-by-step, comprehensive process for making these kinds of modifications across an
enterprise in a reliable and time-efficient manner.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |         BluePhoenix StandardsEnablerA
highly automated solution for reliably facilitating system consolidation into a single
set of naming standards. Since all resources being converted must be changed in parallel,
the large task of manually standardizing the naming of system components is not
practical. Thistool provides an automated solution addressing this problem.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |         BluePhoenix COBOL/LE-EnablerA
highly automated solution that facilitates the migration of COBOL code from non-LE
compliant environments to LE compliant environments.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |         BluePhoenix EuroEnablerA
highly automated solution that enables the transformation of applications to be euro
compliant. EuroEnabler fully preserves system and data integrity and helps to
maintain existing levels of system application development and maintenance throughout the
process.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Enterprise
IT RedevelopmentThese solutions enable companies to mine existing applications
by extracting business rules, data flows, and data models, and then reusing the proven
code base to create more flexible Java/Web-based applications. BluePhoenix tools help
reduce maintenance costs and resources and application development time-to-market.
Enterprise IT redevelopment tools include the following:

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

| |         BluePhoenix RedevelopmentBased
on AppBuilder and Logic Miner, Redevelopment transforms legacy COBOL programs into
service oriented applications deployed on the latest platforms. The resulting application
conforms to industry standards and is written in clean, maintainable source code. This
conformance to standard architectures, such as full object-orientation and Web services,
is a key differentiator in the Redevelopment approach when compared to more common
migrations. Instead of using the common approach where each line of COBOL source code is
translated to one or more statements in the target language (known as 1-1 approach), Redevelopment uses
a model based approach. Redevelopment develops a platform independent model from
platform specific models of legacy COBOL applications identified by BluePhoenix
LogicMiner. This platform independent model may then be extended to meet new business
requirements. Finally the application is generated to J2EE, .NET, or COBOL.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |         Visual
MainWin® for the Unix and Linux platforms (formerly MainWin)Visual MainWin® for
the Unix and Linux platforms is an application-porting platform that enables independent
software vendors to develop applications in Visual C++ and deploy them natively on Unix
and Linux without the investment that is usually associated with designing and developing
a new source code base for Unix platforms.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Customers

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

        In
the financial services sector -Citibank, Credit Suisse, Fidelity International
Resource Management, Laiki Group, Rabobank Netherland BV, Rural Servicios Informaticos
(Spain), SDC Udvikling (Denmark) and Woolwich PLC.

        In
the insurance sector American Family Life Assurance company of Columbus,
DesJardins General Insurance Group Inc., Employees retirement system, Europe Assistance,
Friends Provident, Management Services Ltd., Legal and general Resources, Scottish
Equitable Plc. and New York City.

        In
other industries Ansys Inc., Canonburg, Altera Corporation, Business Objects
Corp., Commonwealth of Australia represented by the Department of Immigration and
Multicultural and Indigenous Affairs, Daimler Chrysler AG, Erhervs-og Selskabsstyrelsen,
ESRI  Environmental Research institute, Inc., IBM de Mexico Comercializaion y-
servicios S.A., IBM (Rational Software), Lawson Products, Mentor Graphics Corporation,
Ministry of Defense (Israel), Siebel Systems, Inc., Toyota Motor Sales, USA, Inc. and
TEMENOS Group.

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Sapiens

Sapiens
International Corporation N.V., or Sapiens, 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, OneBeacon, Principal
Financial Group, ING, Occidental Fire & Casualty, Texas Farm Bureau Insurance
Companies and Menora Mivtachim Insurance in Israel. Sapiens service offerings
include a standard consulting offering that helps customers make better use of IT in order
to achieve their business objectives.

Sapiens
core technology, Sapiens eMerge, is a rules-based application development
suite which enables rapid solution development for complex mission-critical enterprises to
deliver new functionality, achieve legacy modernization and enterprise application
integration. The primary building block of Sapiens solution offerings is Sapiens
eMerge, Sapiens business rules engine. 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.

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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 core technology, Sapiens eMerge.

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

| |  | SapiensINSIGHT 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | SapiensINSIGHT for
Life & Pensionsis a powerful and comprehensive framework-based life and pensions
solution that serves companies administering life insurance, pension funds, health
insurance and saving plans. INSIGHT for Life & Pensions is dynamic, highly
customizable and can be easily accommodated to administer changes in processes. It is
fully web-enabled, prepared to utilize the advantages of the internet and intranet.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | SapiensINSIGHT for
Underwriting (formerly MediRisk INSIGHT) is an underwriting solution for life,
health and disability insurance. It reduces customers costs by automating a larger
portion of the process of evaluating the risks of new business and by streamlining the
procedures for handling new business. By using this solution, an insurance company can
make underwriting assessments on new cases earlier in the business cycle and achieve
greater consistency in its decision-making. Sapiens markets INSIGHT for
Underwriting on the basis of licensing and distribution agreements with MediRisk
Solutions Ltd. which developed the solution and holds the intellectual property rights to
it.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | SapiensINSIGHT for
Reinsurance is a sophisticated solution for the insurance market, designed to support
carriers and reinsurers in the management of all types of reinsurance for the general
(property and casualty) and life insurance markets, according to the rapidly changing
requirements of the international reinsurance market. This state-of-the-art, web-enabled
solution streamlines and reduces the cost of handling all reinsurance functions through
automation, is based on ACORD standards and B2B XML technology, and is designed for a
multi-language, multi-currency and multi-company environment.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | SapiensINSIGHT for
Claims is a solution that effectively manages and streamlines the information flow of
claim handling across an insurance providers entire organization. This solution
uses highly accessible business rules and messaging standards and allows the use of a
companys existing information assets.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | SapiensINSIGHT 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
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
System z, IBM System i and HP UNIX at the host-side and Intel-based 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.

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.

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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
has emerged as a leader in the field of workforce 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 solutions that address the
rapidly changing challenges posed to the customer by todays global, complex
workforce. nextSource ability to meet a customers entire workforce management
present and future needs, as a single source, positions it as the workforce solutions
provider of choice.

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 (TAMS). TAMS is an industry
leading, 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 3rd generation and covers the United States,
Canada, United Kingdom and India.

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| |  | 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.

| |  | 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.

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Sales and Marketing

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

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

|                        | Software 
Services | Proprietary
Software 
Products | Total
|----------------------- | ------------------ | ------------------------------ | -----
|
|
|
|
|Year ended December 31, |                    |                                |      
|2006                    |                    |                                |      
|2005                    |                    |                                |      
|2004                    |                    |                                |      

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 (includes various countries, mainly in Europe) |                        
|                                                     |                        
|                                                     |                        
|                                                     |                        
|                                                     |                        
|                                                     |                        
|Total                                                |                        
|                                                     |                        

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Competition

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

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

| |  | longer
operating histories;
| | - | ---------------------------

| |  | greater
financial, technical, marketing and other resources;
| | - | ------------------------------------------------------------

| |  | greater
name recognition;
| | - | -------------------------

| |  | well-established
relationships with our current and potential clients; and
| | - | --------------------------------------------------------------------------

| |  | a
broader range of products and services.
| | - | -----------------------------------------

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

Matrixs
principal competitors in the domestic Israeli market are Israeli IT services companies and
systems integrators, the largest of which are Ness Technologies Inc. and Team-Malam.
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.

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

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BluePhoenixs
principal competitors consist of system integrators, offshore outsourcers, and tool
vendors, including leading software developers, who enable customers to replace or
modernize their legacy systems. Major system integrators in the market include IBM,
Accenture, Capgemini, and EDS. IBM has established legacy modernization as a strategic
aspect of its long-term application development strategy. Major system integrators have a
specific and dominant advantage in the underlying application development infrastructure
associated with many legacy environments (predominantly IBM mainframes) and a large
service delivery capability. In some cases, BluePhoenix cooperates with some of these
system integrators in providing specific solutions or portions of comprehensive projects.
Major offshore outsourcers in the market include TCS (Tata Consulting Services), WIPRO,
Patni, and Infosys. Both systems integrators and offshore outsourcers have vertical market
groups offering consulting and professional services.

In
addition, BluePhoenix faces competition from niche companies operating in each of the four
principal areas of the enterprise IT modernization market. For example, Micro Focus
International markets its solutions to the COBOL market, Most Software Technologies
addresses the ADABAS/Natural arena, and other competitors focus on collecting sufficient
information about application portfolios to enable improved working processes. Other
solution developers provide legacy and distributed repository solutions that are important
for a variety of modernization processes.

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

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

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.

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Software Development

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

Intellectual Property
Rights

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

|C. | Organizational
Structure
|-- | ------------------------

Formula
is the parent company of the Formula Group.

The
following table presents certain information regarding the control and ownership of our
significant subsidiaries, as of June 20, 2007.

| | Subsidiary                             | Country of Incorporation     | Percentage
Of Ownership
| | -------------------------------------- | ---------------------------- | -----------------------
|
|
|
|
| | Matrix IT Ltd.                         | Israel                       | 50.3%                  
| | Magic Software Enterprises Ltd.        | Israel                       | 50.01%                 
| | Sapiens International Corporation N.V. | Netherlands Antilles Islands | 63.4%                  
| | nextSource Inc.                        | United States                | 100.00%                

BluePhoenix
was our subsidiary during the periods covered by this annual report but we sold our entire
shareholdings in it in June 2007.

The
ordinary shares of Magic and Sapiens are traded on the NASDAQ National Market and on the
TASE, and the ordinary shares of Matrix are traded on the TASE.

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|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 90,000 square feet of office space in Herzlia, pursuant to a lease which
expires on October 31, 2009. One of our subsidiaries leases approximately 23,000 square
feet of office space in another building in Herzlia pursuant to a lease ending in December
2008, with an option to extend for an additional 24 months. We also lease approximately
160,000 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 45,300 square feet of office space in Rechovot, Israel and
several of our subsidiaries lease approximately 184,000 square feet of office space and
sales and support premises in the United States, Europe and Asia.

The
aggregate amount we paid pursuant to our lease agreements in 2006 was approximately $11.2
million.

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.

# 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,
Matrix and Sapiens. In addition, we wholly own nextSource. We consolidate the results of
operations of our subsidiaries with ours. Our operating results are directly influenced by
the consolidation and cessation of consolidation of our subsidiaries. This could cause
significant fluctuations of our consolidated operating results. As a result, we believe
that period-to-period comparisons of our results of operations are not necessarily
meaningful and you should not rely on these comparisons as indications of our future
performance.

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On
June 20, 2007 we completed the sale of our entire holdings in our subsidiary BluePhoenix
to international institutional investors for aggregate consideration of approximately $64
million. Formula expects to recognize capital gains of approximately $18 million from the
sale.

On
December 26, 2006, we spun-off Formula Vision and Formula Vision is no longer a subsidiary
of us. The spin-off was effected by way of distributing 36,696,000 Formula Vision shares
owned by us (representing approximately 57% of the outstanding share capital of Formula
Vision) as a dividend to our shareholders. Formula Vision shares were distributed at a
ratio of 2.78 Formula Vision shares for every one outstanding ordinary share of Formula
held at the close of trading on December 14, 2006, the record date, prior to withholding
taxes. For more information, see Critical Accounting Policies- Spin-off of the
Investment in Formula Vision and Critical Accounting Policies
Discontinued Operation below.

On
December 31, 2006, Formula Vision paid to us approximately $51 million, as a full
repayment of the principal of the debentures and interest accrued thereon.

In
March 2005, we completed a private placement of 2,400,000 Formula shares for aggregate
consideration of $33.0 million. The shares were issued to FIMGold LP, an entity owned in
equal shares by Dan Goldstein, our former chief executive officer and chairman of the
board, and FIMI Opportunity Fund (which is managed by a company in which our former
directors, Ishay Davidi and Yarom Oren serve as officers).

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

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

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

Our
functional and reporting currency

Formula
and some of our subsidiaries operate primarily in the economic environment of the NIS. The
functional currency of our other subsidiaries is the dollar. We have elected to use the
dollar as our reporting currency.

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

Critical
Accounting Policies

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

Revenue
Recognition

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

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

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

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

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

We
recognize revenues from projects billed on a time and material basis, based on SOP 81-1
Accounting for Performance of Construction  Type and Certain Production 
Type Contracts, using contract accounting on a percentage of completion method,
based on the relationship of actual costs incurred to total costs estimated to be incurred
over the duration of the contract. Provision for estimated losses on uncompleted contracts
is made in the period in which such losses are first determined, in the amount of the
estimated loss on the entire contract. As of December 31, 2006, no such estimated losses
were identified.

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

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

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

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

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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.

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 (SFAS 142), effective January 1, 2002, indefinite life
intangible assets and goodwill are not amortized but rather subject to annual impairment
testing.

Goodwill
and intangible assets are 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. In estimating the fair value of
the reporting unit for the purpose of our annual or periodic analysis, we make estimates
and judgments about the future cash flows of that reporting unit. Although our cash flow
forecasts are based on assumptions that are consistent with our plans and estimates we are
using to manage the underlying businesses, there is significant exercise of judgment
involved in determining the cash flows attributable to a reporting unit over its estimated
remaining useful life. In addition, we make certain judgments about allocating shared
assets to the estimated balance sheets of our reporting units. 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.

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Spin-off
of the Investment in Formula Vision

According
to APB No. 29 Accounting for Nonmonitary 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, that is provided that the operations, assets and liabilities and
cash flows of the component have been eliminated from the companys consolidated
operations and the Company will no longer have any significant continuing involvement in
the operations of the component.

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

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

Revenues.
          Revenues increased 14% from $432.5 million in 2005 to $492.7 million in 2006.
          Revenues from the two categories of our operation were as follows: Revenues
from           the delivery of software services increased 16% from $274.9 million in
2005 to           $320.0 million in 2006. 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
2006           were $172.8 million compared to $157.6 million in 2005, an increase of
10%. This           was due to an increase in BluePhoenixs and Sapiens revenues.
          Magics revenues remained relatively the same in 2006 and 2005.

Cost
of Revenues. Cost of revenues consists primarily of wages and related expenses and
hardware and other materials costs. Cost of revenues increased 16% from $293.6 million in
2005 to $340.0 million in 2006. As a percentage of revenues, cost of revenues were
relatively at the same level in 2005 and in 2006, 68% and 69%, 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
increased 12.4% to $84.4 million in 2006 from $75.1 million in 2005, primarily due to the
increase in the cost of revenues of all of our proprietary software solutions
subsidiaries. Cost of revenues for software services increased 16.5% from $218.6 million
in 2005 to $255.6 million in 2006, primarily due to the increase in the cost of revenues
of our subsidiaries Matrix and nextSource.

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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 2006 and 2005 were $32.3 million and $31.9 million,
respectively. In 2006, we capitalized software costs of $15.9 million compared to $16.5
million in 2005. Capitalization of software costs in 2006 was attributable to our
proprietary software solutions subsidiaries. Software development costs, net, increased
from $15.4 million in 2005 to $16.4 million in 2006. As a percentage of revenues, software
development costs, net remained at the same level in 2006 and 2005, 3.3% and 3.5%,
respectively. The increase in software development costs was attributable primarily to
BluePhoenix, Magic and Sapiens which had research and development expenditures of
approximately $9.4 million, $3.9 million and $2.5 million, respectively. Amortization of
capitalized software costs were $16.4 million in 2006 and $12.4 million in 2005, 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 2006 and 2005 were $113.7 million and $111.2
million, respectively. As a percentage of revenues, selling, general and administrative
expenses remained relatively the same in 2006 and 2005. 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.

Restructuring
Costs.Restructuring costs in 2006 were $3.2 million and were primarily attributable
to restructuring activities of Magic, which had restructuring costs of $2.4 million, and
Sapiens which had restructuring costs of $758,000. The restructuring costs of Magic
resulted mainly from severance payments paid in connection with the restructuring and
impairment plan announced by Magic in the third quarter of 2006, which aimed to reduce
costs and improve profitability. Restructuring costs in 2005 were $1.5 million and were
primarily attributable to restructuring activities of Sapiens which had restructuring
costs of $1.1 million and Magic which had restructuring costs of $342,000. The
restructuring costs of Sapiens resulted from the lay-off of approximately 40 employees.

Operating
Income. Our operating income increased from $10.7 million in 2005 to $19.5 million in
2006. The operating income in 2006 is attributable to the improvement in the operating
results of our subsidiaries, and in particular Matrix which had operating income of $19.2
million, BluePhoenix which had operating income of $8.0 million and a decrease in the net
operating loss of Sapiens, which had operating loss of $1.3 million. The improvement was
offset by the operating loss of $5.4 million of Magic. The operating income in 2005 is
attributable to the improvement in the operating results of our subsidiaries, and in
particular Matrix which had operating income of $17.0 million and our privately held
subsidiary nextSource. BluePhoenixs operating income in 2005 was $4.0 million. The
improvement in 2005 was offset by the operating loss of $4.2 million of Magic and the
operating loss of $5.5 million of Sapiens.

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Financial
Expenses, net. Financial expenses, net increased from $4.0 million in 2005 to $8.1
million in 2006. 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. The increase in financial expenses in 2006 resulted from interest expenses incurred
by our subsidiaries, and in particular, BluePhoenix which had financial expenses of $3.5
million and Sapiens which had financial expenses of $2.2 million. The increase in
BluePhoenix financial expenses was due the issuance of convertible notes in February 2006
and convertible debentures in March 2006. The calculation of the discount amortization and
the fair value adjustments of related financial instruments resulted in non-cash financial
expenses. The non-cash expenses related to the convertible notes and debentures were $1.2
million in 2006 compared to $556,000 in 2005. This increases in our financial expenses was
offset by a decrease in the financial expenses of Matrix and Magic.

Other
income (expenses), net. Other expenses, net in 2006 were $820,000 and other income,
net in 2005 was $704,000.

Gain
on Realization of Shareholdings. Gain on realization of shareholdings in 2006 was $3.8
million compared to $3.2 million in 2005. Gain on realization of shareholdings in 2006 was
attributable primarily to the sale of Matrix One by Matrix and the decrease in the
shareholding percentage by Matrix of its subsidiary Tiltan which resulted in aggregate
consideration of approximately $4.0 million. Gain on realization of shareholdings in 2005
was attributable to the sale of a portion of the shares of Matrix in the open market which
resulted in gain to Formula of $1.7 million, and gain from a decrease in our shareholding
in Matrix due to the conversion of Matrix debentures into shares by third parties which
resulted in gain to Formula of $1.6 million.

Taxes
on Income. Taxes on income in 2006 were $3.5 million compared to $4.8 million in 2005.
The decrease in taxes on income in 2006 was mainly attributable to the decrease in taxes
of Sapiens.

Companys
Equity in Results of Affiliates, net. Our equity in gains of affiliates, net were
$46,000 in 2006 compared to $61,000 in 2005.

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 2006 was $7.2 million compared to $687,000
in 2005.

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

Revenues.
          Revenues increased 9.4% from $395.3 million in 2004 to $432.5 million in 2005.
          The increase in revenues was mainly attributable to incerase in revenues of
          Matrix and nextSource. Such increase was partially offset by a decrease in
          Sapiens and Magics revenues. Revenues from the two categories of
our           operation were as follows: Revenues from the delivery of software services
          increased 21% from $227.3 million in 2004 to $274.9 million in 2005. 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 decreased 6.0% from $168.0 million in 2004 to
          $157.6 million in 2005. This decrease was primarily due to a decrease in
          revenues of Magic and Sapiens which was slightly offset by an increase in
          BluePhoenix revenues.

50

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Cost
of Revenues. Cost of revenues increased 16% from $253.5 million in 2004 to $293.6
million in 2005. As a percentage of revenues, cost of revenues was 64% in 2004 and 68% in
2005. Cost of revenues for proprietary software solutions in 2005 was $75.1 million
compared $75.2 million in 2004. Cost of revenues for software services increased 23% from
$178.3 million in 2004 to $218.6 million in 2005, primarily due to the increase in cost of
revenues of our subsidiaries, Matrix and nextSource.

Software
Development Costs, net. Software developments costs, gross, in 2005 and 2004 were
$31.9 million and $28.7 million, respectively. In 2005, we capitalized software costs of
$16.5 million compared to $13.5 million in 2004. Capitalization of software costs in 2005
was attributable to our proprietary software solutions subsidiaries. Software development
costs, net, in 2005 and 2004 remained relatively at the same level, $15.4 million and
$15.2 million, respectively. As a percentage of revenues, software development costs, net
were 3.6% in 2005 and 3.8% in 2004. Amortization of capitalized software costs were $12.4
million in 2005 and $9.5 million in 2004, which amounts were included in cost of revenues.

Selling,
General and Administrative Expenses. Selling, general and administrative expenses
increased 4% from $106.6 million in 2004 to $111.2 million in 2005. As a percentage of
revenues, selling, general and administrative expenses remained relatively the same in
2004 and 2005.

Restructuring
Costs.Restructuring costs in 2005 were $1.5 million and were primarily attributable
to restructuring activities of Sapiens which had restructuring costs of $1.1 million and
Magic which had restructuring costs of $342,000. The restructuring costs of Sapiens
resulted from the lay-off of approximately 40 employees.

Operating
Income. Our operating income decreased from $20.0 million in 2004 to $10.7 million in
2005. The operating income in 2005 is attributable to the improvement in the operating
results of our subsidiaries, and in particular Matrix which had operating income of $17.0
million and our privately held subsidiary nextSource. BluePhoenixs operating income
in 2005 was $4.0 million. The improvement was offset by the operating loss of $4.2 million
of Magic and the operating loss of $5.5 million of Sapiens. The operating income in 2004
is attributable to the improvement in the operating results of our subsidiaries, in
particular Matrix which had operating income of $15.5 million and BluePhoenix which had
operating income of $3.5 million.

Financial
Expenses, net. Financial expenses, net in 2005 and 2004 were $4.0 million and $5.8
million, respectively. The financial expenses, net in 2005 were mainly attributable to the
influence of the interest expenses incurred by our subsidiaries, Matrix, Sapiens and
BluePhoenix. The financial expenses, net in 2004 were mainly attributable to the influence
of the interest expenses paid on the debentures issued by us to the public and interest
expenses incurred by our subsidiaries, Matrix, Sapiens and BluePhoenix.

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Other
income (expenses), net. Other income, net in 2005 was $704,000 compared to other
expenses of $79,000 in 2004.

Gain
on Realization of Shareholdings. Gain on realization of shareholdings in 2005 was $3.2
million compared to $8.3 million in 2004. Gain on realization of shareholdings in 2005 was
attributable to the sale of a portion of the shares of Matrix in the open market which
resulted in gain to Formula of $1.7 million, and gain from a decrease in our shareholding
in Matrix due to the conversion of Matrix debentures into shares by third parties which
resulted in gain to Formula of $1.6 million. Gain on realization of shareholdings in 2004
was attributable to the sale of a portion of the shares we held in Magic and Matrix in the
open market which resulted in a gain to Formula of $1.1 million, $3.6 million and
$383,000, respectively. In addition, gain on realization of shareholdings in 2004 included
gain from realization of unrealized gains in Matrix of $2.8 million.

Taxes
on Income. Taxes on income in 2005 were $4.8 million compared to $3.6 million in 2004.
The increase in taxes on income in 2005 was mainly attributable to the increase in taxes
of Sapiens which had taxes on income of $1.7 million.

Companys
Equity in Results of Affiliates, net. Our equity in gains of affiliates, net were
$61,000 in 2005 compared to equity in losses of affiliates of $407,000 in 2004. Our equity
in losses of affiliates, net in 2004 relates primarily to affiliates of BluePhoenix.

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 2005 was $687,000 compared to $4.1 million
in 2004. This decrease in minority interest, net is attributable to the increase in the
net loss of Sapiens and Magic which had net loss of $9.1 million and $4.6 million,
respectively. These losses were offset by the increase in net profit of our subsidiaries,
Matrix, BluePhoenix and nextSource.

Impact of Inflation and
Currency Fluctuations on Results of Operations

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

| | that
the inflation rate in Israel will exceed the NIS devaluation rate against the dollar or
the        euro;
|- | -------------------------------------------------------------------------------------------------------------

| | that
the devaluation process will lag behind the NIS inflation timing; or
|- | -------------------------------------------------------------------------

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| | that
the euro experiences devaluation against the dollar.
|- | ---------------------------------------------------------

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

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

|For the year ended December 31, | Inflation rate in Israel | Devaluation of NIS against the US$ | Devaluation of euro against the US$
|------------------------------- | ------------------------ | ---------------------------------- | -----------------------------------
|
|
|
|
|2004                            | 1.2                      | (1.6)                              | (7.4)                              
|2005                            | 2.4                      | 6.8                                | 13.3                               
|2006                            | (0.1)                    | (8.2)                              | (11.3)                             

Political, Economic and
Military Conditions in Israel

Our
headquarters and principal research and development facilities are located in Israel.
Although we generate approximately 45% of our revenues from international markets, we are,
nonetheless, directly influenced by the political, economic and military conditions
affecting Israel. Major hostilities involving Israel, including as a result of the
military conflicts between the Fatah and Hamas in Gaza Strip, Judea and Samaria, or the
interruption or curtailment of trade between Israel and its present trading partners could
have a material adverse effect on our business, operating results and financial condition.
Furthermore, several countries restrict business with Israeli companies. In addition,
nonexempt male adult citizens of Israel, including some of our officers and employees, are
obligated to perform military reserve duty until the age of 40 or 45 depending on their
function in the army, and are subject to being called for active duty under emergency
circumstances. While we have operated effectively under these requirements since our
incorporation, we cannot predict the full impact of such conditions on 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.

|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.

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Cash

At
December 31, 2006 we had cash and cash equivalents and short-term investments of $132.5
million and at December 31, 2005, we had cash and cash equivalents and short-term
investments of $81.6 million. At December 31, 2006, we had indebtedness to banks and
others of $120.3 million, of which $41.0 million was current liabilities and $79.3 million
was long-term liabilities. At December 31, 2005, we had indebtedness to banks and others
of $117.3 million, of which $64.9 million was current liabilities and $52.4 million was
long-term liabilities.

Formula
has entered into credit facilities with several banks, pursuant to which Formula may
borrow from time to time, on a short-term and long-term basis, up to an aggregate of
approximately $16.0 million, as of the date of this annual report. Formulas loan
agreements contain a number of conditions and limitations on the way in which Formula can
operate its business, including limitations on its ability to raise debt and sell assets.
The loan agreements also contain various covenants which require Formula to maintain
certain financial ratios related to shareholders equity and operating results.

Some
of Formulas assets are pledged to banks. These assets include certain of our
shareholdings in Matrix and Magic.

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

Cash
flow provided by operating activities in 2006 was $26.0 million compared to cash flow
provided by operating activities of $6.3 million in 2005.

Financing
activities

Cash
flow used in financing activities in 2006 was $4.0 million compared to cash flow used in
financing activities of $3.2 million in 2005. This was mainly the result of the following
transactions:

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. As a result, we no longer hold an interest in Formula
Vision.

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On
December 31, 2006, Formula Vision paid approximately $51 million to us, as a full
repayment of the principal and interest owed to us by Formula Vision.

In
April 2006, we repaid the outstanding amount of the debentures issued by us to FIMI and
IDB. The aggregate amount repaid by us was approximately $3.6 million.

In
March 2006, BluePhoenix completed a $3 million follow-on private placement of convertible
debentures and warrants to certain institutional investors, who previously invested in
BluePhoenix in 2004.

In
March 2006, Matrix distributed to its shareholders a cash dividend in the aggregate amount
of approximately $3.0 million, of which $1.5 million was received by Formula.

In
February 2006, BluePhoenix completed a public offering in Israel of convertible debentures
convertible into BluePhoenix ordinary shares, resulting in gross proceeds to BluePhoenix
of approximately $11.5 million.

In
2006, Formula and certain of our subsidiaries received long term loans of approximately
$31.4 million from banks, of which $11.8 million were received by Formula, $14.4 million
by BluePhoenix and $4.9 million by Matrix.

In
2006, our subsidiaries repaid long-term loans to banks and others of approximately $9.7
million of which $8.0 million was repaid by Matrix and $1.1 million by Sapiens.

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

In
June 2005, we distributed to our shareholders a cash dividend of approximately $4.0 per
share. The aggregate amount distributed by Formula was approximately $50.2 million.

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

In
2005, Formula and certain of our subsidiaries received long-term loans of approximately
$51.2 million from banks, of which $30.4 million were received by Formula, $7.0 million by
BluePhoenix and $13.5 million by Matrix.

In
2005, our subsidiaries repaid long-term loans to banks and others of approximately $19.6
million of which $7.5 million were repaid by Matrix, $9.7 million by Sapiens and $1.8
million by Formula Vision.

In
2005, FTS, a subsidiary of Formula Vision, consummated a public offering of its shares at
the AIM, the London Stock Exchange. The net proceeds to FTS were $5.3 million.

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In
2005, Matrix distributed to its shareholders a cash dividend in the aggregate amount of
approximately $8.9 million, of which $4.5 million was received by Formula.

In
2005, certain of Formula Visions subsidiaries distributed to their shareholders cash
dividends in the aggregate amount of $6.2 million, of which approximately $3.5 million
were distributed to the minority shareholders.

Investing
activities

Net
cash used in investing activities in 2006 was $6.2 million and in 2005, $24.2 million.
These investing activities were comprised of the following transactions:

In
February 2006, Formula Vision sold certain of its holdings in its affiliate, FIS, to a
third party for a consideration of $4.0 million.

In
February 2006, Formula Vision sold the activities of its subsidiary T-Soft for a
consideration of $3.0 million.

In
March 2006, Formula Vision sold certain of its holdings in its affiliate Transtech to a
third party for a consideration of $8.75 million.

In
April 2006, Formula Vision paid to FIMI and IDB $5.4 million.

In August
2006, we invested $2.0 million in Sapiens in consideration for 1,562,500 common shares of
Sapiens issued to us by Sapiens.

In
2006, we purchased in the open market shares of several of our subsidiaries as follows:
624,216 shares of Matrix for aggregate consideration of $1.9 million, 3,622,697 shares of
Formula Vision for aggregate consideration of $1.3 million and 252,400 shares of Sapiens
for aggregate consideration of $336,686.

In
2006, we converted warrants of Matrix into 704,592 shares of Matrix for consideration of
$1.3 million.

In
2006, our subsidiaries capitalized software development costs and other costs in an
aggregate amount of $18.8 million.

In
2005, we sold 1,557,352 of Matrix shares in the open market for aggregate consideration of
$4.3 million.

In
2005, we purchased in the open market shares of several of our subsidiaries as follows:
81,856 shares of BluePhoenix for aggregate consideration of $337,000, 484,432 shares of
Formula Vision for aggregate consideration of $358,000 and 380,636 shares of Sapiens for
aggregate consideration of $760,000.

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In
2005, we converted warrants of Matrix into 5,300,000 shares of Matrix for consideration of
$8.3 million.

In
June 2005, we invested $2.0 million in Sapiens in consideration for 1,041,667 common
shares of Sapiens issued to us by Sapiens.

In
2005, our subsidiaries capitalized software development costs and others in an aggregate
amount of $17.7 million.

In
2005, we sold in the open market marketable securities for aggregate consideration of
$13.9 million (of which $10.3 million were sold by Sapiens, $1.5 million were sold by
Formula and $664,000 were sold by Magic).

During
2005, our subsidiaries acquired certain investments resulting in aggregate consideration
of $5.3 million, of which $3.3 million was paid by Formula Vision, $1.3 million was paid
by BluePhoenix and $600,000 was paid by Matrix.

Recent
investment activities

On
June 20, 2007 we completed the sale of our entire shareholdings in BluePhoenix to
international institutional investors for aggregate consideration of approximately $64
million.

In
June 2007, we invested $5.0 million in Sapiens in consideration for 1,606,667 common
shares of Sapiens issued to us by Sapiens.

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

Commitments and
Contingent Liabilities

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

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

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.

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Related Party Transactions

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 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 holds does 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). Formula believes that it was in the best interests
of Formula to effect such amendment due to Formulas shareholding interest in Formula
Vision at that time and other strategic reasons.

Effective Corporate Tax
Rates in Israel

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

On
January 1, 2006, an additional tax reform has taken 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 31% in 2006,
29% in 2007, 27% in 2008, 26% in 2009 and 25% in 2010.

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

In
2006, we spent $16.4 million on research and development activities, in 2005 we spent
$15.4 million and in 2004 we spent $15.2 million. The increase in the amount spent on
research and development activities in 2006 compared to 2005 relates primarily to an
increase in research and development expenditures of BluePhoenix . The amount spent on
research and development activities in 2005 remained at the same level compared to 2004.
For a description of 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
|-- | -----------------

We
are affected by global economic changes, in particular trends in capital spending in the
IT sector. Changes in purchasing patterns in the IT industry directly affect our operating
results. For example, during 2001 through 2003, the overall business slowdown in the North
American and European markets influenced the purchasing patterns of leading software
developers who delayed their planned orders and caused developers to reduce the amount of
their planned license commitment. These changes in purchasing patterns in the IT industry
directly affected the operating results of some of our subsidiaries, which in turn
affected our consolidated operating results. In 2006, we generated $10.0 million net
income from our operations. However, in 2002 and 2001 we had a net loss of $2.4 million
and $59.9 million, respectively. The net loss in 2002 and 2001 was a reversal from prior
years in which we had net income. As IT spending is more cautious, we have pursued a
strategy aimed at addressing current market needs through the introduction of
cost-effective, new and enhanced products. We cannot know how the economic conditions will
continue to affect our business.

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|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,
2006.

|                                                      | Payments due by period
|----------------------------------------------------- | ----------------------
|
|
|
|
|Long term debt obligations                            |                       
|                                                      |                       
|Lease obligations                                     |                       
|                                                      |                       
|Liability in respect of the acquisition of activities |                       
|                                                      |                       
|Other long-term liabilities reflected on our 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.

# ITEM 6. DIRECTORS,
SENIOR MANAGEMENT AND EMPLOYEES

|A. | Directors
and Senior Management
|-- | -------------------------------

The
following table describes information about our directors and senior management as of June
20, 2007.

|Name                   | Age | Position                             
|---------------------- | --- | -------------------------------------
|
|
|
|
|Gad Goldstein          | 48  | President and Chief Executive Officer
|Naamit Salomon         | 43  | Chief Financial Officer              
|Guy Bernstein          | 39  | Chairman of the Board                
|Shimon Laor            | 38  | Director                             
|Tal Barnoach           | 44  | Director                             
|Hadas Gazit Kaiser     | 31  | Director                             
|Dr. Shlomo Nass        | 47  | Director                             
|Dr. Ronnie Vinkler (1) | 61  | Director                             
|Ofer Lavie (1)         | 62  | Director                             

---

(1)     Outside
director. 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.

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Gad
Goldstein was appointed our president in 1995 and has served as our chief executive
officer since 2006. Mr. Goldstein is also a director of other companies within the Formula
Group, including Matrix, Magic and Sapiens. Mr. Goldstein holds a BA degree in economics
and a Masters degree in business administration, both from Tel Aviv University.

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

Guy
Bernstein has served as one of our directors since November 2006. Since December 2006,
he has served as the chief executive officer of Emblaze, our controlling shareholder, a
publicly-traded company listed on the AIM, the London Stock Exchange. From April 2004 to
December 2006, Mr. Bernstein served as the chief financial officer of Emblaze and 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, a position he held since 1999. He
joined Magic 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.

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
Orca Interactive Ltd. and Visual Defence Inc., partially-owned subsidiaries 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.

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, a
publicly-traded company listed on the AIM. In addition, he serves 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.. From 2000 and until 2003, he served as the chairman of
Icognito and Dotomi. 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 has
served as the chief financial officer and finance director of Emblaze since December 2006.
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.
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.

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Dr.
          Shlomo Nasshas served as one of our directors since April 2003. Mr. Nass
is           the 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.,           Ayalon Insurance Company Ltd., TAO, N.M.C. and Yuli Shukei Hon 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.
          Mr. Winkler is an independent business development and management analysis
          consultant. He has many years of experience in the Hi-tech industries, projects
          management and research and development. Dr. Vinkler also serves as a director
          of Mofet Israel Technology Fund Ltd. In 2002 and 2003, Mr. 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. Mr. 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 publicly-traded company listed on the
NASDAQ Global Market and the TASE. Mr. Lavie also serves as chairman of the international
tax subcommittee of the CFO Forum and as a director of Yozma Pension Fund for Self
Employed Ltd. and of Procognia Israel Ltd. Mr. Lavie holds a B.Sc. degree in economics
from Tel Aviv University.

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

In
2006, we paid to our directors and officers (nine persons) aggregate direct remuneration
of approximately $1.1 million. This amount includes amounts set aside or accrued to
provide post-employment benefits.

This
amount does not include the following:

| |  | amounts
expended by us for automobiles made available to our officers;
| | - | ----------------------------------------------------------------------

| |  | expenses,
including business travel, professional and business association dues and expenses,
                that we reimburse our officers for; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------

| |  | other
fringe benefits that companies in Israel commonly reimburse or pay to their officers.
| | - | -------------------------------------------------------------------------------------------

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The
amount also includes payment of directors fees to our outside directors and Mr.
Shlomo Nass. We compensate our outside directors in accordance with the regulations
promulgated under the Israeli Companies Law, 1999, referred to as the Companies Law. We
compensate Mr. Shlomo Nass in such amounts specified in the regulations.

Our
employee directors do not receive fees for their services as directors. In 2006, we paid
an aggregate amount of $53,500 for post-employment benefits for our executive officers and
directors. Under Israeli law, we are not required to disclose, and have not otherwise
disclosed, the compensation of our senior management and directors on an individual basis.

We
entered 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 3 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. Two of our executive officers
are entitled to bonuses which aggregate approximately 2% of our consolidated net income
exceeding $10 million. These two executive officers are also entitled to compensation in
the event of a sale of a certain subsidiary, such compensation to be calculated based on
the net proceeds from the sale.

|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.

Outside
Directors

Under
the Companies Law, companies incorporated under the laws of Israel whose shares have been
offered to the public in or outside of Israel, are required to appoint at least two
outside directors. This law provides that a person may not be appointed as an outside
director if the person or the persons relative, partner, employer or any entity
under the persons control, has, as of the date of the persons appointment to
serve as outside director, or had, during the two years preceding that date, any
affiliation with the company or any entity controlling, controlled by or under common
control with the company. The term affiliation includes:

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| |  | 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 and Ofer Lavie have financial and
accounting expertise.

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
February 2008. Under a recent amendment to 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.

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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.

Qualifications
of Other Directors

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 each of Shlomo Nass and Ofer Lavie 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.

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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.

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 2006 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;
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | (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
| | ---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (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.

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Approval
of Certain Transactions Under the Companies Law

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

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

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

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

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

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

| | a
person would become, as a result of such transaction, a controlling shareholder of the
company.
|- | -------------------------------------------------------------------------------------------------

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

We
have approximately 5,960 full-time employees, of whom approximately 5,150 are software
professionals. In 2005, we had approximately 4,660 full-time employees, of whom
approximately 4,100 were software professionals. In 2004, we had approximately 4,240
full-time employees, of whom approximately 3,700 were software professionals. The increase
in the number of employees in 2006 compared to 2005 related primarily to the increase in
the number of employees in Matrix and nextSource. The increase in the number of employees
in 2005 compared to 2004 stems from an increase in the number of employees of members of
the group as a result of the growth in their activities, in particular Matrix and
nextSource.

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

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

As
of June 20, 2007, none of our directors and officers had a share ownership in our company,
nor did they hold options to purchase shares.

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

Formula
has no option plan or arrangement which is currently in effect for involving its employees
in the share capital of the company.

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

# ITEM 7. MAJOR
SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

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

The
following table presents information regarding the ownership of our ordinary shares at
June 20, 2007 by each person known to us to be the beneficial owner of more than 5% of our
ordinary shares based on information provided to us by the holders or disclosed in public
filings with the SEC. None of the holders of the ordinary shares listed in this table have
voting rights different from other holders of our ordinary shares. Except where we have
indicated otherwise, we believe, based on information furnished by these owners, that the
beneficial owners of our shares listed below have sole investment and voting power with
respect to the shares.

|Name and Address                             | Shares Beneficially
Owned | Percent of
Class (1)
|-------------------------------------------- | ------------------------- | --------------------
|
|
|
|
|Emblaze Ltd.(2)                              |                           |                     
|                                             |                           |                     
|Menora Mivtachim Holdings Ltd.(3)            |                           |                     
|                                             |                           |                     
|Clal Insurance Enterprises Holdings Ltd. (4) |                           |                     

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---

|(1) | Ordinary
shares deemed beneficially owned by virtue of the right of any person                or
group to acquire these ordinary shares within 60 days of June 20, 2007, are
               treated as outstanding only for the purposes of determining the percent
owned by                this person or group. Percentages in the above table are based on
13,200,000                ordinary shares outstanding as of June 20, 2007.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(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 June 20, 2007, Emblase
purchased additional                shares of Formula in the open market and in privately
negotiated transactions,                bringing its holdings in Formula to 50.1% as of
June 20, 2007. Emblaze is a                public company traded on the AIM. 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 13.81% of the outstanding                share capital
of Emblaze) and Eli Reifman, vice-chairman of the board of                directors of
Emblaze (who holds approximately 9.43% of the outstanding share                capital of
Emblaze).
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Menora
Mivtachim Holdings Ltd. is a holding company publicly-traded on the TASE.
               63.56% of Menora Mivtachim Holdings outstanding shares are held,
directly                and indirectly, by Menachem Gurevitch, and 36.44% is held by the
public.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Clal
Insurance Enterprises Holdings Ltd. is publicly traded on the TASE. The
               controlling shareholder of Clal Insurance is IDB Development Corporation
Ltd.                (51.2%) and Bank Hapoalim Ltd. holds a 14.1% interest in Clal
Insurance.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As
of June 20, 2007, 13,200,000 ordinary shares were issued and outstanding, excluding 24,780
ordinary shares that we purchased during 2002. On June 20, 2007, we had approximately 4
shareholders of record. All of our ordinary shares have equal voting rights. However,
under applicable Israeli law, the shares we hold have no voting rights and, therefore, are
excluded from the number of our outstanding shares.

As
of June 20, 2007, 390,446 ADSs were issued and outstanding pursuant to a depositary
agreement with The Bank of New York, representing 390,446 of our ordinary shares. As of
that date, there were approximately 17 registered holders of ADSs in the United States.

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

Transactions
between Formula and Formula Vision

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

In
January 2004, Formula Vision issued to Formula 38,000,000 shares representing 59.4% of
Formula Visions outstanding share capital in exchange for $35 million of the amount
of the debentures. The price per share reflected the average closing market price of
Formula Visions shares on the TASE during the 30 days preceding the date of approval
of the transaction by Formulas board of directors.

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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
holds does 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). In
2005, such loans exceeded the amount of cash and cash equivalents of Formula Vision. On
December 31, 2006, Formula Vision paid approximately $51 million to us, as a full
repayment of the principal of the debentures and interest accrued thereon.For more information about the amendment of the debentures, see Item
5. Operating and Financial Review and ProspectsLiquidity and Capital
ResourcesRelated Party TransactionsTransactions between Us and Formula
Vision.

Indemnification
of Office Holders

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

The
new indemnification letters provide, among other things, that we will indemnify each of
our office holders to the maximum extent permitted by our articles of association. Advance
payments for coverage of legal expenses in criminal proceedings will be required to be
repaid by our 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 our 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.

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

72

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| | (i) | a
breach by the office holder of his or her duty of loyalty, unless the office
          holder acted in good faith and had a reasonable basis to believe that the act
          would not prejudice the company;
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (ii) | a
breach by the office holder of his or her duty of care if the breach was done
          intentionally or recklessly;
| | ---- | ----------------------------------------------------------------------------------------------------------------------

| | (iii) | any
act or omission done with the intent to derive an illegal personal benefit;           or
| | ----- | --------------------------------------------------------------------------------------------

| | (iv) | any
fine levied against the office holder.
| | ---- | ------------------------------------------

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

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 2006 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, except as described below.

In
July 2003, a former Liraz shareholder filed an application with the Tel Aviv Jaffa
District Court to approve a claim filed by him against BluePhoenix, as a class action. The
claim relates to the acquisition of Liraz shares, which BluePhoenix completed in March
2003. The shareholder alleges that the share price BluePhoenix paid to Lirazs
shareholders in the tender offer and in a subsequent mandatory purchase was lower than the
fair price of Liraz shares. The maximum amount of the claim is approximately $7.3 million
in the aggregate. Under Israeli law, the courts approval is required for the
plaintiff to represent all of the shareholders of Liraz who sold their shareholdings to us
pursuant to the tender offer and the mandatory acquisition. The plaintiff has applied for
such approval in the lawsuit. Based on BluePhoenixs analysis of the statement of
claim, including an evaluation of the fair value of the Liraz shares, and the price paid
for Liraz in a previous transaction immediately prior to the tender offer, we believe that
the allegations against BluePhoenix in this proceeding are without merit and intend to
vigorously defend the claim and contest the allegations made therein.

Dividend
policy

In
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.

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.

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

Except
for the sale of BluePhoenix shares consummated in June 2007 and as otherwise disclosed in
this annual report, there has been no material change in our financial position since
December 31, 2006.

# 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 June
20, 2007 was NIS 4.187 = $1.00.

|Period                 | Closing Price Per Share
|---------------------- | -----------------------
|
|
|
|
|2002                   |                        
|2003                   |                        
|2004                   |                        
|2005                   |                        
|First Quarter          |                        
|Second Quarter         |                        
|Third Quarter          |                        
|Fourth Quarter         |                        
|2006                   |                        
|First Quarter          |                        
|Second Quarter         |                        
|Third Quarter          |                        
|Fourth Quarter         |                        
|December               |                        
|2007                   |                        
|First Quarter          |                        
|January                |                        
|February               |                        
|March                  |                        
|April                  |                        
|May                    |                        
|June (through June 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 National Market.

|Period                 | Closing Price Per Share
|---------------------- | -----------------------
|
|
|
|
|2002                   |                        
|2003                   |                        
|2004                   |                        
|2005                   |                        
|First Quarter          |                        
|Second Quarter         |                        
|Third Quarter          |                        
|Fourth Quarter         |                        
|2006                   |                        
|First Quarter          |                        
|Second Quarter         |                        
|Third Quarter          |                        
|Fourth Quarter         |                        
|December               |                        
|2007                   |                        
|First Quarter          |                        
|January                |                        
|February               |                        
|March                  |                        
|April                  |                        
|May                    |                        
|June (through June 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 National Market, under
the symbol FORTY.

|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 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.

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 25% of the voting rights of
the acquirer which would result in any shareholder becoming a controlling shareholder;
and
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | there
is no cross ownership of shares of the merging companies, as described above.
|- | -------------------------------------------------------------------------------------

Tender
Offers

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

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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 and the transactions with Formula
Vision as material contracts. For more information about these transactions, 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
of the depositary, the Bank of New York and Israeli income taxes. Because exchange rates
between the NIS and the dollar fluctuate continuously, a U.S. shareholder will be subject
to the risk of currency fluctuations between the date when we declare NIS-denominated
dividends and the date when we pay them in NIS. See Item 3. 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 information regarding Israeli tax laws to which U.S. and other non-Israeli
shareholders may be subject. The information below does not apply to specified persons or
cover specified situations. Therefore, you are advised to consult your own tax advisor as
to particular tax consequences unique to you related to an investment in our ordinary
shares or ADSs, including the effects of applicable Israeli or foreign or other tax laws
and possible changes in the tax laws.

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

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 for 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, 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 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 by the company paying the dividend,
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 (as defined in the Investment Law) 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 of
which the company owns 50% or more of the outstanding voting shares.

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A
nonresident of Israel who receives dividends with respect to 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 material United
States federal income tax consequences of the purchase, ownership and disposition of our
ordinary shares or ADSs to a United States holder. A United States holder is a holder of
our ordinary shares or ADSs who is:

| |  | an
individual 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.

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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 or who own, directly, indirectly or constructively, 10% or more of our
outstanding voting shares, United States holders holding the ordinary shares or ADSs as
part of a hedging, straddle or conversion transaction, United States holders whose
functional currency is not the United States dollar, insurance companies, tax-exempt
organizations, financial institutions, financial service entities, persons who
acquired their shares upon the exercise of employee stock options or otherwise as
compensation, real estate investment trusts, regulated investment companies, grantor
trusts, individual retirement and tax-deferred accounts, certain former citizens or
long-term residents of the United States and persons subject to the alternative minimum
tax, who may be subject to special rules not discussed below. Additionally, the tax
treatment of persons who are, or hold the ordinary shares or ADSs through, a partnership
or other pass-through entity is not considered, nor is the possible application of United
States federal estate or gift taxes or any aspect of state, local or non- United States
tax laws.

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

Taxation
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 Israeli
taxes withheld, as described above under Israeli Taxation. 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 foreign corporation if certain
holding period and other requirements are met and either (a) the stock of the foreign
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 foreign 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.

85

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

Dividends
paid by us in NIS generally will be included in the income of United States holders at the
dollar amount of the dividend (including any Israeli taxes withheld therefrom), based upon
the spot rate of exchange in effect on the date 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 will 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 Israeli income tax withheld from dividends received in
respect of the ordinary shares or ADSs. The limitations on claiming a foreign tax credit
include, among others, computation rules under which foreign tax credits allowable with
respect to specific classes of income cannot exceed the United States federal income taxes
otherwise payable with respect to each such class of income. In this regard, dividends
paid by us generally will be foreign source passive income for U.S. foreign
tax credit purposes or, in the case of a financial services entity, financial
services income (and for the tax years beginning after December 31, 2006 as
general category income). United States holders that do not elect to claim a
foreign tax credit may instead claim a deduction for the Israeli income tax withheld if
they itemize deductions. The rules relating to foreign tax credits are complex, and you
should consult your tax advisor to determine whether and to what extent you would be
entitled to this credit. A United States holder will be denied a foreign tax credit for
Israeli income tax withheld from a dividend received on the ordinary shares or ADSs (i) if
the United States holder has not held the ordinary shares or ADSs for at least 16 days of
the 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. Distribution of current or accumulated earnings and
profits generally will be foreign source passive income for United States foreign tax
credit purposes.

86

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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 limitations.

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) will have foreign exchange gain or loss
based on any appreciation or depreciation in the value of the foreign currency against the
dollar, which will generally be United States source ordinary income or loss.

87

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Tax Consequences if We
Are a Passive Foreign Investment Company

We
will be a passive foreign investment company, or PFIC, for a taxable year if either (1)
75% or more of our gross income in the taxable year is passive income; or (2) the average
percentage (by value) 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.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 each year and the
United States holder recognizes as ordinary income or loss an amount equal to the
difference as of the close of the taxable year between the fair market value of our
ordinary shares or ADSs and the United States holders adjusted tax basis therein.
Losses are allowed only to the extent of net mark-to-market gain previously included by
the United States holder under the election for prior taxable years. An electing United
States holders adjusted basis in our ordinary shares or ADSs is increased by income
recognized under the mark-to-market election and decreased by the deductions allowed
under the election.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

88

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| | Under
the mark-to-market election, gain on the sale of our ordinary shares or ADSs is treated
as ordinary income, and loss on the sale of our ordinary shares or ADSs, to the extent
the amount of loss does not exceed the net mark-to-market gain previously included, is
treated as ordinary loss (losses in excess of net mark-to-market gain previously included
is generally capital loss). The mark-to-market election applies to the tax year for which
the election is made and all later tax years, unless the ordinary shares or ADSs cease to
be marketable or the 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) 100% of the gain from the disposition of our
ordinary shares or ADSs (including gain deemed recognized if the ordinary shares or ADSs
are used as security for a loan).
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Excess
distributions must be allocated ratably to each day that a United States holder has held
our ordinary shares or ADSs. A United States holder must include amounts allocated to the
current taxable year and to any period prior to the first day of the first taxable year
for which we are a PFIC in its gross income as ordinary income for the current taxable
year. All amounts allocated to other years of the United States holder would be taxed at
the highest tax rate for each such prior year applicable to ordinary income. The United
States holder also would be liable for interest on the deferred tax liability for each
such other year calculated as if such liability had been due with respect to each such
other year. The portions of distributions that are not characterized as excess
distributions are subject to tax in the current year under the normal tax rules of
the Code. A United States person who inherits shares or ADSs in a foreign corporation
that was a PFIC in the hands of the decedent is generally denied the otherwise available
step-up in the tax basis of such shares or ADSs to fair market value at the date of death.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We
believe that in 2006 we were not a PFIC and currently we expect that we will not be a PFIC
in 2007. However, PFIC status is determined as of the end of the taxable year and is
dependent on a number of factors, including the value of our assets and the amount and
type of our gross income. Therefore, there can be no assurance that we will not become a
PFIC for the current taxable year ending December 31, 2007 or in a future year. We will
notify United States holders in the event we conclude that we will be treated as a PFIC
for any taxable year to enable United States holders to consider whether or not to elect
to treat us as a QEF for United States federal income tax purposes or to mark to
market the ordinary shares or ADSs or to become subject to the excess
distribution regime.

89

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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 and tax-exempt organizations, 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.

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 will be subject to tax in the United
States if the non-United States holder is present in the United States for 183 days or
more in the taxable year of the sale and other conditions are met.

Non-United
States holders 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.

90

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|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 reports with the SEC, including annual reports
on Form 20-F by June 30 each year. In addition, we file 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 SECs public
reference room, located 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 at such address. Please call the SEC at 1-800-SEC-0330 for further
information on the public reference room. In addition, the SEC maintains an Internet
website at http://www.sec.gov that contains reports and other material that are
filed through the SECs Electronic Data Gathering, Analysis and Retrieval
(EDGAR) system. Formula began filing through the EDGAR system beginning in
October 2002.

Descriptions
of contracts or other documents in this annual report are necessarily summaries. If the
contract or document described is filed as an exhibit to this annual report, you should
refer to the exhibit for the complete text of such contract or document.

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.

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

91

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# ITEM 11. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

# Currency Exchange Rate
Fluctuations and Impact of Inflation

In
light of the nature of Formulas activities, Formula invests its cash and cash
equivalents in short-term deposits. As of December 31, 2006, Formula invested
substantially all of the cash it held in dollar accounts bearing interest based on LIBOR
and in NIS accounts bearing interest based on the Israeli prime rate. In addition, Formula
has outstanding short-term and long-term loans in NIS.

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

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

# Fluctuations in Market
Price of Securities We Hold

We
hold securities of several publicly traded companies on the NASDAQ Global Market and the
TASE. These companies include Magic, 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.

# 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.

92

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# ITEM 14. MATERIAL
MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

Not applicable.

# ITEM 15T. CONTROLS AND
PROCEDURES

(a)Disclosure
Controls and Procedures.Formulas management, with the participation of its
chief executive officer and chief financial officer, evaluated the effectiveness of
Formulas disclosure controls and procedures over financial reporting (as defined in
Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of December 31, 2006. Based on
this evaluation, its chief executive officer and chief financial officer have concluded
that, as of such date, Formulas disclosure controls and procedures were (1) designed
to ensure that information relating to Formula, including its consolidated subsidiaries,
is accumulated and communicated to its management, including its chief executive officer
and chief financial officer, and by others within those entities, as appropriate to allow
timely decisions regarding required disclosure, particularly during the period in which
this report was being prepared; and (2) effective, in that they provide reasonable
assurance that information required to be disclosed by Formula in the reports that it
files or submits under the Exchange Act, is recorded, processed, summarized and reported
within the periods specified by the SECs rules and forms.

(b)Managements
Annual Report on Internal Control Over Financial Reporting.Formulas management,
under the supervision of its chief executive officer and its chief financial officer, is
responsible for establishing and maintaining adequate internal controls over financial
reporting for Formula. Based on the top-down, risk-based approach for testing the
effectiveness of internal controls, management has assessed Formulas internal
control over financial reporting as effective as of December 31, 2006.

Because
of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Projections of any evaluation of effectiveness to future periods are
subject to the risks 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. In
          accordance with temporary SEC rules, this annual report does not include an
          attestation report regarding internal control over financial reporting of
          Formulas registered public accounting firm.

(d)
Changes in Internal Control Over Financial Reporting.No change in
          Formulas internal controls over financial reporting (as defined in
          Rules 13a-15(f) and 15d-15(f) of the Exchange Act) occurred
          during the year ended December 31, 2006, that has materially affected, or
          is reasonably likely to materially affect, Formulas internal control over
          financial reporting.

93

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# ITEM 16. [RESERVED]

# ITEM 16A. AUDIT
COMMITTEE FINANCIAL EXPERT

Our
board of directors has determined that each of Shlomo Nass and Ofer Lavie, members of our
audit committee and independent members 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 registered public accountants (Isr.) BDO member firm. These services
may include audit services, audit-related services, tax services and other services, as
further described below. The audit committee sets forth the basis for its pre-approval in
detail, listing the particular services or categories of services which are pre-approved,
and setting forth a specific budget for such services. Additional services may be
pre-approved by the audit committee on an individual basis. Once services have been
pre-approved, Ziv Haft registered public accountants (Isr.) BDO member firm and our
management then report to the audit committee on a periodic basis regarding the extent of
services actually provided in accordance with the applicable pre-approval, and regarding
the fees for the services performed.

Principal Accountant Fees
and Services

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

| |                    | 2006 | 2005
| | ------------------ | ---- | ----
|
|
|
|
| | Audit Fees         |      |     
| | Audit-Related Fees |      |     
| | Tax Fees           |      |     
| | All Other Fees     |      |     
| |                    |      |     
| | Total              |      |     
| |                    |      |     

94

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The
Audit Fees for the years ended December 31, 2006 and 2005 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 year ended December 31, 2005 were incurred by one of our
subsidiaries in connection with audits related to acquisitions.

Tax
Fees for the years ended December 31, 2006 and 2005 were for services related to tax
compliance, including the preparation of tax returns and claims for refund, and tax
advice.

All
other Fees for the year ended December 31, 2006 were primarily for due diligence related
to acquisitions of certain subsidiaries.

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

Not applicable.

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

Not applicable.

95

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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 report 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, 2006 and 2005                                                       | F-2 
|Consolidated Statements of Operations for theYears Ended December 31, 2006, 2005 and 2004                       | F-4 
|Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2006, 2005 and 2004 | F-5 
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004                      | F-6 
|Notes to Consolidated Financial Statements                                                                      | F-11

# 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 |  | An
agreement dated November 17, 2005 between the Registrant and Formula Vision Technologies
(F.V.T) Ltd. (English translation                               from Hebrew original)(2)
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

96

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# Exhibit No.

|4.3 |  | International
Securities Purchase Agreement dated June 15, 2007 between the Registrant and each of the
purchasers identified on the signature pages of the agreement
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

---

(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.

97

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FORMULA SYSTEMS (1985) LTD.

(An Israeli corporation)

2006 Annual Report

---

---



FORMULA SYSTEMS (1985) LTD.

(An
Israeli Corporation)

2006
CONSOLIDATED FINANCIAL STATEMENTS

TABLE OF CONTENTS

|                                                         |  |                
|-------------------------------------------------------- |  | ---------------
|                                                         |  | Page           
|                                                         |  |                
|                                                        
|REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM: |  | F  1          
|                                                         |  |                
|CONSOLIDATED
  FINANCIAL STATEMENTS:                     |  |                
|                                                         |  |                
|Balance Sheets                                           |  | F  2  F  3  
|                                                         |  |                
|Statements of
Operations                                 |  | F  4          
|                                                         |  |                
|Statements of Changes in
Shareholders
  Equity          |  | F  5          
|                                                         |  |                
|Statements of Cash
Flows                                 |  | F  6  F  10 
|                                                         |  |                
|Notes to Financial
Statements                            |  | F  11  F  61

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

---

---

---

---

---



Report of Independent
Registered Public Accounting Firm

To the Shareholders and Board of Directors of

FORMULA SYSTEMS (1985) LTD.

We have audited the
consolidated balance sheets of Formula Systems (1985) Ltd. and its subsidiaries
(the Company) as of December 31, 2006 and 2005 and the consolidated statements
of operations, changes in shareholders equity and cash flows for each of the
three years in the period ended December 31, 2006. 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  19% and  22.27%  of  total
consolidated  assets as of  December  31, 2006 and 2005,  respectively,  and whose  consolidated  revenues
constitute  approximately  23%,  24.42%  and 28.58% of total  consolidated  revenues  for the years  ended
December 31, 2006,  2005 and 2004,  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. The company is not required to have, nor were we engaged
to perform, an audit of its internal control over financial reporting.

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

In our opinion, based on our
audits and the reports of other auditors, the consolidated financial statements
present fairly, in all material respects, the consolidated financial position
of the Company as of December 31, 2006 and 2005, and the related consolidated
results of operations and cash flows for each of the three years in the period
ended December 31, 2006, in conformity with generally accepted accounting
principles as applied in the United States of America.

|                 |                                      
|---------------- | -------------------------------------
|Tel-Aviv, Israel |                                      
|________, 2007   |                                      
|                 |                                      
|                 | Ziv
  Haft                           
|                 | Certified
  Public Accountants (Isr.)
|                 | BDO
  member firm                    

F  1

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

CONSOLIDATED BALANCE SHEETS

|                                                                                                                                 |  |                         |         |      |  |         | 
|-------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ------- | 
|                                                                                                                                 |  | December 31,            |        
|                                                                                                                                 |  |                         |        
|                                                                                                                                 |  | 2006                    |         | 2005 | 
|                                                                                                                                 |  |                         |         |      | 
|                                                                                                                                 |  | (U.S. $ in
  thousands) |        
|                                                                                                                                 |  |                         |        
|ASSETS                                                                                                                           |  |                         |         |      |  |         | 
|                                                                                                                                
|CURRENT ASSETS:                                                                                                                  |  |                         |         |      |  |         | 
|                                                                                                                                
|Cash and cash
  equivalents                                                                                                      |  |                         | 116,402 |      |  | 63,849  | 
|                                                                                                                                
|Short-term
  investments (Note 3)                                                                                                |  |                         | 16,084  |      |  | 17,711  | 
|                                                                                                                                
|Trade
  receivables (net of allowances for doubtful debts of $4,866 and $4,781 as of
  December 31, 2006 and 2005, respectively) |  |                         | 149,335 |      |  | 112,396 | 
|                                                                                                                                
|Other current
  assets (Note 16A)                                                                                                |  |                         | 19,155  |      |  | 18,223  | 
|                                                                                                                                
|Inventories                                                                                                                      |  |                         | 3,080   |      |  | 3,731   | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|                                                                                                                                 |  |                         | 304,056 |      |  | 215,910 | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|LONG-TERM INVESTMENTS, LOANS AND
  RECEIVABLES:                                                                                  |  |                         |         |      |  |         | 
|                                                                                                                                
|Loans and other
  investments (Note 4)                                                                                           |  |                         | 3,915   |      |  | 2,021   | 
|                                                                                                                                
|Long term trade
  receivables                                                                                                    |  |                         | 1,390   |      |  | -       | 
|                                                                                                                                
|Investments in
  affiliates (Note 5)                                                                                             |  |                         | 720     |      |  | 456     | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|                                                                                                                                 |  |                         | 6,025   |      |  | 2,477   | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|SEVERANCE PAY FUND                                                                                                               |  |                         | 34,013  |      |  | 30,562  | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|PROPERTY AND EQUIPMENT, NET
  (Note 6)                                                                                           |  |                         | 18,457  |      |  | 19,133  | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|GOODWILL
  (Note 1J and Note 7)                                                                                                  |  |                         | 159,316 |      |  | 145,000 | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|OTHER ASSETS, NET (Note 8)                                                                                                       |  |                         | 73,637  |      |  | 62,386  | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|TOTAL ASSETS ATTRIBUTED TO DISCONTINUED
OPERATIONS (Note 17)                                                                     |  |                         | -       |      |  | 154,617 | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|                                                                                                                                 |  |                         |         |      |  |         | 
|                                                                                                                                 |  |                         | 595,504 |      |  | 630,085 | 
|                                                                                                                                 |  |                         |         |      |  |         | 

F  2

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ------- | -
|                                                                                                                                                                                          |  | December 31,            |        
|                                                                                                                                                                                          |  |                         |        
|                                                                                                                                                                                          |  | 2006                    |         | 2005 | 
|                                                                                                                                                                                          |  |                         |         |      | 
|                                                                                                                                                                                          |  | (U.S. $ in
  thousands) |        
|                                                                                                                                                                                          |  |                         |        
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                      |  |                         |         |      |  |         |  
|                                                                                                                                                                                         
|CURRENT LIABILITIES:                                                                                                                                                                      |  |                         |         |      |  |         |  
|                                                                                                                                                                                         
|Liabilities to banks and others (Notes 10B
  and 16B)                                                                                                                                     |  |                         | 41,023  |      |  | 64,897  |  
|                                                                                                                                                                                         
|Trade payables                                                                                                                                                                            |  |                         | 54,461  |      |  | 40,650  |  
|                                                                                                                                                                                         
|Other accounts payable (Note 16C)                                                                                                                                                         |  |                         | 73,775  |      |  | 61,154  |  
|                                                                                                                                                                                         
|Debentures (Note 9)                                                                                                                                                                       |  |                         | 8,932   |      |  | 8,004   |  
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|                                                                                                                                                                                         
|                                                                                                                                                                                          |  |                         | 178,191 |      |  | 174,705 |  
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|LONG-TERM LIABILITIES:                                                                                                                                                                    |  |                         |         |      |  |         |  
|                                                                                                                                                                                         
|Debentures (Note 11)                                                                                                                                                                      |  |                         | 24,113  |      |  | 16,809  |  
|                                                                                                                                                                                         
|Provision for losses in formerly owned
  investee                                                                                                                                         |  |                         | 1,971   |      |  | 1,971   |  
|                                                                                                                                                                                         
|Deferred taxes                                                                                                                                                                            |  |                         | 457     |      |  | 896     |  
|                                                                                                                                                                                         
|Customer advances                                                                                                                                                                         |  |                         | 449     |      |  | 645     |  
|                                                                                                                                                                                         
|Liabilities to banks and others (Note 10)                                                                                                                                                 |  |                         | 79,295  |      |  | 52,414  |  
|                                                                                                                                                                                         
|Liability in respect of the acquisition of
  activities                                                                                                                                   |  |                         | 1,489   |      |  | 1,761   |  
|                                                                                                                                                                                         
|Accrued severance pay                                                                                                                                                                     |  |                         | 41,109  |      |  | 35,421  |  
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|                                                                                                                                                                                          |  |                         | 148,883 |      |  | 109,917 |  
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|                                                                                                                                                                                         
|TOTAL LIABILITIESATTRIBUTED TO
  DISCONTINUED OPERATIONS (Note 17)                                                                                                                        |  |                         | -       |      |  | 88,865  |  
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|MINORITY INTEREST                                                                                                                                                                         |  |                         | 115,140 |      |  | 93,153  |  
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|                                                                                                                                                                                         
|COMMITMENTS AND CONTINGENCIES (Note 13)                                                                                                                                                   |  |                         |         |      |  |         |  
|                                                                                                                                                                                         
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|                                                                                                                                                                                         
|SHAREHOLDERS EQUITY (Note 14):                                                                                                                                                           |  |                         |         |      |  |         |  
|                                                                                                                                                                                         
|Share capital - ordinary shares of
  NIS 1 par value (authorized - December 31, 2006 and 2005 - 25,000,000
  shares; issued: December 31, 2006 - 13,224,780 and 2005 - 13,224,780 shares) |  |                         | 3,736   |      |  | 3,736   |  
|                                                                                                                                                                                         
|Additional paid-in capital                                                                                                                                                                |  |                         | 132,545 |      |  | 132,487 |  
|                                                                                                                                                                                         
|Retained earnings                                                                                                                                                                         |  |                         | 32,165  |      |  | 49,164  |  
|                                                                                                                                                                                         
|Accumulated other comprehensive loss                                                                                                                                                      |  |                         | (14,897 | )    |  | (21,683 | )
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|                                                                                                                                                                                          |  |                         | 153,549 |      |  | 163,704 |  
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|Cost of 24,780 treasury shares                                                                                                                                                            |  |                         | (259    | )    |  | (259    | )
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|TOTAL SHAREHOLDERS
  EQUITY                                                                                                                                                              |  |                         | 153,290 |      |  | 163,445 |  
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|                                                                                                                                                                                          |  |                         |         |      |  |         |  
|                                                                                                                                                                                          |  |                         | 595,504 |      |  | 630,085 |  
|                                                                                                                                                                                          |  |                         |         |      |  |         |  

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

F  3

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

CONSOLIDATED
STATEMENTS OF OPERATIONS

|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|------------------------------------------------------------------------- |  | ------------------------------------------------- | ------- | ---- |  | ------- | - |  | ------- | -
|                                                                          |  | Year Ended
  December 31,                         |        
|                                                                          |  |                                                   |        
|                                                                          |  | 2006                                              |         | 2005 |  | 2004    |  
|                                                                          |  |                                                   |         |      |  |         |  
|                                                                          |  | (U.S. $ in
  thousands, except per share amounts) |        
|                                                                          |  |                                                   |        
|Revenues (Note 16I(2))                                                    |  |                                                   |         |      |  |         |   |  |         |  
|                                                                         
|Proprietary software
  products                                           |  |                                                   | 172,796 |      |  | 157,589 |   |  | 168,000 |  
|                                                                         
|Software services                                                         |  |                                                   | 319,939 |      |  | 274,901 |   |  | 227,262 |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Total revenues                                                            |  |                                                   | 492,735 |      |  | 432,490 |   |  | 395,262 |  
|                                                                         
|Cost of revenues                                                          |  |                                                   |         |      |  |         |   |  |         |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Proprietary software
  products                                           |  |                                                   | 84,420  |      |  | 75,084  |   |  | 75,186  |  
|                                                                         
|Software services                                                         |  |                                                   | 255,627 |      |  | 218,560 |   |  | 178,311 |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Total cost of revenues                                                    |  |                                                   | 340,047 |      |  | 293,644 |   |  | 253,497 |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Gross profit                                                              |  |                                                   | 152,688 |      |  | 138,846 |   |  | 141,765 |  
|                                                                         
|Research and development
  costs, net                                     |  |                                                   | 16,388  |      |  | 15,420  |   |  | 15,168  |  
|                                                                         
|Selling, general and
  administrative expenses                            |  |                                                   | 113,664 |      |  | 111,246 |   |  | 106,613 |  
|                                                                         
|Restructuring and
  non-recurring costs (Note 16D)                        |  |                                                   | 3,152   |      |  | 1,455   |   |  | -       |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Operating income                                                          |  |                                                   | 19,484  |      |  | 10,725  |   |  | 19,984  |  
|                                                                         
|Financial expenses, net
  (Note 16E)                                      |  |                                                   | (8,097  | )    |  | (4,036  | ) |  | (5,776  | )
|                                                                         
|Gain on realization of
  shareholdings, net (Note 16G)                    |  |                                                   | 3,755   |      |  | 3,186   |   |  | 8,282   |  
|                                                                         
|Other income (expenses),
  net (Note 16F)                                 |  |                                                   | (820    | )    |  | 704     |   |  | (79     | )
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Income before taxes on income                                             |  |                                                   | 14,322  |      |  | 10,579  |   |  | 22,411  |  
|                                                                         
|Taxes on income (Note 15)                                                 |  |                                                   | 3,497   |      |  | 4,824   |   |  | 3,571   |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|                                                                          |  |                                                   | 10,825  |      |  | 5,755   |   |  | 18,840  |  
|Equity in gains (losses) of
  affiliated companies, net                   |  |                                                   | 46      |      |  | 61      |   |  | (407    | )
|                                                                         
|Minority interest in
  earnings of subsidiaries, net                      |  |                                                   | (7,155  | )    |  | (687    | ) |  | (4,085  | )
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Income from continuing operation                                          |  |                                                   | 3,716   |      |  | 5,129   |   |  | 14,348  |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Income (loss) from discontinued operation, net
(Note 17)                  |  |                                                   | 6,299   |      |  | (4,946  | ) |  | (6,249  | )
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Net income                                                                |  |                                                   | 10,015  |      |  | 183     |   |  | 8,099   |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Earnings
  per share generated from continuing operation:                 |  |                                                   |         |      |  |         |   |  |         |  
|                                                                         
|Basic                                                                     |  |                                                   | 0.30    |      |  | 0.40    |   |  | 1.18    |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Diluted                                                                   |  |                                                   | 0.27    |      |  | 0.40    |   |  | 1.05    |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Earnings
  (losses) per share generated from discontinued operation:      |  |                                                   |         |      |  |         |   |  |         |  
|                                                                         
|Basic                                                                     |  |                                                   | 0.50    |      |  | (0.39   | ) |  | (1.30   | )
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Diluted                                                                   |  |                                                   | 0.46    |      |  | (0.39   | ) |  | (1.15   | )
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Total
  earnings per share                                                |  |                                                   |         |      |  |         |   |  |         |  
|                                                                         
|Basic                                                                     |  |                                                   | 0.8     |      |  | 0.01    |   |  | 0.73    |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Diluted                                                                   |  |                                                   | 0.73    |      |  | 0.01    |   |  | 0.65    |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Weighted
  average number of shares outstanding in thousands  (Note 16J): |  |                                                   |         |      |  |         |   |  |         |  
|                                                                         
|Basic                                                                     |  |                                                   | 13,200  |      |  | 12,800  |   |  | 10,800  |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  
|Diluted                                                                   |  |                                                   | 13,298  |      |  | 12,800  |   |  | 10,800  |  
|                                                                          |  |                                                   |         |      |  |         |   |  |         |  

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

F  4

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS EQUITY

|                                                                                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  
|------------------------------------------------------------------------------------------ |  | ------------------------------ | ---------- | ------ |  | ------------------------------ |  | ------------------- | ------- | -------------------------------------- |  | --------------------------- | - | ----- | ------- | - |  | ---- | - |  | ------- | -
|                                                                                           |  | Share Capital                  |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |     
|                                                                                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |     
|                                                                                           |  | Number of
  Shares             |            | Amount |  | Additional
  paid-in
  Capital |  | Retained
  Earnings |         | Accumulated other
  comprehensive loss |  | Cost of
  Treasury
  Shares |   | Total |        
|                                                                                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |        
|                                                                                           |  | (U.S. $ in t h o u s a n d s ) |           
|                                                                                           |  |                                |           
|Balance as of January 1, 2004                                                              |  |                                | 10,800,000 |        |  | 3,215                          |  |                     | 99,275  |                                        |  | 91,067                      |   |       | (17,294 | ) |  | (259 | ) |  | 176,004 |  
|Changes during 2004:                                                                       |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  
|Net Income                                                                                 |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | 8,099                       |   |       | -       |   |  | -    |   |  | 8,099   |  
|Unrealized gains from available-for-sale
securities, net                                   |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | -                           |   |       | (50     | ) |  | -    |   |  | (50     | )
|Currency translation adjustments                                                           |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | -                           |   |       | 2,465   |   |  | -    |   |  | 2,465   |  
|                                                                                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  
|Total comprehensive income                                                                 |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | -                           |   |       | -       |   |  | -    |   |  | 10,514  |  
|Beneficial conversion features                                                             |  |                                | -          |        |  | -                              |  |                     | 106     |                                        |  | -                           |   |       | -       |   |  | -    |   |  | 106     |  
|Deferred compensation                                                                      |  |                                | -          |        |  | -                              |  |                     | 101     |                                        |  | -                           |   |       | -       |   |  | -    |   |  | 101     |  
|Capital fund arising from elimination of gain on
realization of
  development stage entity |  |                                | -          |        |  | -                              |  |                     | 53      |                                        |  | -                           |   |       | -       |   |  | -    |   |  | 53      |  
|                                                                                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  
|Balance as of December 31, 2004                                                            |  |                                | 10,800,000 |        |  | 3,215                          |  |                     | 99,535  |                                        |  | 99,166                      |   |       | (14,879 | ) |  | (259 | ) |  | 186,778 |  
|Changes during 2005:                                                                       |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  
|Net Income                                                                                 |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | 183                         |   |       | -       |   |  | -    |   |  | 183     |  
|Unrealized loss from available-for-sale securities,
net                                    |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | -                           |   |       | (56     | ) |  | -    |   |  | (56     | )
|Currency translation adjustments                                                           |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | -                           |   |       | (6,770  | ) |  | -    |   |  | (6,770  | )
|                                                                                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  
|Total comprehensive income                                                                 |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | -                           |   |       | -       |   |  | -    |   |  | (6,643  | )
|Issuance of shares, net*                                                                   |  |                                | 2,400,000  |        |  | 521                            |  |                     | 32,786  |                                        |  | -                           |   |       | -       |   |  | -    |   |  | 33,307  |  
|Dividend distribution                                                                      |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | (50,185                     | ) |       | -       |   |  | -    |   |  | (50,185 | )
|Beneficial conversion features                                                             |  |                                | -          |        |  | -                              |  |                     | 181     |                                        |  | -                           |   |       | -       |   |  | -    |   |  | 181     |  
|Capital fund arising from elimination of gain on
realization of development
  stage entity |  |                                | -          |        |  | -                              |  |                     | 7       |                                        |  | -                           |   |       | -       |   |  | -    |   |  | 7       |  
|                                                                                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  
|Balance as of December 31, 2005                                                            |  |                                | 13,200,000 |        |  | 3,736                          |  |                     | 132,509 |                                        |  | 49,164                      |   |       | (21,705 | ) |  | (259 | ) |  | 163,445 |  
|Changes during 2006:                                                                       |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  
|Net Income                                                                                 |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | 10,015                      |   |       | -       |   |  | -    |   |  | 10,015  |  
|Unrealized gain from available - for-sale securities, net                                  |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | -                           |   |       | 376     |   |  | -    |   |  | 376     |  
|Currency translation adjustments                                                           |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | -                           |   |       | 6,433   |   |  | -    |   |  | 6,433   |  
|                                                                                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  
|Total comprehensive income                                                                 |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | -                           |   |       | -       |   |  | -    |   |  | 16,824  |  
|Employee stock options exercised                                                           |  |                                | -          |        |  | -                              |  |                     | 36      |                                        |  | -                           |   |       | -       |   |  | -    |   |  | 36      |  
|Spin-off                                                                                   |  |                                | -          |        |  | -                              |  |                     | -       |                                        |  | (27,015                     | ) |       | -       |   |  | -    |   |  | (27,015 | )
|                                                                                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  
|Balance as of December 31, 2006                                                            |  |                                | 13,200,000 |        |  | 3,736                          |  |                     | 132,545 |                                        |  | 32,164                      |   |       | (14,896 | ) |  | (259 | ) |  | 153,290 |  
|                                                                                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  
|Accumulated unrealized gain from available - for-sale
securities                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       | 249     |   |  |      |   |  |         |  
|Accumulated currency translation adjustments                                               |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       | (15,145 | ) |  |      |   |  |         |  
|                                                                                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  
|Accumulated other comprehensive loss                                                       |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       | (14,896 | ) |  |      |   |  |         |  
|                                                                                           |  |                                |            |        |  |                                |  |                     |         |                                        |  |                             |   |       |         |   |  |      |   |  |         |  

* Net of issuance expenses
in the amount of $3,000 thousands

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

F  5

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

CONSOLIDATED
STATEMENTS OF CASH FLOWS

|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|----------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ------- | - |  | ------ | -
|                                                                                    |  | Year ended December 31, |        
|                                                                                    |  |                         |        
|                                                                                    |  | 2006                    |         | 2005 |  | 2004    |  
|                                                                                    |  |                         |         |      |  |         |  
|                                                                                    |  | (U.S. $ in thousands)   |        
|                                                                                    |  |                         |        
|CASH
  FLOWS FROM OPERATING ACTIVITIES:                                             |  |                         |         |      |  |         |   |  |        |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Net income                                                                          |  |                         | 10,015  |      |  | 183     |   |  | 8,099  |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Adjustments to reconcile net income to net cash
provided by operating
  activities: |  |                         |         |      |  |         |   |  |        |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Impairment and write down of investments in
investees and loans                     |  |                         | 956     |      |  | 138     |   |  | 471    |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Minority interest in earnings of consolidated
subsidiaries                          |  |                         | 13,523  |      |  | 1,491   |   |  | 2,480  |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Equity in losses(gains) of affiliated companies,
net                                |  |                         | (459    | )    |  | 3,109   |   |  | 2,523  |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Depreciation and amortization                                                       |  |                         | 44,887  |      |  | 25,130  |   |  | 20,597 |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Impairment of software development costs                                            |  |                         | -       |      |  | -       |   |  | 901    |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Increase in accrued severance pay, net                                              |  |                         | 1,839   |      |  | 108     |   |  | 287    |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Gain from sale  of affiliated companies                                             |  |                         | (2,485  | )    |  | -       |   |  | -      |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Losses (gains) from sale of property and
equipment                                  |  |                         | 15      |      |  | (20     | ) |  | (60    | )
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Gain on realization of shareholdings                                                |  |                         | (38,500 | )    |  | (4,107  | ) |  | (8,893 | )
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Loss for sale of operation                                                          |  |                         | 917     |      |  | -       |   |  | -      |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Amortization of deferred option
compensation                                        |  |                         | 59      |      |  | 134     |   |  | 194    |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Change in accrued interest and capital loss on
debentures                           |  |                         | 255     |      |  | 1,699   |   |  | 3,471  |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Changes in value of long term loans and deposits,
net                               |  |                         | 2,249   |      |  | 247     |   |  | 715    |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Deferred taxes                                                                      |  |                         | (2,353  | )    |  | (391    | ) |  | (1,101 | )
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Accrued interest on redeemable shares in a
subsidiary                               |  |                         | -       |      |  | -       |   |  | 64     |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Gain on payment of convertible subordinated
notes                                   |  |                         | -       |      |  | -       |   |  | 50     |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Sale of trading marketable securities,
net                                          |  |                         | (1,261  | )    |  | (393    | ) |  | (3,533 | )
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Increase (decrease) in trade marketable
securities                                  |  |                         | (3      | )    |  | 1,785   |   |  | (26    | )
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Capital loss (gain) on sale of available for sale
marketable
  securities           |  |                         | 45      |      |  | 206     |   |  | (64    | )
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Changes in operating assets and
liabilities:                                        |  |                         |         |      |  |         |   |  |        |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Decrease (increase) in inventories                                                  |  |                         | 1,008   |      |  | 237     |   |  | (1,850 | )
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Increase in trade receivables                                                       |  |                         | (26,045 | )    |  | (20,717 | ) |  | (8,044 | )
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Decrease (increase) in other accounts
receivable                                    |  |                         | 2,499   |      |  | (472    | ) |  | (2,146 | )
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Increase in trade payables                                                          |  |                         | 9,573   |      |  | 5,038   |   |  | 3,033  |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Increase (decrease) in other accounts payable and
restructuring
  accrual           |  |                         | 12,045  |      |  | (7,265  | ) |  | (4,641 | )
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Increase (decrease) in customer advances, net of
work in progress                   |  |                         | (2,829  | )    |  | 146     |   |  | 5,279  |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  
|Net cash
  provided by operating activities                                         |  |                         | 25,950  |      |  | 6,286   |   |  | 17,806 |  
|                                                                                    |  |                         |         |      |  |         |   |  |        |  

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

F  6

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|--------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ------- | - |  | ------- | -
|                                                                                              |  | Year ended December 31, |        
|                                                                                              |  |                         |        
|                                                                                              |  | 2006                    |         | 2005 |  | 2004    |  
|                                                                                              |  |                         |         |      |  |         |  
|                                                                                              |  | (U.S. $ in thousands)   |        
|                                                                                              |  |                         |        
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                         |  |                         |         |      |  |         |   |  |         |  
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Acquisition of newly-consolidated subsidiaries
(Appendix C)                                   |  |                         | (15,928 | )    |  | (5,342  | ) |  | 13,724  |  
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Proceeds from realization of investment  in
previously-consolidated subsidiaries (Appendix D) |  |                         | (1,581  | )    |  | -       |   |  | (353    | )
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Proceeds from sale of activity in a consolidated
company                                      |  |                         | 2,895   |      |  | -       |   |  | -       |  
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Proceeds from repayment of debentures                                                         |  |                         | -       |      |  | (41     | ) |  | -       |  
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Loans to employees                                                                            |  |                         | -       |      |  | -       |   |  | (235    | )
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Restricted short term deposit, net                                                            |  |                         | 5,290   |      |  | (3,918  | ) |  | (600    | )
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Restricted long term deposit, net                                                             |  |                         | (2,533  | )    |  | 1,434   |   |  | 2,554   |  
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Purchase of property and equipment                                                            |  |                         | (6,460  | )    |  | (6,006  | ) |  | (5,718  | )
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Purchase of available for sale marketable
securities, net                                     |  |                         | 3,917   |      |  | 6,100   |   |  | (16,413 | )
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Proceeds from sale of property and
equipment                                                  |  |                         | 838     |      |  | 1,963   |   |  | 1,827   |  
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Investment in and loans to affiliated and other
companies                                     |  |                         | (8,900  | )    |  | (1,582  | ) |  | (6,162  | )
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Proceeds from sale of investments in and loans to
affiliated
  companies                      |  |                         | 46,558  |      |  | 813     |   |  | 4,160   |  
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Purchase of an activity by a consolidated
company                                             |  |                         | -       |      |  | (111    | ) |  | -       |  
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Purchase of intangible assets by consolidated
companies                                       |  |                         | (50     | )    |  | -       |   |  | (449    | )
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Investment in long term bank deposits,
net                                                    |  |                         | 489     |      |  | (698    | ) |  | (639    | )
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Capitalization of software development and other
costs                                        |  |                         | (18,837 | )    |  | (17,743 | ) |  | (15,367 | )
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Purchase of minority interest in
subsidiaries                                                 |  |                         | (9,737  | )    |  | (2,253  | ) |  | (5,710  | )
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Proceeds from realization of investment in
subsidiaries                                       |  |                         | 9,661   |      |  | 4,331   |   |  | 11,025  |  
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Proceeds from investments in short term bank
deposits, net                                    |  |                         | 595     |      |  | (1,118  | ) |  | 1,245   |  
|                                                                                              |  |                         |         |      |  |         |   |  |         |  
|Net cash
  used in investing activities                                                       |  |                         | 6,217   |      |  | (24,171 | ) |  | (17,111 | )
|                                                                                              |  |                         |         |      |  |         |   |  |         |  

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, |        
|                                                                   |  |                         |        
|                                                                   |  | 2006                    |         | 2005 |  | 2004    |  
|                                                                   |  |                         |         |      |  |         |  
|                                                                   |  | (U.S. $ in thousands)   |        
|                                                                   |  |                         |        
|                                                                  
|CASH FLOWS FROM FINANCING ACTIVITIES:                              |  |                         |         |      |  |         |   |  |         |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Spin-off consolidated company (Appendix
D)                         |  |                         | (24,154 | )    |  | -       |   |  | -       |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Issuance of convertible debt                                       |  |                         | 14,140  |      |  | -       |   |  | 4,357   |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Issuance of shares                                                 |  |                         | -       |      |  | 33,307  |   |  | -       |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Exercise of share options in subsidiaries                          |  |                         | 7,570   |      |  | 2,217   |   |  | -       |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Dividend distribution                                              |  |                         | -       |      |  | (50,185 | ) |  | -       |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Dividend to minority shareholders in
subsidiaries                  |  |                         | (4,239  | )    |  | (8,352  | ) |  | (88     | )
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Short-term bank credit, net                                        |  |                         | (17,780 | )    |  | 5,467   |   |  | 20,410  |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Repayment of long-term loans                                       |  |                         | (9,676  | )    |  | (19,629 | ) |  | (29,521 | )
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Receipt of long-term loans                                         |  |                         | 31,372  |      |  | 51,156  |   |  | 12,681  |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Issuance in a subsidiary to minority shareholders,
net             |  |                         | 5,998   |      |  | 5,344   |   |  | 4,405   |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Convertible debt issuance expenses in a
subsidiary                 |  |                         | (655    | )    |  | -       |   |  | (32     | )
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Payment of issuance expenses in a
subsidiary                       |  |                         | -       |      |  | -       |   |  | (20     | )
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Debenture repayment                                                |  |                         | (6,219  | )    |  | (18,357 | ) |  | -       |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Purchase of treasury stock in a subsidiary by a
subsidiary thereof |  |                         | (307    | )    |  | (4,134  | ) |  | (102    | )
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Net cash
  provided by (used in) financing activities              |  |                         | (3,950  | )    |  | (3,166  | ) |  | 12,090  |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|Effect of exchange rate changes on cash and cash
  equivalents     |  |                         | 6,418   |      |  | (4,356  | ) |  | 933     |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|NET
  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS             |  |                         | 34,635  |      |  | (25,407 | ) |  | 13,718  |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|CASH AND
  CASH EQUIVALENTS AT BEGINNING OF YEAR                   |  |                         | 81,767  |      |  | 107,174 |   |  | 93,456  |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  
|CASH AND
  CASH EQUIVALENTS AT END OF YEAR                         |  |                         | 116,402 |      |  | 81,767  |   |  | 107,174 |  
|                                                                   |  |                         |         |      |  |         |   |  |         |  

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

F  8

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

CONSOLIDATED STATEMENTS OF CASH FLOWS

Appendix A - Supplemental cash flow
information:

|                                         |  |                         |       |      |  |        |  |  |       | 
|---------------------------------------- |  | ----------------------- | ----- | ---- |  | ------ |  |  | ----- | 
|                                         |  | Year ended December 31, |      
|                                         |  |                         |      
|                                         |  | 2006                    |       | 2005 |  | 2004   | 
|                                         |  |                         |       |      |  |        | 
|                                         |  | (U.S. $ in thousands)   |      
|                                         |  |                         |      
|                                         |  |                         |      
|Cash paid during the year in respect of: |  |                         |       |      |  |        |  |  |       | 
|                                         |  |                         |       |      |  |        |  |  |       | 
|Interest                                 |  |                         | 9,965 |      |  | 10,052 |  |  | 7,066 | 
|                                         |  |                         |       |      |  |        |  |  |       | 
|                                         |  |                         |       |      |  |        |  |  |       | 
|Income tax                               |  |                         | 7,717 |      |  | 7,467  |  |  | 6,357 | 
|                                         |  |                         |       |      |  |        |  |  |       | 

Appendix B - Non-cash activities:

|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|--------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | --- | ---- |  | ----- |  |  | ----- | 
|                                                                                                                            |  | Year ended December 31, |    
|                                                                                                                            |  |                         |    
|                                                                                                                            |  | 2006                    |     | 2005 |  | 2004  | 
|                                                                                                                            |  |                         |     |      |  |       | 
|                                                                                                                            |  | (U.S. $ in thousands)   |    
|                                                                                                                            |  |                         |    
|                                                                                                                            |  |                         |    
|Purchase of fixed assets against trade
  payables                                                                           |  |                         | 21  |      |  | 343   |  |  | 39    | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|Investment in a consolidated company
  against issuance of share capital to minority shareholders of consolidated
  company |  |                         | 275 |      |  | 1,577 |  |  | -     | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|Purchase of shares from minority
  shareholders of subsidiary, against accounts payable                                     |  |                         | -   |      |  | 100   |  |  | -     | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|Investments in available marketable
  securities, against accounts payable                                                  |  |                         | 884 |      |  | -     |  |  | -     | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|Exchange of assets in a subsidiary                                                                                          |  |                         | -   |      |  | 70    |  |  | -     | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|Purchase of technology from affiliated
  company against loan                                                               |  |                         | -   |      |  | -     |  |  | 1,695 | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 
|Current maturities of royalties liabilities
  against account receivables                                                   |  |                         | -   |      |  | 13    |  |  | -     | 
|                                                                                                                            |  |                         |     |      |  |       |  |  |       | 

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

Appendix C - Acquisition of newly-consolidated subsidiaries:

|                                                                              |  |                         |         |      |  |        |   |  |         |  
|----------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ------ | - |  | ------- | -
|                                                                              |  | Year ended December 31, |        
|                                                                              |  |                         |        
|                                                                              |  | 2006                    |         | 2005 |  | 2004   |  
|                                                                              |  |                         |         |      |  |        |  
|                                                                              |  | (U.S. $ in thousands)   |        
|                                                                              |  |                         |        
|Assets
  and liabilities of subsidiaries consolidated as of acquisition date: |  |                         |         |      |  |        |   |  |         |  
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Working capital (other than cash and cash
equivalents)                        |  |                         | 2,327   |      |  | 5,446  |   |  | 11,670  |  
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Liabilities arising from the acquisition                                      |  |                         | -       |      |  | 209    |   |  | -       |  
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Investment in affiliates and loans                                            |  |                         | 370     |      |  | 801    |   |  | (27,436 | )
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Property and equipment                                                        |  |                         | (480    | )    |  | (813   | ) |  | (4,671  | )
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Other assets and deferred expenses                                            |  |                         | (3,985  | )    |  | (4,697 | ) |  | (13,085 | )
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Other assets arising upon acquisition                                         |  |                         | (13,855 | )    |  | (7,981 | ) |  | (60,524 | )
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Long-term liabilities                                                         |  |                         | (305    | )    |  | 533    |   |  | 18,507  |  
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Debentures                                                                    |  |                         | -       |      |  | -      |   |  | 45,336  |  
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Unrealized gain                                                               |  |                         | -       |      |  | -      |   |  | (1,508  | )
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Issuance of shares by a subsidiary                                            |  |                         | -       |      |  | 1,408  |   |  | -       |  
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Minority interest at acquisition date                                         |  |                         | -       |      |  | (248   | ) |  | 9,182   |  
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Exchange of debentures against shares                                         |  |                         | -       |      |  | -      |   |  | 36,253  |  
|                                                                              |  |                         |         |      |  |        |   |  |         |  
|Total                                                                         |  |                         | (15,928 | )    |  | (5,342 | ) |  | 13,724  |  
|                                                                              |  |                         |         |      |  |        |   |  |         |  

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

|                                                                                |  |                         |         |      |  |      |  |  |         |  
|------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ---- |  |  | ------- | -
|                                                                                |  | Year ended December 31, |        
|                                                                                |  |                         |        
|                                                                                |  | 2006                    |         | 2005 |  | 2004 | 
|                                                                                |  |                         |         |      |  |      | 
|                                                                                |  | (U.S. $ in thousands)   |        
|                                                                                |  |                         |        
|                                                                                |  |                         |        
|Assets and liabilities of consolidated subsidiaries
  as of date of realization |  |                         |         |      |  |      |  |  |         |  
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Working capital (other than cash and cash
equivalents)                          |  |                         | (43,835 | )    |  | -    |  |  | (14,204 | )
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Investments and loans in subsidiaries                                           |  |                         | 13,056  |      |  | -    |  |  | -       |  
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Accrued severance pay, net                                                      |  |                         | (2,175  | )    |  | -    |  |  | -       |  
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Investment in affiliate (including loans)                                       |  |                         | 1,642   |      |  | -    |  |  | 1,139   |  
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Property and equipment                                                          |  |                         | 4,546   |      |  | -    |  |  | 2,081   |  
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Other assets and deferred expenses                                              |  |                         | 43,520  |      |  | -    |  |  | -       |  
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Long term deposits                                                              |  |                         | 368     |      |  | -    |  |  | -       |  
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Goodwill                                                                        |  |                         | 6,462   |      |  | -    |  |  | 7,756   |  
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Other comprehensive loss                                                        |  |                         | (755    | )    |  | -    |  |  | -       |  
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Long-term liabilities                                                           |  |                         | (246    | )    |  | -    |  |  | (392    | )
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Gain from realization of investments in
subsidiaries                            |  |                         | (4,383  | )    |  | -    |  |  | -       |  
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Retained earnings                                                               |  |                         | (27,015 | )    |  | -    |  |  | -       |  
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Minority interest                                                               |  |                         | (16,920 | )    |  | -    |  |  | 3,267   |  
|                                                                                |  |                         |         |      |  |      |  |  |         |  
|Total                                                                           |  |                         | (25,735 | )    |  | -    |  |  | (353    | )
|                                                                                |  |                         |         |      |  |      |  |  |         |  

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

F  10

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO 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 National Market in the United States. Each ADS represents
one ordinary share of the 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 principal business segments, IT Services and Proprietary Software
Solutions. For a description of the segments - see Note 16H.

The
following table presents certain information regarding the control and
ownership of Formulas significant subsidiaries and material investments, as of
the dates indicated:

|                                                                                           |  |                                       |  |                  |   |  |  |  |       |  | 
|------------------------------------------------------------------------------------------ |  | ------------------------------------- |  | ---------------- | - |  |  |  | ----- |  | 
|                                                                                           |  | Percentage of ownership and
  control | 
|                                                                                           |  |                                       | 
|                                                                                           |  | December 31, 2006                     |  | December 31,2005 |  
|                                                                                           |  |                                       | 
|Name of subsidiary:                                                                        |  | %                                     | 
|                                                                                           |  |                                       | 
|                                                                                          
|Matrix IT Ltd. (Matrix)                                                                  |  |                                       |  | 50.26            |   |  |  |  | 51.11 |  | 
|                                                                                           |  |                                       |  |                  |   |  |  |  |       |  | 
|BluePhoenix Solutions Ltd. (BluePhoenix)
  (formerly - Crystal Systems Solutions Ltd.) |  |                                       |  | 56.22            |   |  |  |  | 59.22 |  | 
|                                                                                           |  |                                       |  |                  |   |  |  |  |       |  | 
|Magic Software Enterprises
  Ltd. (Magic)                                                |  |                                       |  | 50.01            |   |  |  |  | 50.27 |  | 
|                                                                                           |  |                                       |  |                  |   |  |  |  |       |  | 
|NextSource Inc.                                                                            |  |                                       |  | 100              |   |  |  |  | 100   |  | 
|                                                                                           |  |                                       |  |                  |   |  |  |  |       |  | 
|Sapiens International
  Corporation N.V.(Sapiens)                                        |  |                                       |  | 61.96            |   |  |  |  | 59.22 |  | 
|                                                                                           |  |                                       |  |                  |   |  |  |  |       |  | 
|Formula Vision Technologies
  (F.V.T.) Ltd.(Formula Vision)                              |  |                                       |  | -                | * |  |  |  | 56.9  |  | 

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

* See note 2A.

Accounting Principles

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

F  11

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 1      | Summary of Significant Accounting Policies (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|A.           | Functional and Reporting Currency:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|             | The currency
  of the primary economic environment in which the operations of Formula and
  most of its subsidiaries are conducted is the New Israeli Shekel (NIS). The
  functional currency of the remaining subsidiaries is the United States dollar
  (dollar). Formula has elected to use the dollar as its reporting currency.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|             | The
  financial statements of Formula and most of its subsidiaries whose functional
  currency is the NIS have been translated into dollars under the principles
  described in Financial Accounting Standards Board Statement No. 52, Foreign
  Currency Translation. Assets and liabilities have been translated at
  period-end exchange rates. The results of operations have been translated at
  the exchange rates on the dates on which the transactions occurred or at
  average exchange rates. Differences resulting from translation are presented
  under shareholders equity, in the item accumulated other comprehensive loss.
  Accordingly, the financial statements of subsidiaries whose functional
  currency is the dollar are presented in the consolidated financial statements
  in their original amounts.
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|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.                                                                                                                                                                                                                                                                                                                                                                   
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|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, and
  a certain variable interest entity that the Company is required to
  consolidate pursuant to Financial Accounting Standards Board Interpretation
  No. 46, Consolidation of Variable Interest Entities as revised in December
  2003 (FIN 46B). 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

F  12

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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.                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|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 collect ability.                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|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.                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|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.                                                                                                                                                                                                                                                                                                                

F  13

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                                                                                                                                                                             
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|I. | Property and Equipment, net:                                                                                                                                                                                                
|   |                                                                                                                                                                                                                             
|   | Property and
  equipment are stated at cost, net of accumulated depreciation. Depreciation
  is calculated by the straight-line method over their estimated useful lives.
  The following are the annual depreciation rates:

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

| |                                                                                                
| | -----------------------------------------------------------------------------------------------
| | *Over the term of the lease or the estimated useful life of the
  assets, whichever is shorter.

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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 as required by previous accounting standards.
  Furthermore, SFAS 142 requires purchased intangible assets other than goodwill
  to be amortized over their useful lives unless those lives are determined to
  be indefinite.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | The Company
  has selected December 31st as the date on which it will perform its annual
  goodwill impairment test.                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   | Goodwill
  related to equity method investees and cost investees are 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, 2006, 2005 and 2004, no impairment was required. There can be no
  assurance that future goodwill impairment tests will not result in a charge
  to net income.                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|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.                                                                                                                      

F  14

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 1      | Summary of Significant Accounting Policies (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|K.           | Software Development Costs (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | Software
  development costs incurred before technological feasibility has been
  established are charged to the statement of income as incurred, net of
  participation of the Office of the Chief Scientist of the Israeli Ministry of
  Industry and Trade (the OCS).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | Amortization
  of capitalized software development costs begins when the product is
  available for general release to customers. Annual amortization is calculated
  according to the higher of the straight-line method over the remaining useful
  life of the product or based on the ratio of current gross revenues to
  current and anticipated future gross revenues. At present, amortization is
  computed under the straight-line method, mainly over a period of 3-5 years.
  During the year ended December 31, 2006, consolidated subsidiaries
  capitalized software development costs aggregating $15.9 million (2005 -
  $16.5 million, 2004 - $13.5 million) and amortized capitalized software
  development costs aggregating$16.4 million (2005 - $12.4 million, 2004 - $9.5
  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, 2006 no impairment
  was recorded.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|L.           | Other Intangible Assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | Other   intangible   assets   are   comprised   of
         costumer'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.  customer and acquired
         technology are amortized over a period of 8 and 5-10 years, respectively.                                                                                                                                                                                                                                                                                                                                                                              
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | The Company
  reviews the useful life of its intangible assets annually.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|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, 2005 and
  2004, no impairment losses have been identified.

F  15

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------------ | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 1      | Summary of Significant Accounting Policies (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|N.           | Severance Pay:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             | The
  Companys liability for severance pay to its employees pursuant to Israeli
  law and employment agreements is covered in part by managers insurance
  policies, for which the Company makes monthly payments. The value of these
  polices is recorded as an asset in the Companys balance sheet. The Company
  may only make withdrawals from the managers insurance policies for the
  purpose of paying severance pay. The severance pay liability is calculated on
  the basis of one months salary for each year of service, based on the most
  recent salary of each employee.
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             | Pursuant to
  Section 14 of the Severance Compensation Act, 1963 (Section 14), certain
  employees of the Company who elected to be included under this section, are
  entitled only to monthly deposits, at a rate of 8.33% of their monthly
  salary, made in their name with insurance companies. Payments in accordance
  with Section 14 release the Company from any future severance payments in
  respect of those employees. Deposits under Section 14 are not recorded as an
  asset in the Companys balance sheet.                                                               
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             | The expenses
  in respect of severance pay for the years ended December 31, 2006, 2005 and
  2004 were $6,537 thousand, $6,807 thousand and $4,387 thousand, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                     
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|O.           | Revenue Recognition:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             | Revenues
  derived from direct software license agreements are recognized in accordance
  with Statement of Position (SOP) 97-2 Software Revenue Recognition (as
  amended by SOP 98-4 and SOP 98-9), upon delivery of the software when
  collection is probable, where the license fee is otherwise fixed or
  determinable, and when there is persuasive evidence that an arrangement
  exists.                                                                                                                                                                                           
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             | When a
  project involves significant modification of software, revenue is generally
  recognized according to the percentage of completion method. Under this
  method, estimated revenue is generally accrued based on costs incurred to
  date as a percentage of the total updated estimated costs.                                                                                                                                                                                                                                                                                        
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             | The
  arrangements, which include multiple elements, are usually arrangements where
  the Company sells software products and Post Contract Support (PCS).                                                                                                                                                                                                                                                                                                                                                                                                                                     
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             | In addition
  there are certain arrangements where the Company sells software and
  consulting services. Consulting service fees are based on time invested.For  these  multiple  elements,  SOP 97-2 requires
         that the fair  value of each  component  in a multiple  element  arrangement  will be  determined
         based on the  vendor's  specific  objective  evidence  (VSOE) for that  element,  and  revenue is
         allocated to each component based on its fair value.                                                                                             

F  16

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 1      | Summary of Significant Accounting Policies (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|O.           | Revenue Recognition (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|             | 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
  specific objective evidence for the PCS is established by the price charged
  on separate PCS renewal contracts. The VSOE for the consulting services is
  established by the price charged on other time based consulting service
  contracts where no sale of other elements is involved, considering, among
  other things, the territory where the service is performed, the size of the
  customer, the quantity of the purchased services and the professional
  expertise of the consultants. The revenue associated with the delivered
  elements is recognized using the residual method discussed above.
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|             | The Company
  recognizes revenues from consulting fees with respect to projects billed on a
  time and material basis, based on the number of hours performed.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|             | In some of
  the agreements with the Companys customers, the customers have the right to
  receive unspecified upgrades on an if-and-when available basis (the Company
  does not provide specific upgrades). These upgrades are considered PCS.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|             | Revenue
  allocated to the PCS is recognized ratably over the term of the PCS.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

| |                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Company
  recognizes revenues from projects as follows:                                                                            
| |                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | (i)                                                                                                                                     | Revenue from
  projects billed on a time and material basis is recognized in accordance with
  SOP 81-1 Accounting for Performance of Construction - Type and Certain
  Production - Type Contracts, using contract accounting on a percentage of
  completion method, on the basis of the relationship between actual costs
  incurred and the total costs that are expected to be incurred over the
  duration of the contract. Provision is made for estimated losses and
  uncompleted contracts, in the amount of the estimated losses on the entire
  contract in the period in which such losses first become evident. As of December
  31, 2006, no such estimated losses were identified.
| |                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | (ii)                                                                                                                                    | Revenue from
  fixed fee
  contracts is also recognized in accordance with the percentage of
  completion method. The Company recognizes contract losses, if any, in the
  period in which they first become evident.                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |                                                                                                                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | 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.                               

F  17

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

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

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Revenues
  from sale of hardware are recognized when the merchandise is delivered to the
  customer, provided no significant vendor obligations remain.                                                                                                                                                                                                                                                                                              
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | Some of the
  Companys contracts include client acceptance clauses. In these contracts,
  the Company follows the guidance of TPA 5100.67 and SAB 104. In determining
  whether revenue can be recognized, when an acceptance clause exists, the
  Company considers, among other things, its history with similar arrangements,
  the customers involvement in the progress, and the existence of other
  service providers and the payment terms.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | There are no
  rights of return, price protection or similar contingencies in the Companys
  contracts.                                                                                                                                                                                                                                                                                                                                             
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | 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.                                                                                                                                                                                                     
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | Management
  believes that the Companys revenue recognition policies are in accordance
  with the Securities and Exchange Commission Staff Accounting Bulletin
  No. 101 and SAB 104, Revenue Recognition in Financial Statements.                                                                                                                                                                                                                
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | Tax collected from costumers 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 the of its subsidiaries do not record
  any provision for warranties in respect of their products and services.

|   |                   
|-- | ------------------
|S. | Advertising Costs:

| |                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Company
  records advertising expenses as incurred. Advertising costs in the amount of
  $2,607 thousand, 1,593 thousand in the years 2006, 2005 respectively.

F  18

---

---



FORMULA SYSTEMS (1985)
LTD.

(An Israeli corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                      
|-- | -------------------------------------
|T. | 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.

|   |                       
|-- | ----------------------
|R. | 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.

|   |                           
|-- | --------------------------
|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 and to retained earnings, respectively.

F  19

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                 
|-- | ----------------------------------------------------------------
|W. | Concentration of Credit Risks - Allowance for Doubtful Accounts:

| | Most of the
  Groups cash and cash equivalents and short-term investments as of December
  31, 2006 and 2005 were deposited with Israeli, U.S. and European banks. The
  Company is of the opinion that the credit risk in respect of these balances
  is remote.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | Most of the
  Groups sales are made in Israel, North America and Europe, to a large number
  of customers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | The Groups trade
  receivables are derived from sales to large, firm organizations located
  mainly in Europe, North America and Israel. The Group performs ongoing credit
  evaluations of its customers and has established an allowance for doubtful
  accounts based upon factors relating to the credit risk of specific customers
  and other information. In certain circumstances, the Company may require
  letters of credit, other collateral or additional guarantees. From time to
  time, the Company sells certain of its accounts receivable to financial
  institutions, within the normal course of business. Where receivables are
  sold without recourse to the Company, the relevant receivable is
  de-recognized and cash recorded. Where receivables are sold with full or
  partial recourse to the Company, the receivable is not de-recognized and a
  liability reflecting the obligation to the financial institution is recorded
  within financial debts until the Companys liability is discharged through
  the financial institution receiving payment from the customer.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | Formula and
  its subsidiaries had no off-balance-sheet concentration of credit risk such
  as foreign exchange contracts, options contracts or other foreign currency
  hedging arrangements as of December 31, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | The  provision  for doubtful  accounts  charged to
         general and  administrative  expenses  amounted to $1.3  million,  $2.5 and $1.3  million in the
         years 2006,  2005 and 2004,  respectively,  and was  determined  for specific  debts where doubt
         existed as to their collect ability.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

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

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Effective 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.

F  20

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 1      | Summary of Significant Accounting Policies (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|X.           | Options Granted to Employees (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|             | 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 as from January 1, 2006,
  with no restatement of prior periods to
  reflect the fair value method of
  expensing share-based compensation.                                                                                           
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|             | 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, 2006, the Company recorded stock-based
  compensation costs in the amount of $59 thousand. The total unrecognized
  compensation cost on employee stock options amounted to $41 thousand, at December 31, 2006, and is expected to be
  recognized over a weighted average period of 3 years.
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|             | The Company issues stock
  options to its employees
  and directors and provides the right to purchase stock pursuant to approved stock option and employee stock
  purchase programs. Prior to the adoption of FAS 123R, the Company elected to
  follow Accounting Principles Board Opinion No. 25, Accounting for Stock Options Issued to
  Employees and related interpretations (collectively APB No. 25), in
  accounting for its stock option plans. Under APB No. 25, when the exercise
  price of an employee stock option is less than the market price of the
  underlying stock on the date of grant, compensation expense is recognized.             

F  21

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 1      | Summary of Significant Accounting Policies (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                             
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|X.           | Options Granted to Employees (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|             | Compensation
  costs in respect of such plans in the net amounts of $70 thousand and, $65
  thousand, respectively, were charged to income in 2005 and, 2004. Had the
  compensation costs in respect of the Companys plans been determined based on
  the fair value at the grant date, consistent with the method of SFAS 123
  as amended by SFAS 148, the Companys net income and earnings per share would
  have been decreased to the pro-forma amounts indicated below:

| |                                                                                                                                                    |  |                                                      |        |      |  |        |  
| | -------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------- | ------ | ---- |  | ------ | -
| |                                                                                                                                                    |  | Year Ended
  December 31                             |       
| |                                                                                                                                                    |  |                                                      |       
| |                                                                                                                                                    |  | 2005                                                 |        | 2004 | 
| |                                                                                                                                                    |  |                                                      |        |      | 
| |                                                                                                                                                    |  | (U.S. $ in
  thousands
  except per share
  amounts) |       
| |                                                                                                                                                    |  |                                                      |       
| |                                                                                                                                                    |  |                                                      |        |      |  |        |  
| | Net income from continuing operations, as
  reported                                                                                               |  |                                                      | 5,129  |      |  | 14,348 |  
|
| | Add: Stock-based employee compensation
  expenses included in reported net income, net of related tax effects                                      |  |                                                      | 70     |      |  | 65     |  
|
| | Less: Total stock-based employee
  compensation expenses determined under the fair value based method for all
  awards, net of related tax effects |  |                                                      | (4,270 | )    |  | (1,615 | )
| |                                                                                                                                                    |  |                                                      |        |      |  |        |  
| | Pro-forma net income                                                                                                                               |  |                                                      | 929    |      |  | 12,798 |  
| |                                                                                                                                                    |  |                                                      |        |      |  |        |  
| | Earnings per share from continuing
  operations * :                                                                                                |  |                                                      |        |      |  |        |  
|
| | Basic - as reported                                                                                                                                |  |                                                      | 0.40   |      |  | 1.30   |  
| |                                                                                                                                                    |  |                                                      |        |      |  |        |  
|
| | Basic - pro forma                                                                                                                                  |  |                                                      | 0.07   |      |  | 1.16   |  
| |                                                                                                                                                    |  |                                                      |        |      |  |        |  
| | Diluted - as reported                                                                                                                              |  |                                                      | 0.40   |      |  | 1.15   |  
| |                                                                                                                                                    |  |                                                      |        |      |  |        |  
| |                                                                                                                                                    |  |                                                      |        |      |  |        |  
| | Diluted - pro forma                                                                                                                                |  |                                                      | 0.07   |      |  | 1.00   |  
| |                                                                                                                                                    |  |                                                      |        |      |  |        |  

|   | *                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | The  earnings  per share  generated
                  from discontinued operations have not been effected by the provisions of SFAS 123.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                         
|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.

F  22

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 1      | Summary of Significant Accounting Policies (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|Z.           | Derivatives and Hedging (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|             | Some subsidiaries enter into forward exchange contracts to hedge
  certain transactions denominated in foreign currencies. The purpose of
  Companys foreign currency hedging activities is to protect the subsidiaries
  from risk that the eventual dollar cash flow from international activities
  will be adversely affected by changes in the exchange rates. The
  subsidiaries forward contracts did not qualify as hedging instruments under
  SFAS No. 133. Changes in the fair value of forward contracts are reflected in
  the consolidated statements of operations as financial income or expense.                                                                          
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|AA.          | Fair Value of Financial Instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|             | The estimated fair value of financial instruments has been determined
  by the Company using available market information and valuation
  methodologies. Considerable judgment is required in estimating fair values.
  Accordingly, the estimates may not be indicative of the amounts the Company
  could realize in a current market exchange. The carrying amounts of cash and
  cash equivalents, trade receivables, short-term bank credit and trade
  payables approximate their fair values due to the short-term maturity of such
  instruments. The fair value for marketable securities is based on quoted
  market prices and do not significantly differ from a carrying amount.
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|             | The carrying amounts of the Companys long-term borrowing
  arrangements approximate their fair value. Fair values were estimated using
  discounted cash flow analyses, based on prevailing market borrowing rates.                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|             | The fair value of the debentures with a carrying value in the amount
  of $28,152 thousand as of December 31, 2006 according to the quoted price in
  the TASE is $25,857 thousand. The fair value of the traded warrants does not
  significantly differ from their carrying amount.                                                                                                                                                                                                                                                                                                                                                                                                        
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|AB.          | Spin-off of the Investment in Formula Vision                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|             | During  December  2006,  the company  spun-off its
         investment in Formula Vision to its  shareholders.  Formula  Vision's shares were distributed to
         the company's share holders 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 2A).                                                                                                                                                                                                                                        

F  23

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 1      | Summary of Significant Accounting Policies (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|AC.          | 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, that is provided that the operations, assets and
  liabilities and cash flows of the component have been eliminated from the
  Companys consolidated operations and the Company will no longer have any
  significant continuing involvement in the operations of the component.                                                                                                                                                                                                                     
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|AD.          | Recently
  Issued Accounting Pronouncements:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|             | In February 2006, the FASB
  issued FAS 155, Accounting for Certain Hybrid Financial Instruments, an
  Amendment of FASB Statements No. 133 and 140. This statement permits
  fair value measurement for any hybrid financial instrument that contains an
  embedded derivative that otherwise would require bifurcation. This statement is
  effective for all financial instruments acquired or issued after the
  beginning of an entitys first fiscal year that begins after
  September 15, 2006. The Company is currently evaluating the impact
  of this statement, if any, on its consolidated financial statements.                                                                                                                                                                                                                                                                                 
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|             | In   July   2006,   the   FASB   issued   FIN  48,
         Accounting  for  Uncertainty  in Income  Taxes-an  interpretation  of FAS 109.  This  financial
         interpretation  clarifies  the  accounting  for  uncertainty  in income taxes,  and  prescribes a
         recognition  threshold and  measurement  attributes for the financial  statement  recognition and
         measurement  of a tax  position  taken  or  expected  to be taken  in a tax  return.  FIN 48 also
         provides guidance on various related matters such as  de-recognition,  interest and penalties and
         disclosure.  As  applicable  to the  Company,  the  interpretation  prescribed  by FIN 48 will be
         effective  commencing  January 1,  2007. The Company is currently  evaluating the impact that the
         adoption of FIN 48 would have on its consolidated financial statements.
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|             | In September 2006, the
  FASB issued FAS 157, Fair Value Measurements. This standard establishes a
  framework for measuring fair value and expands related disclosure
  requirements; however, it does not require any new fair value measurement. As
  applicable to the Company, this statement will be effective as of the year
  beginning January 1, 2008. The Company is currently evaluating the
  impact that the adoption of FAS 157 would have on its consolidated financial
  statements.                                                                                                                                                                                                                                                                                                                                                                                                         

F  24

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 1      | Summary of Significant Accounting Policies (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|AD.          | Recently
  Issued Accounting Pronouncements (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             | In September 2006, the SEC
  issued Staff Accounting Bulletin (SAB) 108, which expresses the Staffs views
  regarding the process of quantifying financial statement misstatements. The
  bulletin was effective as of the year beginning January 1, 2006. The
  implementation of this bulletin had no impact on the Companys consolidated
  financial statements.                                                                                                                                                                                                                                          
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             | In February 2007, the FASB
  issued FAS 159, The Fair Value Option for Financial Assets and Financial
  Liabilities. This standard permits entities to choose to measure many
  financial assets and financial liabilities at fair value. Unrealized gains
  and losses on items for which the fair value option has been elected are
  reported in earnings. As applicable to the Company, this statement will be
  effective as of the year beginning January 1, 2008. The Company is
  currently evaluating the impact that the adoption of FAS 159 would have on
  its consolidated financial statements.
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             | In September 2006, the
  FASB issued SFAS No. 158, Employers Accounting for Defined Benefit
  Pension and Other Postretirement Plans-An Amendment of FASB No. 87,
  88, 106 and 132(R) (SFAS 158). SFAS 158 requires that the funded
  status of defined benefit postretirement plans be recognized on the companys
  balance sheet, and changes in the funded status be reflected in comprehensive
  income, effective fiscal years ending after December 15, 2006. The
  adoption of this statement did not have an impact on the consolidated
  financial statements.                                 
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|Note 2      | Certain Transactions:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             | In connection with the
  exercise by Formula Vision in Novemebr 2001 of an option to purchase from the
  Company its entire interest in Formulas privately held companies, Formula
  Vision issued to the Company, in December 2001, a series of 5-year debentures
  of $58.9 million in the aggregate, linked to the Israeli CPI and bearing
  interest at an annual rate of 5%. On March 31, 2002, the Company lent to
  Formula Vision an additional $19.4 million in consideration for a series of
  debentures with similar terms of the debentures issued in December 2001.                             
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             | In January 2004, Formula
  Vision issued to the Company 38,000,000 shares representing 59.4% of Formula
  Visions outstanding share capital in exchange for $35 million of the amount
  of the debentures. The price per share reflected the average closing market
  price of Formula Visions shares on the TASE during the 30 days preceding the
  date of approval of the transaction by Formulas board of directors.                                                                                                                                                                                    

F  25

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                              
|------------ | -----------------------------
|             |                              
|            
|             |                              
|             |                              
|Note 2      | Certain Transactions (cont.):
|             |                              

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | 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 holds does 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). In 2005, such loans exceeded the
  amount of cash and cash equivalents of Formula Vision. On December 31, 2006,
  Formula Vision paid approximately $51 million the Company, as a full
  repayment of the principal of the debentures and interest accrued thereon.                                                                                                                                                                                                     
|  
|   | On
  December, 2006, the Company spun-off Formula Vision.. Therefore, Formula Vision is no longer a
  subsidiary of the Company. The spin-off was effected 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.                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|B. | On May 30
  2002 Formula consummated a public offering in Israel of $14.8 million of
  debentures. In June 2005 the company repaid the outstanding amount of the
  debentures. The aggregate amount repaid was $14.9 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|C. | In December 2003, Sapiens completed an offering of
  securities in Israel, resulting in gross proceeds to Sapiens of approximately
  $17.1 million. In this offering, Sapiens sold 100,000 units of securities,
  each unit consisting of 800 unsecured convertible debentures (Series A), two
  options (Series A) exercisable into debentures (Series A) and six warrants
  (Series 1) exercisable into common shares of Sapiens. The debentures are
  linked to the dollar and bear interest at an annual rate of 6%. The
  debentures are convertible into Sapiens common shares until November 21,
  2009. Each NIS 27 (currently approximately $5.90) amount of debentures may be
  converted into one common share of Sapiens, subject to adjustments. Each
  warrant (Series 1) is exercisable into one common share of Sapiens at an
  exercise price of approximately $6.14. The warrants are exercisable until
  November 21, 2007.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|D. | In April 2000, FID and Israel Discount Bank
  Ltd. (the Investors) invested $15 million in eZoneXchange.com, Inc.
  (eZone), a subsidiary of Sapiens. The private placement to the Investors
  was accompanied by a Put/Call Agreement, according to which the Investors
  were granted the right to require us to repurchase their shares in the
  subsidiary beginning May 2004 in exchange for both cash and Sapiens Common
  Shares. In February 2001, management decided to discontinue the operations of
  eZone. During the same period, Sapiens agreed to a partial exercise of
  Investors put option, resulting in a payment to them of $4.5 million.                                                                                                                                                                                                                                                                          

F  26

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------------ | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 2      | Certain Transactions (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|D.           | (count.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|             | On March 16, 2004, Sapiens
  entered into a new Agreement with the Investors which replaced the Put/Call
  Agreement and which restructured the remaining portion of the put option.
  Sapiens agreed to issue the Investors, in a private placement, 750,000 Common
  Shares and warrants to purchase 350,000 additional common shares that are
  exercisable through December 31, 2007. In addition, Sapiens agreed to pay the
  Investors in two annual installments a total of $8.6 million plus interest at
  7.5% a year by May 1, 2005. The first installment of $4.6 million was paid as
  required at the beginning of May 2004.                                                                                                                        
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | In May 2005, Sapiens
  entered into an agreement with the Investors regarding the payment of the
  remaining $4.0 million due to the Investors, pursuant to the March 2004
  agreement between Sapiens and the Investors.  Sapiens agreed to pay $2.0
  million on May 2, 2005, $1.0 million by April 1, 2006 and $1.0 million by
  August 1, 2006.  The Investors may, at their sole discretion, convert
  all or any portion of the $1.0 million payable on August 1, 2006 into Sapiens
  Common Shares, at a conversion price per each share of $3.20. In addition the
  interest to be paid on the outstanding principal amount was changed to LIBOR plus
  2.5%.  The first installment of $2.0 million was paid as required at the
  beginning of May 2005.
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | In August 2006, Sapiens
  entered into an agreement with the Investors whereby the Investors converted
  the $1.0 million payment that was due on April 1, 2006 into 781,250 of
   Sapiens Common Shares and the payment of the $1.0 million payment due
  on August 1, 2006 was delayed to August 1, 2007.  The Investors may
  still, at their sole discretion, convert all or any portion of the $1.0
  million payable on August 1, 2007 into Sapiens Common Shares, at a conversion
  price per each share of $3.20                                                                                                                                                                                                                                         
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|E.           | On September 23, 2004,
  Formula Vision and Transtech, a subsidiary of Formula Vision,  Giza and Accel, entered into an agreement
  with funds under which the Funds and Formula Vision. invested in Transtech $19
  million (of which $14 million were invested by Giza and Accel) for preferred
  shares representing 47% in the equity of Transtech. The funds were also
  granted an option to purchase 50% of their original investment for a price of
  150% of the current purchase price. The option is for 5 years.                                                                                                                                                                                                                                     
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | Furthermore, the funds
  were granted an option for 3 months to increase the total investment to $25
  million under the above terms.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | No gain or loss arose from
  the transaction since the preferred shares cannot be treated as an investment
  in common shares (per SAB 51). Pursuant to the
  transaction, Formula Vision. held 36.7% of Transtech voting rights. In
  February 2005, the Funds exercised their option and invested an additional $6
  million. Following the investment, Formula Vision. holds 31.14% of Transtech
  voting rights.In March 2006, Formula
  Vision sold some of the shares of its affiliate, Transtech, to a third party
  for a consideration of $8.75 million.                                                                                                                                                                                                

F  27

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Note 2      | Certain Transactions (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|F.           | In March 2005, Formula
  completed a private placement of 2,400,000 Formula shares for an aggregate
  consideration of $33 million. The shares were issued to FIMGold LP, an entity
  owned in equal shares by Dan Goldstein and FIMI Opportunity Fund.
  Concurrently with the closing of the private placement, Dan Goldstein sold to
  FIMGold LP all of his holdings in Formula and Formula Vision. Following these
  transactions, FIMGold LP holds 33.3% controlling interest in Formula and
  approximately 24% interest in Formula Vision.
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|G.           | In August, 2005 a
  subsidiary of Formula Vision(F.T.S  Formula Telecom Solutions Ltd) raised
  $7.5 million in an IPO in the AIM in London, which resulted in a gain of $988
  thousands to the group.                                                                                                                                                                                                                                                                                                                                          
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|H.           | In
  December 2005 and April 2006, Formula repaid to First Israel Mezzanine Investors Ltd and
  Israel Discount Bank, a debenture in the aggregate principal amount of $4.7
  million issued by Formula in 2002.                                                                                                                                                                                                                                                                                                                                  
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Note 3      | Short-term Investments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|A.           | Comprise:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

| |                                 |  |               |  |                       |  |        |  |  |        | 
| | ------------------------------- |  | ------------- |  | --------------------- |  | ------ |  |  | ------ | 
| |                                 |  | Interest rate |  |                       |  |        |  |  |       
| |                                 |  |               |  | December 31,          | 
| |                                 |  | December 31,  |  |                       | 
| |                                 |  | 2006          |  | 2006                  |  | 2005   | 
| |                                 |  |               |  |                       |  |        | 
| |                                 |  | %             |  | (U.S. $ in thousands) | 
| |                                 |  |               |  |                       | 
| |                                 |  |               |  |                       |  |        |  |  |        | 
| | Trading
  securities            |  | -             |  |                       |  | 7,688  |  |  | 7,625  | 
|
| | Available-for-sale
  securities |  | -             |  |                       |  | 8,327  |  |  | 9,718  | 
|
| | Short-term
  deposits           |  | 1.2           |  |                       |  | 69     |  |  | 368    | 
| |                                 |  |               |  |                       |  |        |  |  |        | 
| | Total                           |  |               |  |                       |  | 16,084 |  |  | 17,711 | 
| |                                 |  |               |  |                       |  |        |  |  |        | 

F  28

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                       
|------------ | ------------------------------------------------------------------------------------------------------
|Note 3      | Short-term Investments (cont.):                                                                       
|             |                                                                                                       
|B.           | The following is a summary of marketable debt securities which are
  classified as available-for-sale:

|                                                 |  |                         |       |                      |  |                 |   |                    |       |                        |  |                 |  |  |      |   |  |       | 
|------------------------------------------------ |  | ----------------------- | ----- | -------------------- |  | --------------- | - | ------------------ | ----- | ---------------------- |  | --------------- |  |  | ---- | - |  | ----- | 
|                                                 |  | December
  31,         
|                                                 |  |                         |      
|                                                 |  | 2006                    |       | 2005                 | 
|                                                 |  |                         |       |                      | 
|                                                 |  | (U.S. $ in
  thousands)
|                                                 |  |                         |      
|                                                 |  | Amortized 
  cost       |       | Unrealized 
  losses |  | Market 
  value |   | Amortized 
  costs |       | Unrealized
  
  losses |  | Market 
  value | 
|                                                 |  |                         |       |                      |  |                 |   |                    |       |                        |  |                 | 
|Available-for-sale:                              |  |                         |       |                      |  |                 |   |                    |       |                        |  |                 |  |  |      |   |  |       | 
|Government debentures                            |  |                         | 1,641 |                      |  | (15             | ) |                    | 1,626 |                        |  | 1,732           |  |  | (71  | ) |  | 1,661 | 
|                                                
|Marketable
  securities                          |  |                         | 3,646 |                      |  | -               |   |                    | 3,646 |                        |  | -               |  |  | -    |   |  | -     | 
|Commercial debentures                            |  |                         | 2,855 |                      |  | (30             | ) |                    | 2,825 |                        |  | 7,698           |  |  | (91  | ) |  | 7,607 | 
|                                                
|Equity funds                                     |  |                         | 249   |                      |  | (19             | ) |                    | 230   |                        |  | 486             |  |  | (36  | ) |  | 450   | 
|                                                 |  |                         |       |                      |  |                 |   |                    |       |                        |  |                 |  |  |      |   |  |       | 
|Total
  available-for-sale marketable securities |  |                         | 8,391 |                      |  | (64             | ) |                    | 8,327 |                        |  | 9,916           |  |  | (198 | ) |  | 9,718 | 
|                                                 |  |                         |       |                      |  |                 |   |                    |       |                        |  |                 |  |  |      |   |  |       | 

| |                                                                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | During 2005,
  the Company recorded proceeds from sales of marketable securities in the amount
  of $5,757 thousands and related gains of $10 thousands in financial income,
  net.                                                                                                                                                                     
| |                                                                                                                                                                                                                                                                                                                                                         
| | Since the
  Company has the ability and intent to hold these investments until a recovery
  of fair value, the Company does not consider these investments to be other
  than temporarily impaired as of December 31, 2006. In addition, these
  securities have been in a continuous unrealized losses position for a period
  not more than 12 months.
| |                                                                                                                                                                                                                                                                                                                                                         
| | The
  estimated fair value of available-for-sale investments as of December 31,
  2006, by contractual maturity, are as follows:                                                                                                                                                                                                                        

| |                                   |  |                         |       |                 |  |       |  |                 |       |  |  |       | 
| | --------------------------------- |  | ----------------------- | ----- | --------------- |  | ----- |  | --------------- | ----- |  |  | ----- | 
| |                                   |  | December
  31,          |      
| |                                   |  |                         |      
| |                                   |  | 2006                    |       | 2005            | 
| |                                   |  |                         |      
| |                                   |  | (U.S. $ in
  thousands) |      
| |                                   |  |                         |      
| |                                   |  | Cost                    |       | Market 
  value |  | Cost  |  | Market 
  value |      
| |                                   |  |                         |       |                 |  |       |  |                 |      
| | Available-for-sale:               |  |                         |       |                 |  |       |  |                 |       |  |  |       | 
|
| | Matures in one year               |  |                         | 928   |                 |  | 900   |  |                 | 5,781 |  |  | 5,787 | 
| |                                   |  |                         |       |                 |  |       |  |                 |       |  |  |       | 
| | Matures in one
  to five years    |  |                         | 6,858 |                 |  | 6,828 |  |                 | 3,251 |  |  | 3,076 | 
|
| | Matures in more
  than five years |  |                         | 605   |                 |  | 599   |  |                 | 884   |  |  | 855   | 
| |                                   |  |                         |       |                 |  |       |  |                 |       |  |  |       | 
| |                                   |  |                         | 8,391 |                 |  | 8,327 |  |                 | 9,916 |  |  | 9,718 | 
| |                                   |  |                         |       |                 |  |       |  |                 |       |  |  |       | 

F  29

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                             
|------------ | ----------------------------
|Note 4      | Loans and Other Investments:

Comprise:

|                           |  |   |               |                 |                       |        |  |              |       |      |  |       | 
|-------------------------- |  | - | ------------- | --------------- | --------------------- | ------ |  | ------------ | ----- | ---- |  | ----- | 
|                           |  |   |               |                 |                       |        |  | December 31, |      
|                           |  |   |               |                 |                       |        |  |              |      
|                           |  |   | Interest rate |                 |                       |        |  | 2006         |       | 2005 | 
|                           |  |   |               | Linkage
  basis |                       |        |  |              |      
|                           |  | % |               |                 | (U.S. $ in thousands) |       
|                           |  |   |               |                 |                       |        | 
|                          
|Cost of shares (1)         |  |   |               |                 |                       |        |  |              | 62    |      |  | 469   | 
|                           |  |   |               |                 |                       |        |  |              |       |      |  |       | 
|Long-term prepaid expenses |  |   |               |                 |                       |        |  |              | 208   |      |  | 561   | 
|                           |  |   |               |                 |                       |        |  |              |       |      |  |       | 
|                          
|Restricted deposit         |  |   | 4.9-6         |                 |                       | Dollar |  |              | 2,907 |      |  | -     | 
|                          
|Deposit                    |  |   | -             |                 |                       | Dollar |  |              | 177   |      |  | 244   | 
|                          
|Deposit                    |  |   | -             |                 |                       | CPI    |  |              | 162   |      |  | 186   | 
|                          
|Deposit                    |  |   | 0-3           |                 |                       | Yen    |  |              | 378   |      |  | 544   | 
|                          
|Deposit                    |  |   | -             |                 |                       | Euro   |  |              | 3     |      |  | 2     | 
|                          
|Deposit                    |  |   | -             |                 |                       | GBP    |  |              | 18    |      |  | 15    | 
|                           |  |   |               |                 |                       |        |  |              |       |      |  |       | 
|                           |  |   |               |                 |                       |        |  |              | 3,645 |      |  | 991   | 
|                           |  |   |               |                 |                       |        |  |              |       |      |  |       | 
|Total                      |  |   |               |                 |                       |        |  |              | 3,915 |      |  | 2,021 | 
|                           |  |   |               |                 |                       |        |  |              |       |      |  |       | 

|    |                                                                                      
|--- | -------------------------------------------------------------------------------------
|(1) | During 2006 and 2005 no impairment
  losses on cost investments have been identified.

|             |                                                         
|------------ | --------------------------------------------------------
|Note 5      | Investments in Affiliates:                              
|             |                                                         
|A.           | The Investments are composed and presented
  as follows:

| |                                                                  |  |                       |      |      |  |     |  
| | ---------------------------------------------------------------- |  | --------------------- | ---- | ---- |  | --- | -
| |                                                                  |  | December 31,          |     
| |                                                                  |  |                       |     
| |                                                                  |  | 2006                  |      | 2005 | 
| |                                                                  |  |                       |      |      | 
| |                                                                  |  | (U.S. $ in thousands) |     
| |                                                                  |  |                       |     
| | Investment in shares:                                            |  |                       |      |      |  |     |  
|
| | Cost                                                             |  |                       | 557  |      |  | 147 |  
|
| | Goodwill and
  allocated original excess cost *                  |  |                       | (205 | )    |  | (5  | )
| |                                                                  |  |                       |      |      |  |     |  
| | Net asset value
  as of acquisition date                         |  |                       | 352  |      |  | 142 |  
|
| | Equity in post-acquisition undistributed
retained earnings , net |  |                       | 163  |      |  | 211 |  
| |                                                                  |  |                       |      |      |  |     |  
| | Net asset value
  as of the balance
  sheet date                 |  |                       | 515  |      |  | 353 |  
|
| | Balance of
  goodwill                                            |  |                       | 205  |      |  | 5   |  
| |                                                                  |  |                       |      |      |  |     |  
| |                                                                  |  |                       | 720  |      |  | 358 |  
| |                                                                  |  |                       |      |      |  |     |  
| | Loans to affiliates:                                             |  |                       |      |      |  |     |  
|
| | Index-linked
  and interest-free                                 |  |                       | -    |      |  | 98  |  
| |                                                                  |  |                       |      |      |  |     |  
| | Total                                                            |  |                       | 720  |      |  | 456 |  
| |                                                                  |  |                       |      |      |  |     |  

| |   |                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | * | 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
  1I).
| |   |                                                                                                                                                                                                     
| |  

F  30

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                    
|------------ | -----------------------------------
|Note 5      | Investments in Affiliates (Count.):
|             |                                    
|             |                                    

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

| |                   |  |                       |       |      |  |       | 
| | ----------------- |  | --------------------- | ----- | ---- |  | ----- | 
| |                   |  | December 31,          |      
| |                   |  |                       |      
| |                   |  | 2006                  |       | 2005 | 
| |                   |  |                       |       |      | 
| |                   |  | (U.S. $ in thousands) |      
| |                   |  |                       |      
|
| | Total assets      |  |                       | 6,592 |      |  | 6,370 | 
| |                   |  |                       |       |      |  |       | 
| | Total liabilities |  |                       | 346   |      |  | 4,661 | 
| |                   |  |                       |       |      |  |       | 
| | Net income        |  |                       | 64    |      |  | 162   | 
| |                   |  |                       |       |      |  |       | 

|             |                             
|------------ | ----------------------------
|Note 6      | Property and Equipment, net:

Comprise:

| |                           |  |                       |        |      |  |        | 
| | ------------------------- |  | --------------------- | ------ | ---- |  | ------ | 
| |                           |  | December 31,          |       
| |                           |  |                       |       
| |                           |  | 2006                  |        | 2005 | 
| |                           |  |                       |        |      | 
| |                           |  | (U.S. $ in thousands) |       
| |                           |  |                       |       
| | Cost:                     |  |                       |        |      |  |        | 
|
| | Computers and equipment   |  |                       | 63,652 |      |  | 57,609 | 
|
| | Motor vehicles            |  |                       | 1,450  |      |  | 2,023  | 
|
| | Buildings                 |  |                       | 3,748  |      |  | 3,117  | 
|
| | Leasehold improvements    |  |                       | 14,260 |      |  | 13,576 | 
| |                           |  |                       |        |      |  |        | 
| |                           |  |                       | 83,110 |      |  | 76,325 | 
| |                           |  |                       |        |      |  |        | 
| | Accumulated Depreciation: |  |                       |        |      |  |        | 
|
| | Computers and equipment   |  |                       | 54,903 |      |  | 48,732 | 
|
| | Motor vehicles            |  |                       | 828    |      |  | 904    | 
|
| | Buildings                 |  |                       | 1,663  |      |  | 965    | 
|
| | Leasehold improvements    |  |                       | 7,259  |      |  | 6,591  | 
| |                           |  |                       |        |      |  |        | 
| |                           |  |                       | 64,653 |      |  | 57,192 | 
| |                           |  |                       |        |      |  |        | 
| | Depreciated
  balance     |  |                       | 18,457 |      |  | 19,133 | 
| |                           |  |                       |        |      |  |        | 

| |                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | Depreciation expense totaled $6,407 thousand; $6,045 thousand and
  $6,830 thousand for the years ended December 31, 2006, 2005 and 2004,
  respectively.
| |                                                                                                                                                          
| | See Note 13.B with respect to pledges.                                                                                                                   
| |                                                                                                                                                          
| |                                                                                                                                                          

F  31

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |          
|------------ | ---------
|             |          
|             |          
|             |          
|             |          
|Note 7      | Goodwill:

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

|                                                    |  |                        |         |  
|--------------------------------------------------- |  | ---------------------- | ------- | -
|                                                    |  | U.S. $ in 
  thousands |        
|                                                    |  |                        |        
|                                                   
|Balance as of January 1, 2006                       |  |                        | 145,000 |  
|                                                   
|Acquisition of additional interest in subsidiaries  |  |                        | 4,655   |  
|                                                   
|Realization and decrease in shareholding percentage |  |                        | (884    | )
|                                                   
|Acquisition of newly-consolidated subsidiaries      |  |                        | 6,006   |  
|                                                   
|Foreign currency translation adjustments            |  |                        | 4,539   |  
|                                                    |  |                        |         |  
|Balance as of December 31, 2006                     |  |                        | 159,316 |  
|                                                    |  |                        |         |  

|             |                   
|------------ | ------------------
|Note 8      | Other Assets, Net:

Comprised as follows:

|   |                                          |  |                       |         |      |  |         | 
|-- | ---------------------------------------- |  | --------------------- | ------- | ---- |  | ------- | 
|   |                                          |  | December 31,          |        
|   |                                          |  |                       |        
|   |                                          |  | 2006                  |         | 2005 | 
|   |                                          |  |                       |         |      | 
|   |                                          |  | (U.S. $ in thousands) |        
|   |                                          |  |                       |        
|A. | Original amounts:                        |  |                       |         |      |  |         | 
|  
|   | Capitalized
  software development costs |  |                       | 146,760 |      |  | 119,673 | 
|  
|   | Deferred
  expenses and others           |  |                       | 14,278  |      |  | 12,656  | 
|  
|   | Deferred tax
  asset                     |  |                       | 7,047   |      |  | 6,198   | 
|   |                                          |  |                       |         |      |  |         | 
|   |                                          |  |                       | 168,085 |      |  | 138,527 | 
|   |                                          |  |                       |         |      |  |         | 
|   | Accumulated
  amortization:              |  |                       |         |      |  |         | 
|  
|   | Capitalized software development costs   |  |                       | 86,395  |      |  | 69,437  | 
|  
|   | Deferred expenses and others             |  |                       | 8,053   |      |  | 6,704   | 
|   |                                          |  |                       |         |      |  |         | 
|   |                                          |  |                       | 94,448  |      |  | 76,141  | 
|   |                                          |  |                       |         |      |  |         | 
|   | Total                                    |  |                       | 73,637  |      |  | 62,386  | 
|   |                                          |  |                       |         |      |  |         | 

|   |                                                                                                                                                            
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------
|B. | Amortized expenses totaled $ 17,260 thousand, $15,010 thousand and
  $10,569 thousand for the years ended December 31, 2006, 2005 and 2004,
  respectively.
|   |                                                                                                                                                            
|   | As for impairments of software development cost, see Note 1k.                                                                                              
|   |                                                                                                                                                            
|   |                                                                                                                                                            

F  32

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                           
|------------ | --------------------------
|Note 8      | Other Assets, Net (Cont.):

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

| |                       |  |                          |       | 
| | --------------------- |  | ------------------------ | ----- | 
| |                       |  | (U.S. $ in 
  thousands)
| |                       |  |                         
| | December 31,          |  |                          |       | 
|
| | 2007                  |  |                          | 1,450 | 
|
| | 2008                  |  |                          | 1,300 | 
|
| | 2009                  |  |                          | 721   | 
|
| | 2010                  |  |                          | 236   | 
|
| | 2011 and
  thereafter |  |                          | 2,518 | 

|             |            
|------------ | -----------
|Note 9      | Debentures:

|                                    |  |         |        |  |                       |      |      |              |       |  |  |       | 
|----------------------------------- |  | ------- | ------ |  | --------------------- | ---- | ---- | ------------ | ----- |  |  | ----- | 
|                                    |  |         |        |  |                       |      |      | December 31, |      
|                                    |  |         |        |  |                       |      |      |              |      
|                                    |  |         |        |  |                       |      | 2006 |              | 2005  | 
|                                    |  |         |        |  | Interest 
  rate      |      |      |              |       | 
|                                    |  | Linkage |        |  | (U.S. $ in thousands) |     
|                                    |  |         |        |  |                       |      |     
|Convertible debenture (see note 2D) |  |         | Dollar |  |                       | 6.00 |      |              | 4,450 |  |  | 4,464 | 
|                                   
|Convertible
  debenture             |  |         | Dollar |  |                       | 6.82 |      |              | 4,482 |  |  | -     | 
|                                   
|Convertible debenture               |  |         | CPI    |  |                       | 4.95 |      |              | -     |  |  | 3,540 | 
|                                    |  |         |        |  |                       |      |      |              |       |  |  |       | 
|Total                               |  |         |        |  |                       |      |      |              | 8,932 |  |  | 8,004 | 
|                                    |  |         |        |  |                       |      |      |              |       |  |  |       | 

|             |                                 
|------------ | --------------------------------
|Note 10     | Liabilities to Banks and Others:
|             |                                 
|A.           | Composition:                    

|      |  |                     |  |                 |  |                         |  |                       |        |                                                           |        |                                                           |        |  |        |  |  |  | 
|----- |  | ------------------- |  | --------------- |  | ----------------------- |  | --------------------- | ------ | --------------------------------------------------------- | ------ | --------------------------------------------------------- | ------ |  | ------ |  |  |  | 
|      |  | Interest
  rate     |  | Linkage
  basis |  | Long-term
  liabilities |  | Current
  maturities  |        | Total long-term
  liabilities net of
  current maturities |        | Total long-term
  liabilities net of
  current maturities |       
|      |  |                     |  |                 |  |                         |  |                       |        |                                                           |        |                                                           |       
|      |  | December
  31, 2006 |  |                 |  | December 31, 2006       |  | December 31, 2005     |       
|      |  |                     |  |                 |  |                         |  |                       |       
|      |  | %                   |  |                 |  | (U.S. $ in thousands)   |  | (U.S. $ in thousands) |       
|      |  |                     |  |                 |  |                         |  |                       |       
|      |  | 5.6-7.2             |  |                 |  | Dollar                  |  |                       | 15,960 |                                                           | 5,311  |                                                           | 10,649 |  | 9,981  | 
|     
|      |  | 4.3-5               |  |                 |  | CPI                     |  |                       | 1,375  |                                                           | 883    |                                                           | 492    |  | 1,778  | 
|     
|      |  | 3.7-14              |  |                 |  | Other                   |  |                       | 80,171 |                                                           | 12,017 |                                                           | 68,154 |  | 40,581 | 
|      |  |                     |  |                 |  |                         |  |                       |        |                                                           |        |                                                           |        |  |        |  |  |  | 
|      |  |                     |  |                 |  |                         |  |                       | 97,506 |                                                           | 18,211 |                                                           | 79,295 |  | 52,340 | 
|      |  |                     |  |                 |  |                         |  |                       |        |                                                           |        |                                                           |        |  |        |  |  |  | 
|      |  | Warrants            |  |                 |  |                         |  |                       | -      |                                                           | -      |                                                           | -      |  | 74     | 
|      |  |                     |  |                 |  |                         |  |                       |        |                                                           |        |                                                           |        |  |        |  |  |  | 
|Total |  |                     |  |                 |  |                         |  |                       | 97,506 |                                                           | 18,211 |                                                           | 79,295 |  | 52,414 | 
|      |  |                     |  |                 |  |                         |  |                       |        |                                                           |        |                                                           |        |  |        |  |  |  | 

F  33

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                          
|------------ | -----------------------------------------
|Note 10     | Liabilities to Banks and Others (Count.):
|             |                                          
|             |                                          

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

|                                  |  |                       |        |      |  |        | 
|--------------------------------- |  | --------------------- | ------ | ---- |  | ------ | 
|                                  |  | December 31,          |       
|                                  |  |                       |       
|                                  |  | 2006                  |        | 2005 | 
|                                  |  |                       |        |      | 
|                                  |  | (U.S. $ in thousands) |       
|                                  |  |                       |       
|First year
  (current maturities) |  |                       | 18,211 |      |  | 9,380  | 
|                                 
|Second year                       |  |                       | 22,968 |      |  | 16,363 | 
|                                 
|Third year                        |  |                       | 20,950 |      |  | 17,073 | 
|                                 
|Fourth year                       |  |                       | 35,250 |      |  | 18,088 | 
|                                 
|Fifth year                        |  |                       | 127    |      |  | 890    | 
|                                  |  |                       |        |      |  |        | 
|Total                             |  |                       | 97,506 |      |  | 61,794 | 
|                                  |  |                       |        |      |  |        | 

|             |                                                                             
|------------ | ----------------------------------------------------------------------------
|C.           | For  details  of  liens,   guarantees,   and
credit facilities  see Note 13.
|             |                                                                             
|Note 11     | Debentures:                                                                 

Comprised as follows:

|                                     |  |         |  |                   |      |                       |  |              |        |      |  |        | 
|------------------------------------ |  | ------- |  | ----------------- | ---- | --------------------- |  | ------------ | ------ | ---- |  | ------ | 
|                                     |  |         |  |                   |      |                       |  | December 31, |       
|                                     |  |         |  |                   |      |                       |  |              |       
|                                     |  |         |  |                   |      |                       |  | 2006         |        | 2005 | 
|                                     |  |         |  |                   |      |                       |  |              |        |      | 
|                                     |  | Linkage |  | Interest rate     |      | (U.S. $ in thousands) | 
|                                     |  |         |  |                   |      |                       | 
|                                     |  |         |  | Three-month
Libor |      |                       | 
|Convertible debenture                |  | Dollar  |  |                   | 6.82 | %                     |  |              | 18,531 |      |  | 4,342  | 
|                                     |  |         |  |                   |      |                       |  |              |        |      |  |        | 
|Convertible debenture                |  | CPI     |  |                   | 5    | %                     |  |              | -      |      |  | 3,540  | 
|                                     |  |         |  |                   |      |                       |  |              |        |      |  |        | 
|Convertible debentuere (see Note 2D) |  | Dollar  |  |                   | 6    | %                     |  |              | 16,246 |      |  | 18,483 | 
|                                     |  |         |  |                   |      |                       |  |              |        |      |  |        | 
|                                     |  |         |  |                   |      |                       |  |              | 34,777 |      |  | 26,365 | 
|                                     |  |         |  |                   |      |                       |  |              |        |      |  |        | 
|Deferred issuance expenses, net      |  |         |  |                   |      |                       |  |              | 1,732  |      |  | 1,552  | 
|                                     |  |         |  |                   |      |                       |  |              |        |      |  |        | 
|                                     |  |         |  |                   |      |                       |  |              | 33,045 |      |  | 24,813 | 
|                                     |  |         |  |                   |      |                       |  |              |        |      |  |        | 
|Current maturities                   |  |         |  |                   |      |                       |  |              | 8,932  |      |  | 8,004  | 
|                                     |  |         |  |                   |      |                       |  |              |        |      |  |        | 
|                                     |  |         |  |                   |      |                       |  |              | 24,113 |      |  | 16,809 | 
|                                     |  |         |  |                   |      |                       |  |              |        |      |  |        | 

In accordance
with APB No. 14, Accounting for Convertible debt and Debt Issued with Stock
Purchase Warrants, EITF 98-5, Accounting for Convertible Securities with
Beneficial Conversion features or Contingently Adjustable Conversion Ratios,
and EITF 00-27, Application of issue No. 98-5 to Certain Convertible
Instruments (EITF 00-27), a portion of the proceeds of debt securities
issued with detachable warrants was allocated to the Options and the Warrants,
at time of issuance. Amounts allocated to the Options (Series A) and the
Warrants are accounted for as liabilities, in accordance with EITF 00-19,
Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled In, a Companys Own Stock (EITF 00-19), and are marked to market,
based on their fair values in the TASE at each reporting date, against financial
income (expense).

F  34

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                    
|------------ | -------------------
|Note 11     | Debentures (cont.):

No beneficial
conversion feature was recorded on the Debentures, because the effective
conversion price of the Debentures (Series A) was higher than the fair value of
the Common share on the commitment date.

Pursuant to an
evaluation of the terms of the agreement under the provisions of EITF 00-19, the
Company has classified all the above derivative financial instruments issued in
connection with the private placement as liabilities.

|             |                                       
|------------ | --------------------------------------
|Note 12     | Employee Option Plans in Subsidiaries:

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

The options were mainly granted in the years 1999-2006. In general, the options
are exercisable 2-3 years after the date of grant and expire 7-10 years after
grant. Most of the options were granted as part of plans that were adopted in
accordance with the provisions of Section 102 of the Israeli Income Tax
Ordinance, which stipulate, inter alia, that the subsidiaries will be able to
claim the benefit that was charged to the employees as an expense for tax purposes,
if and when the employees become liable for tax on the said benefit. For
further information with respect to expenses relating to the benefit to the
employees, and additional disclosure required by FAS 123R, see Note 1W.

F  35

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                             
|------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 12     | Employee Option Plans in Subsidiaries
  (cont.):                                                                                                            
|             |                                                                                                                                                             
|A.           | The following is a summary of the status of options plans in
  BluePhoenix as of December 31, 2006, 2005 and 2004 and changes
  during the years then ended:

|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |           |   |      | 
|----------------------------------------------------------------- |  | ------------------------------- | --------- | ------------------------------------- | ------------------------------- |  | ------------------- | ------------------------------- | ------------------------------------- | - | ---- | ------------------- |  | ----------------------------------- | --------- | - | ---- | 
|                                                                  |  | Year ended 
  December 31, 2006 |           |                                       | Year ended 
  December 31, 2005 |  |                     | Year ended 
  December 31, 2004 |                                      
|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                      
|                                                                  |  | Number of
  options             |           | Weighted
  Average
  Exercise
  Price |                                 |  | Number of
  options |                                 | Weighted
  Average
  Exercise
  Price |   |      | Number of
  options |  | Weighted
  Average
  Exercise Price |          
|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |          
|                                                                  |  |                                 |           | $                                     |                                 |  |                     |                                 | $                                     |   |      |                     |  | $                                   |          
|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |          
|Options outstanding at  the beginning of the year                 |  |                                 | 2,765,817 |                                       | 4.78                            |  |                     |                                 | 2,132,587                             |   | 5.00 |                     |  |                                     | 2,159,993 |   | 4.99 | 
|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |           |   |      | 
|Changes during the year:                                          |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |           |   |      | 
|                                                                 
|Granted                                                           |  |                                 | 75,000    |                                       | 5.5                             |  |                     |                                 | 834,712                               |   | 4.96 |                     |  |                                     | 163,721   |   | 6.00 | 
|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |           |   |      | 
|Exercised                                                         |  |                                 | (206,796  | )                                     | 3.53                            |  |                     |                                 | (10,299                               | ) | 3.05 |                     |  |                                     | (33,767   | ) | 3.56 | 
|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |           |   |      | 
|Forfeited                                                         |  |                                 | (411,054  | )                                     | 6.19                            |  |                     |                                 | (191,183                              | ) | 8.04 |                     |  |                                     | (157,360  | ) | 6.29 | 
|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |           |   |      | 
|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |           |   |      | 
|Options outstanding  at the end of the
year                       |  |                                 | 2,222,967 |                                       | 4.6                             |  |                     |                                 | 2,765,817                             |   | 4.78 |                     |  |                                     | 2,132,587 |   | 5.00 | 
|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |           |   |      | 
|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |           |   |      | 
|Options exercisable at year-end                                   |  |                                 | 2,017,300 |                                       | 4.71                            |  |                     |                                 | 2,399,484                             |   | 4.78 |                     |  |                                     | 877,049   |   | 6.08 | 
|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |           |   |      | 
|Weighted-average fair value of options
  granted during the year* |  |                                 |           |                                       | 2.65                            |  |                     |                                 |                                       |   | 1.47 |                     |  |                                     |           |   | 1.71 | 
|                                                                  |  |                                 |           |                                       |                                 |  |                     |                                 |                                       |   |      |                     |  |                                     |           |   |      | 

| |   |                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | * | The fair
  value of each option that was granted is estimated on the date of grant,
  using the                                                                                                                                                                                                                    
| |   | Black-Scholes
  option-pricing model with the following weighted average assumptions:
  dividend yield of 0% for all years; expected volatility: 2006 - 45%, 2005 -
  41%, 2004 - 26%, risk-free interest rate 2006 - 4.97%, 2005 - 3.93%, 2004 -
  2.78% and expected life: 2006, 2005 - 5.5 years, 2004 -3 years.

F  36

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                          
|------------ | ---------------------------------------------------------------------------------------------------------
|Note 12     | Employee Option Plans in Subsidiaries (cont.):                                                           
|             |                                                                                                          
|A.           | (cont.):                                                                                                 
|             |                                                                                                          
|             | The
  following table summarizes information in respect of outstanding options as
  of December 31, 2006.

|                             |  |                                               |  |                                                 |  |                                   |  |                                               |       |                                     |           |  |  |  |       | 
|---------------------------- |  | --------------------------------------------- |  | ----------------------------------------------- |  | --------------------------------- |  | --------------------------------------------- | ----- | ----------------------------------- | --------- |  |  |  | ----- | 
|                             |  | Options Outstanding                           |  | Options Exercisable                             | 
|                             |  |                                               |  |                                                 | 
|Range of
  Exercise
  Prices |  | Number
  Outstanding
  at December
  31, 2006 |  | Weighted Average
  Remaining
  Contractual Life |  | Weighted Average
  Exercise Price |  | Number
  Exercisable at
  December 31,
  2006 |       | Weighted
  Average
  Exercise Price |          
|                             |  |                                               |  |                                                 |  |                                   |  |                                               |       |                                     |           |  | 
|$                            |  |                                               |  | Years                                           |  | $                                 |  |                                               |       | $                                   |          
|                             |  |                                               |  |                                                 |  |                                   |  |                                               |       |                                     |          
|                             |  |                                               |  |                                                 |  |                                   |  |                                               |       |                                     |           |  |  |  |       | 
|2.25                         |  | 395,000                                       |  |                                                 |  | 6.25                              |  |                                               | 2.25  |                                     | 291,000   |  |  |  | 2.25  | 
|                            
|3.00                         |  | 106,701                                       |  |                                                 |  | 6.50                              |  |                                               | 3.00  |                                     | 106,701   |  |  |  | 3.00  | 
|                            
|3.00                         |  | 63,600                                        |  |                                                 |  | 5.50                              |  |                                               | 3.00  |                                     | 63,600    |  |  |  | 3.00  | 
|                            
|3.00                         |  | 80,000                                        |  |                                                 |  | 5.09                              |  |                                               | 3.00  |                                     | 53,333    |  |  |  | 3.00  | 
|                            
|3.50                         |  | 34,700                                        |  |                                                 |  | 6.50                              |  |                                               | 3.50  |                                     | 34,700    |  |  |  | 3.50  | 
|                            
|4.00                         |  | 200,000                                       |  |                                                 |  | 6.83                              |  |                                               | 4.00  |                                     | 200,000   |  |  |  | 4.00  | 
|                            
|4.00                         |  | 150,000                                       |  |                                                 |  | 9.00                              |  |                                               | 4.00  |                                     | 150,000   |  |  |  | 4.00  | 
|                            
|4.50                         |  | 38,533                                        |  |                                                 |  | 4.50                              |  |                                               | 4.50  |                                     | 38,533    |  |  |  | 4.50  | 
|                            
|4.50                         |  | 63,000                                        |  |                                                 |  | 8.67                              |  |                                               | 4.50  |                                     | 63,000    |  |  |  | 4.50  | 
|                            
|5.00                         |  | 37,400                                        |  |                                                 |  | 8.83                              |  |                                               | 5.00  |                                     | 37,400    |  |  |  | 5.00  | 
|                            
|5.00                         |  | 430,712                                       |  |                                                 |  | 9.00                              |  |                                               | 5.00  |                                     | 430,712   |  |  |  | 5.00  | 
|                            
|5.50                         |  | 13,000                                        |  |                                                 |  | 3.83                              |  |                                               | 5.50  |                                     | 13,000    |  |  |  | 5.50  | 
|                            
|5.50                         |  | 75,000                                        |  |                                                 |  | 9.58                              |  |                                               | 5.50  |                                     | -         |  |  |  | 5.50  | 
|                            
|6.00                         |  | 28,000                                        |  |                                                 |  | 7.00                              |  |                                               | 6.00  |                                     | 28,000    |  |  |  | 6.00  | 
|                            
|6.00                         |  | 143,721                                       |  |                                                 |  | 7.42                              |  |                                               | 6.00  |                                     | 143,721   |  |  |  | 6.00  | 
|                            
|6.00                         |  | 150,000                                       |  |                                                 |  | 8.67                              |  |                                               | 6.00  |                                     | 150,000   |  |  |  | 6.00  | 
|                            
|6.50                         |  | 2,000                                         |  |                                                 |  | 7.00                              |  |                                               | 6.50  |                                     | 2,000     |  |  |  | 6.50  | 
|                            
|8.00                         |  | 80,000                                        |  |                                                 |  | 2.50                              |  |                                               | 8.00  |                                     | 80,000    |  |  |  | 8.00  | 
|                            
|9.63                         |  | 43,000                                        |  |                                                 |  | 3.25                              |  |                                               | 9.63  |                                     | 43,000    |  |  |  | 9.63  | 
|                            
|10.50                        |  | 88,600                                        |  |                                                 |  | 4.25                              |  |                                               | 10.50 |                                     | 88,600    |  |  |  | 10.50 | 
|                             |  |                                               |  |                                                 |  |                                   |  |                                               |       |                                     |           |  |  |  |       | 
|                             |  | 2,222,967                                     |  |                                                 |  |                                   |  |                                               |       |                                     | 2,017,300 |  |  |  |       | 
|                             |  |                                               |  |                                                 |  |                                   |  |                                               |       |                                     |           |  |  |  |       | 

F  37

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                  
|------------ | -----------------------------------------------------------------------------------------------------------------
|Note 12     | 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, 2006, 2005 and 2004:

|                                                                 |  |                                |           |                                        |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
|---------------------------------------------------------------- |  | ------------------------------ | --------- | -------------------------------------- |  | ------------------------------ |  | ------------------------------------- | --------- | ------------------- |  | ------------------------------------- |  |  | --------- | - |  | ---- | 
|                                                                 |  | Year ended
  December 31, 2006 |           | Year ended
  December 31, 2005         |  | Year ended
  December 31, 2004 | 
|                                                                 |  |                                |           |                                        |  |                                |  |                                       |           |                     |  |                                       | 
|                                                                 |  | Number of
  Options            |           | Weighted 
  Average
  Exercise
  Price |  | Number of
  Options            |  | Weighted
  Average
  Exercise
  Price |           | Number of
  Options |  | Weighted
  Average
  Exercise
  Price | 
|                                                                 |  |                                |           |                                        |  |                                |  |                                       |           |                     |  |                                       | 
|                                                                 |  |                                |           |                                        |  | $                              |  |                                       |           |                     |  | $                                     |  |  |           |   |  | $    | 
|                                                                 |  |                                |           |                                        |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
|Options outstanding at the beginning of the year                 |  |                                | 3,061,216 |                                        |  | 2.62                           |  |                                       | 2,513,237 |                     |  | 2.95                                  |  |  | 3,346,406 |   |  | 2.26 | 
|                                                                
|Granted                                                          |  |                                | 62,000    |                                        |  | 1.69                           |  |                                       | 820,028   |                     |  | 1.70                                  |  |  | 406,601   |   |  | 4.84 | 
|                                                                
|Exercised                                                        |  |                                | (253,346  | )                                      |  | 1.11                           |  |                                       | (80,604   | )                   |  | 1.04                                  |  |  | (973,551  | ) |  | 1.28 | 
|                                                                
|Cancelled                                                        |  |                                | -         |                                        |  | -                              |  |                                       | -         |                     |  | -                                     |  |  | -         |   |  | -    | 
|                                                                
|Forfeited                                                        |  |                                | (517,238  | )                                      |  | 3.41                           |  |                                       | (191,445  | )                   |  | 3.54                                  |  |  | (266,219  | ) |  | 3.6  | 
|                                                                 |  |                                |           |                                        |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
|Outstanding at the end of the year                               |  |                                | 2,352,632 |                                        |  | 2.52                           |  |                                       | 3,061,216 |                     |  | 2.62                                  |  |  | 2,513,237 |   |  | 2.95 | 
|                                                                 |  |                                |           |                                        |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
|                                                                
|Exercisable at the end of the year                               |  |                                | 2,290,032 |                                        |  | 2.54                           |  |                                       | 3,061,216 |                     |  | 2.62                                  |  |  | 1,423,970 |   |  | 2.28 | 
|                                                                 |  |                                |           |                                        |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 
|Weighted average fair value of options granted during the year
* |  |                                |           |                                        |  | 1.7                            |  |                                       |           |                     |  | 1.1                                   |  |  |           |   |  | 2.2  | 
|                                                                 |  |                                |           |                                        |  |                                |  |                                       |           |                     |  |                                       |  |  |           |   |  |      | 



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | * | The fair value of each option granted is estimated on the date of
  grant, using the Black-Scholes Option Valuation Model, with the following
  weighted-average assumptions for each of the three years in the period ended
  December 31, 2006, 2005 and 2004: expected volatility of 64%, 80% and 67.3%,
  respectively, risk-free interest rates of 4.7% 3.9% and 2.8% respectively,
  dividend yields of 0% for each year, and a weighted average expected life of
  the option of 5 years, 5 years and 3 years, respectively.

F  38

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                    
|------------ | ---------------------------------------------------------------------------------------------------
|Note 12     | Employee
Option Plans in Subsidiaries (cont.):                                                     
|             |                                                                                                    
|B.           | (cont.):                                                                                           
|             |                                                                                                    
|             | The following table summarizes information regarding options
  outstanding as of December 31, 2006:

|                               |  |                                                |           |                                                   |  |                                     |  |                                                 |  |                                       |           |  |  |  |       |  | 
|------------------------------ |  | ---------------------------------------------- | --------- | ------------------------------------------------- |  | ----------------------------------- |  | ----------------------------------------------- |  | ------------------------------------- | --------- |  |  |  | ----- |  | 
|                               |  | Options Outstanding                            |           | Options Exercisable                               | 
|                               |  |                                                |           |                                                   | 
|Range of 
  Exercise 
  Prices |  | Number
  Outstanding 
  at December
  31, 2006 |           | Weighted Average 
  Remaining 
  Contractual Life |  | Weighted Average 
  Exercise  Price |  | Number 
  Exercisable at
  December 31, 
  2006 |  | Weighted 
  Average 
  Exercise Price |          
|                               |  |                                                |           |                                                   |  |                                     |  |                                                 |  |                                       |          
|$                              |  |                                                |           | Years                                             |  | $                                   |  |                                                 |  | $                                     |          
|                               |  |                                                |           |                                                   |  |                                     |  |                                                 |  |                                       |          
|                              
|0-1                            |  |                                                | 214,355   |                                                   |  | 6                                   |  | 0.83                                            |  |                                       | 214,355   |  |  |  | 0.83  |  | 
|1-2                            |  |                                                | 1,253,793 |                                                   |  | 7                                   |  | 1.37                                            |  |                                       | 1,191,793 |  |  |  | 1.36  |  | 
|2-3                            |  |                                                | 15,600    |                                                   |  | 3                                   |  | 2.48                                            |  |                                       | 15,600    |  |  |  | 2.48  |  | 
|3-4                            |  |                                                | 466,333   |                                                   |  | 7                                   |  | 3.82                                            |  |                                       | 466,333   |  |  |  | 3.82  |  | 
|4-5                            |  |                                                | 230,840   |                                                   |  | 7                                   |  | 4.13                                            |  |                                       | 230,840   |  |  |  | 4.13  |  | 
|5-6                            |  |                                                | 135,500   |                                                   |  | 7                                   |  | 5.95                                            |  |                                       | 135,500   |  |  |  | 5.95  |  | 
|6-7                            |  |                                                | 711       |                                                   |  | 3                                   |  | 6.14                                            |  |                                       | 711       |  |  |  | 6.14  |  | 
|10-11                          |  |                                                | 26,500    |                                                   |  | 3                                   |  | 10.16                                           |  |                                       | 26,500    |  |  |  | 10.16 |  | 
|18-19                          |  |                                                | 9,000     |                                                   |  | 3                                   |  | 18.79                                           |  |                                       | 9,000     |  |  |  | 18.79 |  | 
|                               |  |                                                |           |                                                   |  |                                     |  |                                                 |  |                                       |           |  |  |  |       |  | 
|                               |  |                                                | 2,352,632 |                                                   |  | 7                                   |  | 2.52                                            |  |                                       | 2,290,632 |  |  |  | 2.54  |  | 
|                               |  |                                                |           |                                                   |  |                                     |  |                                                 |  |                                       |           |  |  |  |       |  | 

|   |                                                                                                                                                 
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------
|C. | The following is a summary of the status of option plans in Matrix as
  of December 31, 2006 and 2005 and changes
  during the years then ended:

|                                                                    |  |                                |            |                                        |  |                     |  |                                        |            |   |  |       | 
|------------------------------------------------------------------- |  | ------------------------------ | ---------- | -------------------------------------- |  | ------------------- |  | -------------------------------------- | ---------- | - |  | ----- | 
|                                                                    |  | Year ended
  December 31, 2006 |            | Year ended
  December 31, 2005         | 
|                                                                    |  |                                |            |                                        |  |                     |  |                                        |           
|                                                                    |  | Number of
  options            |            | Weighted
  Average
  Exercise 
  Price |  | Number of
  options |  | Weighted
  Average
  Exercise 
  Price |           
|                                                                    |  |                                |            |                                        |  |                     |  |                                        |           
|                                                                    |  |                                |            | $                                      |  |                     |  | $                                      |           
|                                                                    |  |                                |            |                                        |  |                     |  |                                        |           
|Options
  outstanding at the beginning of the year                  |  |                                | 5,203,659  |                                        |  | 1.588               |  |                                        | 6,031,380  |   |  | 1.8   | 
|                                                                   
|Changes during the year:                                            |  |                                |            |                                        |  |                     |  |                                        |            |   |  |       | 
|                                                                   
|Granted                                                             |  |                                | -          |                                        |  |                     |  |                                        | 530,800    |   |  | 1.710 | 
|                                                                   
|Exercised                                                           |  |                                | (2,219,136 | )                                      |  | 1.54                |  |                                        | (1,329,302 | ) |  | 1.434 | 
|                                                                   
|Forfeited                                                           |  |                                | (35,232    | )                                      |  | 1.524               |  |                                        | (29,219    | ) |  | 1.410 | 
|                                                                    |  |                                |            |                                        |  |                     |  |                                        |            |   |  |       | 
|Options
  outstanding at the end of the year                        |  |                                | 2,949,291  |                                        |  | 1.625               |  |                                        | 5,203,659  |   |  | 1.588 | 
|                                                                    |  |                                |            |                                        |  |                     |  |                                        |            |   |  |       | 
|Options
  exercisable at end of year                                |  | 2,949,291                      |            | 1.625                                  |  | 5,180,707           |  | 1.588                                  |           
|                                                                    |  |                                |            |                                        |  |                     |  |                                        |            |   |  |       | 
|Weighted
  average fair value of options granted during the year(*) |  |                                |            |                                        |  | -                   |  |                                        |            |   |  | -     | 
|                                                                    |  |                                |            |                                        |  |                     |  |                                        |            |   |  |      

F  39

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

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

| |                                                                                                        
| | -------------------------------------------------------------------------------------------------------
| | The following table summarizes information in respect of options
  outstanding as of December 31, 2006:

|                              |  |                                                 |                     |                                                    |                     |                                      |      |                                                   |  |                                       |       |  |  |  |           |  |  |       |  |  |  | 
|----------------------------- |  | ----------------------------------------------- | ------------------- | -------------------------------------------------- | ------------------- | ------------------------------------ | ---- | ------------------------------------------------- |  | ------------------------------------- | ----- |  |  |  | --------- |  |  | ----- |  |  |  | 
|                              |  |                                                 | Options Outstanding |                                                    | Options Exercisable |                                     
|                              |  |                                                 |                     |                                                    |                     |                                     
|Range of
  Exercise 
  Prices |  | Number 
  Outstanding 
  at December
  31, 2006 |                     | Weighted
  Average
  Remaining 
  Contractual Life |                     | Weighted 
  Average
  Exercise Price |      | Number 
  Exercisable
  at
  December 
  31, 2006 |  | Weighted 
  Average 
  Exercise Price |      
|                              |  |                                                 |                     |                                                    |                     |                                      |      |                                                   |  |                                       |      
|$                             |  |                                                 |                     | Years                                              |                     | $                                    |      |                                                   |  | $                                     |      
|                              |  |                                                 |                     |                                                    |                     |                                      |      |                                                   |  |                                       |      
|1.99                          |  |                                                 |                     | 186,734                                            |                     |                                      | 2.68 |                                                   |  |                                       | 1.199 |  |  |  | 186,734   |  |  | 1.199 |  | 
|                             
|1.399                         |  |                                                 |                     | 1,317,783                                          |                     |                                      | 3.39 |                                                   |  |                                       | 1.399 |  |  |  | 1,317,783 |  |  | 1.399 |  | 
|                             
|1.599                         |  |                                                 |                     | 492,662                                            |                     |                                      | 3.55 |                                                   |  |                                       | 1.599 |  |  |  | 492,662   |  |  | 1.599 |  | 
|                             
|1.999                         |  |                                                 |                     | 952,112                                            |                     |                                      | 4.34 |                                                   |  |                                       | 1.999 |  |  |  | 952,112   |  |  | 1.999 |  | 
|                              |  |                                                 |                     |                                                    |                     |                                      |      |                                                   |  |                                       |       |  |  |  |           |  |  |       |  | 
|                              |  |                                                 |                     | 2,949,291                                          |                     |                                      |      |                                                   |  |                                       |       |  |  |  | 2,949,291 |  |  |       |  | 
|                              |  |                                                 |                     |                                                    |                     |                                      |      |                                                   |  |                                       |       |  |  |  |           |  |  |       |  | 

F  40

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                         
|------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 12     | Employee Option Plans in Subsidiaries (cont.):                                                                                                          
|             |                                                                                                                                                         
|D.           | The
  following is a summary of the status of options plans in Sapiens as of
  December 31, 2006, 2005 and 2004 and changes during the years then ended:

|                                                                |  |                                |                |                                       |  |                                |  |                                       |                |                     |  |                                       |  |  |                |   |  |       | 
|--------------------------------------------------------------- |  | ------------------------------ | -------------- | ------------------------------------- |  | ------------------------------ |  | ------------------------------------- | -------------- | ------------------- |  | ------------------------------------- |  |  | -------------- | - |  | ----- | 
|                                                                |  | Year ended
  December 31, 2006 |                | Year ended
  December 31, 2005        |  | Year ended
  December 31, 2004 | 
|                                                                |  |                                |                |                                       |  |                                | 
|                                                                |  | Number of
  options            |                | Weighted
  Average
  Exercise
  Price |  | Number of
  options            |  | Weighted
  Average
  Exercise
  Price |                | Number of
  options |  | Weighted
  Average
  Exercise
  Price | 
|                                                                |  |                                |                |                                       |  |                                |  |                                       |                |                     |  |                                       | 
|                                                                |  |                                |                | $                                     |  |                                |  | $                                     |                |                     |  | $                                     | 
|                                                                |  |                                |                |                                       |  |                                |  |                                       |                |                     |  |                                       | 
|Options outstanding at the beginning of the year                |  |                                | **
  2,812,212 |                                       |  | 5.54                           |  |                                       | **
  1,640,871 |                     |  | 9.05                                  |  |  | **
  1,558,495 |   |  | 10.25 | 
|Changes during the year:                                        |  |                                |                |                                       |  |                                |  |                                       |                |                     |  |                                       |  |  |                |   |  |       | 
|                                                               
|Granted                                                         |  |                                | 4,000          |                                       |  | 1.34                           |  |                                       | 1,608,200      |                     |  | 2.61                                  |  |  | 321,539        |   |  | 4.05  | 
|                                                               
|Exercised                                                       |  |                                | -              |                                       |  | -                              |  |                                       | (19,500        | )                   |  | -                                     |  |  | (5,000         | ) |  | 4.07  | 
|                                                               
|Forfeited                                                       |  |                                | (391,162       | )                                     |  | 10.76                          |  |                                       | (417,359       | )                   |  | 8.31                                  |  |  | (234,163       | ) |  | 10.23 | 
|                                                                |  |                                |                |                                       |  |                                |  |                                       |                |                     |  |                                       |  |  |                |   |  |       | 
|Options outstanding at the end of the
year                      |  |                                | **2,425,050    |                                       |  | 4.7                            |  |                                       | **2,812,212    |                     |  | 5.54                                  |  |  | **1,640,871    |   |  | 9.05  | 
|                                                                |  |                                |                |                                       |  |                                |  |                                       |                |                     |  |                                       |  |  |                |   |  |       | 
|Options exercisable at year-end                                 |  |                                | 2,421,050      |                                       |  | 4.7                            |  |                                       | 2,812,212      |                     |  | 5.54                                  |  |  | 1,143,432      |   |  | 11.24 | 
|                                                                |  |                                |                |                                       |  |                                |  |                                       |                |                     |  |                                       |  |  |                |   |  |       | 
|Weighted-average fair value of options granted during the
year* |  |                                |                |                                       |  | 0.68                           |  |                                       |                |                     |  | 1.32                                  |  |  |                |   |  | 1.46  | 
|                                                                |  |                                |                |                                       |  |                                |  |                                       |                |                     |  |                                       |  |  |                |   |  |       | 

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | * | For options
  granted prior to January 1, 2006, the fair value of each option granted is
  estimated on the date of grant, using the Black-Scholes option-pricing model
  with the following weighted average assumptions: dividend yield of 0% for all
  years; expected volatility: 2005 - 83%, 2004 - 65%, 2003 - 83%, risk-free
  interest rate 2005 - 4.41%, 2004- 3.74%, 2003 - 2% and expected life: 2005
  -6.9 years, 2004 - 2.5 years and 2003- 3.5 years.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |   | Sapiens has selected  the  binomial  lattice
            option-pricing  model to estimate the fair value for any option  granted  after  December 31,
            2005. The binomial model considers  characteristic of fair value options pricing that are not
            available under the Black-Scholes  model.  Similar to the  Black-Scholes  model, the binomial
            model takes into account  variables  such as  volatility,  dividend yield rate, and risk free
            interest rate.  However,  the binominal  model allows for the use of dynamic  assumptions and
            also considers 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 or
            retirement  of option  holder in computing the value of the option.  For these  reasons,  the
            Company  believes that the binomial  model  provides a better  estimate of an employee  stock
            option's fair value than that calculated using Black-Scholes model.

F  41

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

| |                                                                                                           |                                                                                                                                          
| | --------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------
| | **                                                                                                        | Including   102,100,   62,300   and   59,000
            options re-priced to zero, as of December 31, 2004, 2005 and 2006, respectively.
| |                                                                                                           |                                                                                                                                          
| | The
  following table summarizes information in respect of options outstanding as
  of December 31, 2006:

|                          |  |                                                 |           |                                                     |  |                                     |  |                                               |       |                                     |  |           |  |   |       | 
|------------------------- |  | ----------------------------------------------- | --------- | --------------------------------------------------- |  | ----------------------------------- |  | --------------------------------------------- | ----- | ----------------------------------- |  | --------- |  | - | ----- | 
|                          |  | Options Outstanding                             |           | Options Exercisable                                 | 
|                          |  |                                                 |           |                                                     | 
|Range of Exercise
  Price |  | Number
  Outstanding
  at
  December 31,
  2006 |           | Weighted
  Average
  Remaining
  Contractual
  Life |  | Weighted
  Average
  Exercise Price |  | Number
  Exercisable at
  December 31,
  2006 |       | Weighted
  Average
  Exercise Price | 
|                          |  |                                                 |           |                                                     |  |                                     |  |                                               |       |                                     | 
|$                         |  |                                                 |           | Years                                               |  | $                                   |  |                                               |       | $                                   | 
|                          |  |                                                 |           |                                                     |  |                                     |  |                                               |       |                                     | 
|$ 0                       |  |                                                 | 59,000    |                                                     |  | 0.45                                |  |                                               | -     |                                     |  | 59,000    |  |   | -     | 
|                         
|$ 1.34
  - $ 1.74         |  |                                                 | 309,000   |                                                     |  | 7.83                                |  |                                               | 1.73  |                                     |  | 305,000   |  |   | 1.73  | 
|                         
|$ 1.80
  - $ 2.63         |  |                                                 | 336,950   |                                                     |  | 6.94                                |  |                                               | 2.33  |                                     |  | 336,950   |  |   | 2.33  | 
|                         
|$ 3.00                    |  |                                                 | 1,000,000 |                                                     |  | 8.86                                |  |                                               | 3.00  |                                     |  | 1,000,000 |  |   | 3.00  | 
|                         
|$ 3.28
  - $ 3.75         |  |                                                 | 93,100    |                                                     |  | 1.96                                |  |                                               | 3.59  |                                     |  | 93,100    |  |   | 3.59  | 
|                         
|$ 4.06
  - $ 5.70         |  |                                                 | 519,050   |                                                     |  | 3.01                                |  |                                               | 4.56  |                                     |  | 519,050   |  |   | 4.56  | 
|                         
|$ 11.25
  - $ 16.875      |  |                                                 | 8,100     |                                                     |  | 0.12                                |  |                                               | 13.40 |                                     |  | 8,100     |  |   | 13.40 | 
|                         
|$ 19.375
  - $ 29.375     |  |                                                 | 19,000    |                                                     |  | 3.49                                |  |                                               | 28.68 |                                     |  | 19,000    |  |   | 28.68 | 
|                         
|$ 32.5
  - $ 47.5         |  |                                                 | 59,850    |                                                     |  | 1.95                                |  |                                               | 38.53 |                                     |  | 59,850    |  |   | 38.53 | 
|                         
|$ 61.25
  - $ 69.375      |  |                                                 | 21,000    |                                                     |  | 2.57                                |  |                                               | 66.98 |                                     |  | 35,300    |  |   | 66.98 | 
|                          |  |                                                 |           |                                                     |  |                                     |  |                                               |       |                                     |  |           |  |   |       | 
|                         
|                          |  |                                                 | 2,425,050 |                                                     |  |                                     |  | $                                             | 4.70  |                                     |  | 2,435,350 |  | $ | 4.70  | 
|                          |  |                                                 |           |                                                     |  |                                     |  |                                               |       |                                     |  |           |  |   |       | 

F  42

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 13      | Commitments and Contingencies:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|A.            | Commitments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|              | Some of the Companys subsidiaries have Commitments to the Chief Scientist
  in the Ministry of Industry and Trade and to the Marketing Promotion Fund, to
  pay royalties at a rate of 2%-7% of the proceeds from the sale of software
  products which were developed with the assistance of the Chief Scientist and
  marketed with the assistance of the Marketing Promotion Fund. The amount of
  royalties is limited to 100%-150% of the amount received. The subsidiaries
  are only obliged to repay
  the grants received from the Office of the Chief Scientist if revenue is
  generated from the sale of the said software products.
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|              | The balance of the contingent liability in respect of the aforesaid, amounted to approximately $11.9 million as at
December 31, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

|   |             |                                                                                                                                                                                                                                                                                                                                                                                                 
|-- | ----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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  Formulas  assets  are  pledged  to
             banks  as  support  for  credit  facilities  of  approximately  $40  million.  These  assets
             consisting of portion of Formula's shareholdings in BluePhoenix, Matrix and Magic.                                                                                                                                          
|   |             |                                                                                                                                                                                                                                                                                                                                                                                                 
|   | 3.          | Some of subsidiaries have given floating charges in favor of banks
  and other financial institusions                                                                                                                                                                                                                                                                                           
|   |             |                                                                                                                                                                                                                                                                                                                                                                                                 
|C. | Guarantees:
|   |            
|   | 1.          | Subsidiaries have provided bank guarantees in the amount of approximately $13.3 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.          | Liraz, a subsidiary, of
  BluePhoenix is liable for losses in a subsidiary it had consolidated until
  the second quarter of 2001. The provision for such liability at December
  31, 2006 and December 31, 2005, was accounted for under SFAS No.5 and
  amounted to $2 million, representing the maximum potential amount Liraz has
  guaranteed to secure a bank loan of the said subsidiary.
|   |             |                                                                                                                                                                                                                                                                                                                                                                                                 
|   | 3.          | Subsidiaries have provided bank guarantees in the amount of $1,574 thousand as security for rent to be
  paid for their offices. If the subsidiaries were to breach certain terms of
  their lease, the lessor could demand that the banks providing the guarantees
  pay amount claimed to be due.                                                                                             

F  43

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|              |                                         
|------------- | ----------------------------------------
|Note 13      | Commitments and Contingencies
  (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |                                                                                        
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------
|D. | Others:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |                                                                                        
|   | In connection with credit facilities the
  Company and its
  subsidiaries have entered into
  agreements with various
  banks, accordingly the Company committed, among other things:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   | a.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | To maintain certain financial ratios.                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |                                                                                        
|   | b.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | Not to grant a security interest in all or
  substantially all their respective assets.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   | c.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | The  Company  is  incompliance  with all the
                 above requirements.      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|E. | Legal Proceedings:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|1. | In July 2003, a former Liraz shareholder filed an application with
  the Tel Aviv Jaffa District Court to approve a claim filed by him against
  BluePhoenix, as a class action. The claim relates to the acquisition of Liraz
  shares that BluePhoenix completed in March 2003. The shareholder alleges that
  the share price that BluePhoenix paid to Lirazs shareholders in the tender
  offer and in a subsequent mandatory purchase was lower than the fair price of
  Liraz shares. The maximum amount of the claim is approximately $7.3 million
  in the aggregate. Under Israeli law, the courts approval is required for the
  plaintiff to represent all of the shareholders of Liraz who sold their
  shareholdings to the Company pursuant to the tender offer and the mandatory
  acquisition. The plaintiff has applied for such approval in the lawsuit. The
  company believes that the allegations against it in this proceeding are
  without merit and intend to vigorously defend the claim and contest the
  allegations made therein.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|2. | Lawsuits have been lodged against certain subsidiaries in the
  ordinary course of business. The group followed SFAS No 5, and recorded
  provision where it was appropriate.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|F. | Lease Commitments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   | The
  following are details of the future minimum lease commitments under
  non-cancelable operating leases as of December 31, 2006:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

| |                       |  |  |                     | 
| | --------------------- |  |  | ------------------- | 
| |                       |  |  | U.S. $ in thousands | 
| |                       |  |  |                    
| |                       |  |  |                     | 
| | 2007                  |  |  | 11,997              | 
|
| | 2008                  |  |  | 10,258              | 
|
| | 2009                  |  |  | 6,551               | 
|
| | 2010                  |  |  | 3,262               | 
|
| | 2011
  and thereafter |  |  | 936                 | 
| |                       |  |  |                     | 
| |                       |  |  | 33,004              | 
| |                       |  |  |                     | 

F  44

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                                             
|------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 13     | Commitments and Contingencies (cont.):                                                                                                                      
|             |                                                                                                                                                             
|F.           | Lease Commitments:                                                                                                                                          
|             |                                                                                                                                                             
|             | Rent expenses for the years ended December 31, 2006, 2005 and 2004, were approximately $14,676 thousand, $14,480
thousand and $8,775 thousand, respectively.
|             |                                                                                                                                                             
|             | Most of the building leases will expire during 2007-2010.                                                                                                   
|             |                                                                                                                                                             
|Note 14     | Shareholders Equity:                                                                                                                                       
|             |                                                                                                                                                             
|A.           | Share Capital Authorized, Issued and
Outstanding:                                                                                                           

|                                        |  |                   |            |                   |  |             |  |            |            |        |  |             |  |  |            |  |  |            | 
|--------------------------------------- |  | ----------------- | ---------- | ----------------- |  | ----------- |  | ---------- | ---------- | ------ |  | ----------- |  |  | ---------- |  |  | ---------- | 
|                                        |  | December 31, 2006 |            | December 31, 2005 | 
|                                        |  |                   |            |                   | 
|                                        |  | Authorized        |            | Issued            |  | Outstanding |  | Authorized |            | Issued |  | Outstanding | 
|                                        |  |                   |            |                   |  |             |  |            |            |        |  |             | 
|                                        |  | NIS               |            | NIS               |  | NIS         |  | NIS        |            | NIS    |  | NIS         | 
|                                        |  |                   |            |                   |  |             |  |            |            |        |  |             | 
|                                        |  |                   |            |                   |  |             |  |            |            |        |  |             |  |  |            |  |  |            | 
|Ordinary
  shares, NIS 1 par value each |  |                   | 25,000,000 |                   |  | 13,224,780  |  |            | 13,200,000 |        |  | 25,000,000  |  |  | 13,224,780 |  |  | 13,200,000 | 
|                                        |  |                   |            |                   |  |             |  |            |            |        |  |             |  |  |            |  |  |            | 

|   |                                                                                                                                                                                                                                                                                                  |                                                                                                                                                                                                                    
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | 1.                                                                                                                                                                                                                                                                                               | The shares are traded on the TASE and through ADSs, each representing
  one ordinary share of NIS 1 par value, quoted on the NASDAQ National
  Market in the United States.                                        
|   |                                                                                                                                                                                                                                                                                                  |                                                                                                                                                                                                                    
|   | 2.                                                                                                                                                                                                                                                                                               | During 2002, Formula repurchased 324,780 of its ordinary shares in
  the open market for an aggregate of $3.4 million. During 2003, Formula sold 300,000 of its ordinary shares for an aggregate
  of $4.8 million.
|   |                                                                                                                                                                                                                                                                                                  |                                                                                                                                                                                                                    
|   | 3.                                                                                                                                                                                                                                                                                               | In March
  2005, Formula completed a private placement of 2,400,000 Formula shares for
  an aggregate consideration of $33 million.                                                                                
|   |                                                                                                                                                                                                                                                                                                  |                                                                                                                                                                                                                    
|B. | Details of Share Options Granted to
Employees:                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                  |                                                                                                                                                                                                                    
|   | In November
  2000, Formulas Board of Directors adopted an option plan pursuant to which
  Formula could grant options to Employees of Formula to purchase up to a total
  of 300,000 ordinary shares.                                                                                         
|   |                                                                                                                                                                                                                                                                                                 
|   | In
  accordance with this plan, employees of Formula and its subsidiaries were
  granted, for no consideration, options to purchase 64,500 shares of Formula
  exercisable at $30.8 per share, linked to the CPI. None of these options have
  been exercised and they expired in November 2005.

F  45

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                                                                                                     
|------------ | ------------------------------------------------------------------------------------------------------------------------------------
|Note 14     | Shareholders Equity(cont.):                                                                                                        
|             |                                                                                                                                     
|B.           | Details of Share Options Granted to
Employees:                                                                                      
|             |                                                                                                                                     
|             | The
  following is a summary of the status of Formulas option plans as of December 31, 2005 and 2004, and for
the years then ended:

|                                                  |   |                              |         |                                 |  |                    |  |                                 |        |  |  |      | 
|------------------------------------------------- | - | ---------------------------- | ------- | ------------------------------- |  | ------------------ |  | ------------------------------- | ------ |  |  | ---- | 
|                                                  |   | Year ended
December 31, 2005 |         | Year ended
December 31, 2004    | 
|                                                  |   |                              |         |                                 | 
|                                                  |   | Number of 
Options           |         | Weighted
Average
Exercise
Price |  | Number of 
Options |  | Weighted
Average
Exercise
Price |       
|                                                  |   |                              |         |                                 |  |                    | 
|$                                                 | $
|                                                  |   |                              |         |                                 |  |                    |  |                                 |       
|Outstanding options  at the beginning of the
year |   |                              | 64,500  |                                 |  | 30.8               |  |                                 | 64,500 |  |  | 30.8 | 
|                                                 
|Changes
during the year:                          |   |                              |         |                                 |  |                    |  |                                 |        |  |  |      | 
|                                                  |   |                              |         |                                 |  |                    |  |                                 |       
|Expired and forfeited                             |   |                              | (64,500 | )                               |  | -                  |  |                                 | -      |  |  | -    | 
|                                                  |   |                              |         |                                 |  |                    |  |                                 |        |  |  |      | 
|Outstanding options at the end of the
year        |   |                              | -       |                                 |  | 30.8               |  |                                 | 64,500 |  |  | 30.8 | 
|                                                  |   |                              |         |                                 |  |                    |  |                                 |        |  |  |      | 
|Exercisable options  at the end of the
year       |   |                              | -       |                                 |  | 30.8               |  |                                 | 64,500 |  |  | 30.8 | 
|                                                  |   |                              |         |                                 |  |                    |  |                                 |        |  |  |      | 

|         |                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|-------- | ----------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|         | A. On June
  1, 2005 Formula declared and distributed a cash dividend in the amount of $50
  million.
|         |                                                                                                      
|         | B. See also
  note 2A.                                                                               
|         |                                                                                                      
|Note 15 | Taxes on Income:                                                                                     
|         |                                                                                                      
|A.       | Tax Laws in
  Israel:                                                                                
|         |                                                                                                      
|         | 1.                                                                                                    | Tax benefits under the Israeli Law for the Encouragement of Capital
Investments, 1959 (hereafter - the Law):                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         |                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                                                                                       | Some
  operations of certain subsidiaries have been granted Approved Enterprise
  status under the Law. Since the subsidiaries have elected to receive
  alternative benefits under the Law (i.e. waiver of grants in exchange for a
  tax exemption for a limited period), the following tax rates will apply to
  its income from the Approved Enterprise (which will be determined based on
  the increase in the revenue of the subsidiaries during the year, in relation
  to the revenue in the year preceding the first year of their having the
  above-mentioned status):
|         |                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                                                                                       | Tax
  exemption for 2 years, commencing in the first year it generates taxable
  income. For the remainder of the benefit period - 5 years - a reduced tax
  rate of 25%.                                                                                                                                                                                                                                                                                                                                                                                                             
|         |                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                                                                                       | For some
  subsidiaries, the percentage of its share capital held by foreign
  shareholders has exceeded 25%. Therefore its Approved Enterprises qualify for
  reduced tax rates for an additional three years after the seven years
  mentioned above.                                                                                                                                                                                                                                                                                                                               
|         |                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                                                                                       | The period
  of tax benefits described above will terminate after 7-10 years elapse from
  the first year in which the subsidiaries have taxable income and 14 years
  elapse since the Approved Enterprise was granted and 12 years after the
  commencement of the Approved Enterprise.                                                                                                                                                                                                                                                                                             

F  46

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|         |                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-------- | ----------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|         |                              
|         |                              
|         |                              
|         |                              
|Note 15 | Taxes on Income (cont.):     
|         |                              
|A.       | Tax Laws in
  Israel (cont.):
|         |                              
|         | 1.                            | Tax benefits under the Israeli Law for the Encouragement of Capital
Investments, 1959 (hereafter - the Law) (cont.):                                                                                                                                                                                                                                                                                                                           
|         |                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|         |                               | The
  entitlement to the above benefits is subject to final ratification by the
  Investment Center in the Ministry of Industry and Trade, such ratification
  being conditional upon fulfillment of all terms of the approved program.                                                                                                                                                                                                          
|         |                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|         |                               | In the event
  of a distribution of a cash dividend out of retained earnings, which are tax
  exempt due to the above benefits, the subsidiaries would have to pay tax with
  respect to the amount distributed. Deferred taxes for such taxes were not
  provided because such undistributed earnings are essentially permanent in
  duration and could be distributed to shareholders tax free in liquidation,
  subject to certain conditions.
|         |                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|         |                               | The Law also
  provides that an Approved Enterprise is entitled to accelerated depreciation
  on its property and equipment that is included in an approved investment
  program.                                                                                                                                                                                                                                                                
|         |                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|         |                               | In the event
  the subsidiaries fail to comply with the approved program terms, the tax
  benefits may be canceled and the subsidiaries may be required to refund the
  amount of the benefits they utilized, in whole or in part, with the addition
  of linkage differences and interest.                                                                                                                                                      

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 2. | Measurement of results for tax purposes under the Income Tax
  (Inflationary Adjustments) Law, 1985 (hereafter - the Inflationary
  Adjustments Law):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Results for
  tax purposes in Israel are measured and reflected in real terms in accordance
  with the change in the CPI. The consolidated financial statements are
  presented in dollars. The differences between the change in the Israeli CPI
  and in the NIS/dollar exchange rate causes a difference between taxable
  income or loss and the income or loss before taxes reflected in the
  consolidated financial statements. In accordance with paragraph 9(f) of SFAS
  No. 109, Accounting for Income Taxes (SFAS No. 109), the Company has not
  provided deferred income taxes on this difference between the reporting
  currency and the tax bases of assets and liabilities.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | 3. | Tax benefits under the Law for the Encouragement of Industry
  (Taxation), 1969:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Some
  subsidiaries currently 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.                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

F  47

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                               | 
|------------ | ----------------------------- | 
|Note 15     | Taxes on Income (cont.):      | 
|             |                              
|A.           | Tax Laws in
  Israel (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   | 4.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | Tax Rates Applicable to Income in Israel:                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | On July 25,
  2005, the Law for Amendment of the Income Tax Ordinance (Amendment No.147)
  became effective. Pursuant to this amendment, the income tax applicable to
  Israeli companies will be gradually reduced from 34% in 2005 to 25% in 2010
  and henceforth. This tax rate decrease is not expected to have a material
  effect on the Companys financial position. The Company is evaluating the existence
  of additional impacts of this Amendment.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|B. | Subsidiaries
  Outside Israel:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   | Subsidiaries that are not an Israeli resident are taxed in the
  countries in which they are resident, according to the tax laws in those
  countries.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|C. | Cumulative Tax
  Losses:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   | The  Company have cumulative  operating losses for
         tax  purposes  as of  December  31,  2006  totaling  approximately  $281,089  thousand,  of which
         $235,721  thousand is in respect of Companies in Israel (December 31, 2005 - $204,818  thousand),
         and  approximately  $45,385  thousand in respect of Companies abroad (December 31, 2005 - $95,340
         thousand).  The  likelihood  of the  utilization  of most of these  losses in the  future is low.
         Therefore,  the company recorded a valuation  allowance  against thr deffered taxes attributed to
         the operating losses carried forward.

|   |                                                                                                                                                                                                    |             
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------
|   |                                                                                                                                                                                                   
|   |                                                                                                                                                                                                    |             
|D. | Income Tax Assessments:                                                                                                                                                                           
|   |                                                                                                                                                                                                   
|   | Subsequent to the balance sheet date, Formula reached an agreement with
  the Israel tax authorities for the years 2001-2004. Therefore Formula had to
  pay around 250k as taxes for those years.
|   |                                                                                                                                                                                                   
|E. | Deferred Taxes:                                                                                                                                                                                   
|   |                                                                                                                                                                                                   
|   | 1.                                                                                                                                                                                                 | Composition:

|                                     |  |                         |         |      |  |         |   |  |         |  
|------------------------------------ |  | ----------------------- | ------- | ---- |  | ------- | - |  | ------- | -
|                                     |  | December
  31,          |        
|                                     |  |                         |        
|                                     |  | 2006                    |         | 2005 |  | 2004    |  
|                                     |  |                         |         |      |  |         |  
|                                     |  | (U.S. $ in
  thousands) |        
|                                     |  |                         |        
|                                     |  |                         |         |      |  |         |   |  |         |  
|Net operating losses carried forward |  |                         | 95,671  |      |  | 79,190  |   |  | 76,685  |  
|                                     |  |                         |         |      |  |         |   |  |         |  
|Software development costs           |  |                         | 1,408   |      |  | 1,637   |   |  | 1,171   |  
|                                     |  |                         |         |      |  |         |   |  |         |  
|Allowances and reserves              |  |                         | 4,455   |      |  | 3,618   |   |  | 3,939   |  
|                                     |  |                         |         |      |  |         |   |  |         |  
|                                     |  |                         | 101,534 |      |  | 84,445  |   |  | 81,795  |  
|                                     |  |                         |         |      |  |         |   |  |         |  
|Valuation allowance                  |  |                         | (92,354 | )    |  | (77,619 | ) |  | (74,235 | )
|                                     |  |                         |         |      |  |         |   |  |         |  
|Total                                |  |                         | 9,180   |      |  | 6,826   |   |  | 7,560   |  
|                                     |  |                         |         |      |  |         |   |  |         |  

F  48

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|         |                          | 
|-------- | ------------------------ | 
|Note 15 | Taxes on Income (cont.):

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

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

|                                 |  |                         |       |      |  |       |  
|-------------------------------- |  | ----------------------- | ----- | ---- |  | ----- | -
|                                 |  | December 31,            |      
|                                 |  |                         |      
|                                 |  | 2006                    |       | 2005 | 
|                                 |  |                         |       |      | 
|                                 |  | (U.S. $ in
  thousands) |      
|                                 |  |                         |      
|                                 |  |                         |       |      |  |       |  
|Stated in current assets         |  |                         | 2,590 |      |  | 1,524 |  
|                                 |  |                         |       |      |  |       |  
|Stated in other assets           |  |                         | 7,047 |      |  | 6,198 |  
|                                 |  |                         |       |      |  |       |  
|Stated in long term liabilities  |  |                         | (457  | )    |  | (896  | )
|                                 |  |                         |       |      |  |       |  
|Total included in balance sheets |  |                         | 9,180 |      |  | 6,826 |  
|                                 |  |                         |       |      |  |       |  

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

|         |  |                         |        |      |  |        |  |  |        |  
|-------- |  | ----------------------- | ------ | ---- |  | ------ |  |  | ------ | -
|         |  | Year ended December 31, |       
|         |  |                         |       
|         |  | 2006                    |        | 2005 |  | 2004   | 
|         |  |                         |        |      |  |        | 
|         |  | (U.S. $ in
  thousands) |       
|         |  |                         |       
|         |  |                         |        |      |  |        |  |  |        |  
|Domestic |  |                         | 14,473 |      |  | 7,340  |  |  | 29,779 |  
|         |  |                         |        |      |  |        |  |  |        |  
|Foreign  |  |                         | (151   | )    |  | 3,239  |  |  | (7,368 | )
|         |  |                         |        |      |  |        |  |  |        |  
|Total    |  |                         | 14,322 |      |  | 10,579 |  |  | 22,411 |  
|         |  |                         |        |      |  |        |  |  |        |  

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

| |                                             |  |                         |        |      |  |       |   |  |       |  
| | ------------------------------------------- |  | ----------------------- | ------ | ---- |  | ----- | - |  | ----- | -
| |                                             |  | Year ended December 31, |       
| |                                             |  |                         |       
| |                                             |  | 2006                    |        | 2005 |  | 2004  |  
| |                                             |  |                         |        |      |  |       |  
| |                                             |  | (U.S. $ in thousands)   |       
| |                                             |  |                         |       
| | Current
  taxes:                            |  |                         |        |      |  |       |   |  |       |  
|
| | In Israel                                   |  |                         | 4,487  |      |  | 3,372 |   |  | 2,992 |  
|
| | Abroad                                      |  |                         | 944    |      |  | 789   |   |  | 760   |  
| |                                             |  |                         |        |      |  |       |   |  |       |  
| |                                             |  |                         | 5,431  |      |  | 4,161 |   |  | 3,752 |  
|
| | Taxes
  in Israel in respect of prior years |  |                         | (652   | )    |  | (74   | ) |  | (81   | )
|
| | Deferred
  taxes,  net                      |  |                         | (1,282 | )    |  | 737   |   |  | (100  | )
| |                                             |  |                         |        |      |  |       |   |  |       |  
| | Total                                       |  |                         | 3,497  |      |  | 4,824 |   |  | 3,571 |  
| |                                             |  |                         |        |      |  |       |   |  |       |  

F  49

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                         
|------------ | ------------------------
|Note 15     | Taxes on Income (cont.):
|             |                         

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

| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | -------------------------------------------------------------------------------------- |  | ----------------------- | ------ | ---- |  | ------ | - |  | ------ | -
| |                                                                                        |  | Year ended December 31, |       
| |                                                                                        |  |                         |       
| |                                                                                        |  | 2006                    |        | 2005 |  | 2004   |  
| |                                                                                        |  |                         |        |      |  |        |  
| |                                                                                        |  | (U.S. $ in thousands)   |       
| |                                                                                        |  |                         |       
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Income before taxes on
  income, as per the statement of continuing  operations        |  |                         | 14,322 |      |  | 10,579 |   |  | 22,411 |  
|
| | Statutory tax rate in Israel                                                           |  |                         | 31     | %    |  | 34     | % |  | 35     | %
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Theoretical tax expense                                                                |  |                         | 4,440  |      |  | 3,597  |   |  | 7,844  |  
|
| | Additional tax (tax savings)
  in respect of:                                          |  |                         |        |      |  |        |   |  |        |  
|
| | Non-deductible expenses                                                                |  |                         | 1446   |      |  | 1,223  |   |  | 1,070  |  
|
| | Tax-exempt income (mainly
  relating to decrease in shareholdings)                     |  |                         | -      |      |  | (537   | ) |  | (1,706 | )
|
| | Tax-exempt income and reduced
  tax rates in companies which have approved enterprises |  |                         | (154   | )    |  | -      |   |  | 817    |  
|
| | Losses and temporary
  differences for which deferred taxes were not recorded          |  |                         | (984   | )    |  | (1,770 | ) |  | (4,142 | )
|
| | Write off of deferred taxes and tax
advances                                           |  |                         | 160    |      |  | 1,797  |   |  | -      |  
|
| | Taxes in respect of previous
  years                                                   |  |                         | (763   | )    |  | 64     |   |  | (81    | )
|
| | Effect of the Inflationary
  Adjustments Law                                           |  |                         | (397   | )    |  | (14    | ) |  | (98    | )
|
| | Other                                                                                  |  |                         | (251   | )    |  | 464    |   |  | (133   | )
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Taxes on
  income as per the statement of operations                                   |  |                         | 3,497  |      |  | 4,824  |   |  | 3,571  |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Effective tax rate - in%                                                               |  |                         | 31.2   |      |  | 43.8   |   |  | 16.1   |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  

F  50

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|         |                                                 
|-------- | ------------------------------------------------
|Note 16 | Supplementary Financial Statement
  Information:

Balance Sheet:

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

|                                           |  |                       |        |      |  |        | 
|------------------------------------------ |  | --------------------- | ------ | ---- |  | ------ | 
|                                           |  | December 31,          |       
|                                           |  |                       |       
|                                           |  | 2006                  |        | 2005 | 
|                                           |  |                       |        |      | 
|                                           |  | (U.S. $ in thousands) |       
|                                           |  |                       |       
|                                          
|Government departments                     |  |                       | 5,463  |      |  | 4,671  | 
|                                          
|Employees (1)                              |  |                       | 363    |      |  | 571    | 
|                                          
|Prepaid expenses and advances to suppliers |  |                       | 8,533  |      |  | 10,473 | 
|                                          
|Deferred taxes                             |  |                       | 2,590  |      |  | 1,524  | 
|                                          
|Other                                      |  |                       | 2,206  |      |  | 984    | 
|                                           |  |                       |        |      |  |        | 
|Total                                      |  |                       | 19,155 |      |  | 18,223 | 
|                                           |  |                       |        |      |  |        | 

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

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

|                                                 |  |                 |           |                 |                       |          |      |  |        |  |  |        | 
|------------------------------------------------ |  | --------------- | --------- | --------------- | --------------------- | -------- | ---- |  | ------ |  |  | ------ | 
|                                                 |  | Interest
  rate |           | Linkage
  basis |                       |          |     
|                                                 |  |                 |           |                 |                       |         
|                                                 |  | December 31,    |           |                 |                       |         
|                                                 |  | 2006            |           |                 | December 31, 2006     |          | 2005 | 
|                                                 |  |                 |           |                 |                       |          |      | 
|                                                 |  | %               |           |                 | (U.S. $ in thousands) |         
|                                                 |  |                 |           |                 |                       |          |     
|                                                
|Bank overdraft                                   |  |                 | 5.6-6.6   |                 |                       | Unlinked |      |  | 5,166  |  |  | 3,910  | 
|                                                
|Short-term bank loans                            |  |                 | 5-7.5     |                 |                       | Unlinked |      |  | 8,862  |  |  | 26,336 | 
|                                                
|Short-term bank loans                            |  |                 | 7.3       |                 |                       | Dollar   |      |  | 4,570  |  |  | 22,629 | 
|                                                
|Short-term bank loans                            |  |                 |           |                 |                       | CPI      |      |  | -      |  |  | 12     | 
|                                                
|Short-term bank loans                            |  |                 | 5.5-6     |                 |                       | Euro     |      |  | 3,239  |  |  | 2,630  | 
|                                                
|Short-term
  bank loans                          |  |                 | 2.13-6.75 |                 |                       | Other    |      |  | 975    |  |  | -      | 
|                                                
|Current maturities of long-term loans from banks |  |                 |           |                 |                       |          |      |  | 18,211 |  |  | 9,380  | 
|                                                 |  |                 |           |                 |                       |          |      |  |        |  |  |        | 
|Total                                            |  |                 |           |                 |                       |          |      |  | 41,023 |  |  | 64,897 | 
|                                                 |  |                 |           |                 |                       |          |      |  |        |  |  |        | 

F  51

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                         
|------------ | --------------------------------------------------------
|Note 16     | Supplementary Financial Statement
  Information (cont.):

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

|                                                          |  |                         |        |      |  |        | 
|--------------------------------------------------------- |  | ----------------------- | ------ | ---- |  | ------ | 
|                                                          |  | December 31,            |       
|                                                          |  |                         |       
|                                                          |  | 2006                    |        | 2005 | 
|                                                          |  |                         |        |      | 
|                                                          |  | (U.S. $ in
  thousands) |       
|                                                          |  |                         |       
|                                                         
|Employees and
  other wage and salary related liabilities |  |                         | 25,516 |      |  | 22,714 | 
|                                                         
|Government
  departments                                  |  |                         | 9,271  |      |  | 7,287  | 
|                                                         
|Prepaid income
  and customer advances                    |  |                         | 29,751 |      |  | 22,447 | 
|                                                         
|Accrued
  expenses and other current liabilities          |  |                         | 9,237  |      |  | 8,706  | 
|                                                          |  |                         |        |      |  |        | 
|Total                                                     |  |                         | 73,775 |      |  | 61,154 | 
|                                                          |  |                         |        |      |  |        | 

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

|                                           |  |                         |       |      |  |       |  |  |   | 
|------------------------------------------ |  | ----------------------- | ----- | ---- |  | ----- |  |  | - | 
|                                           |  | Year ended December 31, |      
|                                           |  |                         |      
|                                           |  | 2006                    |       | 2005 |  | 2004  | 
|                                           |  |                         |       |      |  |       | 
|                                           |  | (U.S. $ in
  thousands) |      
|                                           |  |                         |      
|                                          
|Wages and related expenses                 |  |                         | 2,123 |      |  | 1,455 |  |  | - | 
|                                          
|Expenses
  relating to closing of branches |  |                         | 1,029 |      |  | -     |  |  | - | 
|                                          
|Total                                      |  |                         | 3,152 |      |  | 1,455 |  |  | - | 
|                                           |  |                         |       |      |  |       |  |  |   | 

|   |                                                                                                                                                                                                                                                                                
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | Restructuring expenses were recorded by consolidated companies
  and relate to the Proprietary
  Software Products segment. These companies announced the adoption of
  a restructurning plan in
  order to reduce expenses and improve organizational and business efficiency.
|   |                                                                                                                                                                                                                                                                                
|E. | Financial
  Expenses, Net:                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                
|   | Composition:                                                                                                                                                                                                                                                                   

|                                                        |  |                         |        |      |  |         |   |  |        |  
|------------------------------------------------------- |  | ----------------------- | ------ | ---- |  | ------- | - |  | ------ | -
|                                                        |  | Year ended December 31, |       
|                                                        |  |                         |       
|                                                        |  | 2006                    |        | 2005 |  | 2004    |  
|                                                        |  |                         |        |      |  |         |  
|                                                        |  | (U.S. $ in
  thousands) |       
|                                                        |  |                         |       
|                                                       
|Financing income                                        |  |                         | 6,547  |      |  | 14,307  |   |  | 5,154  |  
|                                                       
|Financing costs related to long-term credit             |  |                         | (9,426 | )    |  | (7,729  | ) |  | (4,247 | )
|                                                       
|Financing costs related to short-term credit and others |  |                         | (5,906 | )    |  | (11,426 | ) |  | (7,600 | )
|                                                       
|Gain from marketable securities                         |  |                         | 688    |      |  | 812     |   |  | 917    |  
|                                                        |  |                         |        |      |  |         |   |  |        |  
|Total                                                   |  |                         | (8,097 | )    |  | (4,036  | ) |  | (5,776 | )
|                                                        |  |                         |        |      |  |         |   |  |        |  

F  52

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|             |                                                         
|------------ | --------------------------------------------------------
|Note 16     | Supplementary Financial Statement
  Information (cont.):
|             |                                                         
|F.           | Other Expenses, Net:                                    
|             |                                                         
|             | Composition:                                            

|                                                          |  |                         |      |      |  |      |   |  |      |  
|--------------------------------------------------------- |  | ----------------------- | ---- | ---- |  | ---- | - |  | ---- | -
|                                                          |  | Year ended December 31, |     
|                                                          |  |                         |     
|                                                          |  | 2006                    |      | 2005 |  | 2004 |  
|                                                          |  |                         |      |      |  |      |  
|                                                          |  | (U.S. $ in
  thousands) |     
|                                                          |  |                         |     
|Gain on sale of fixed assets, net                         |  |                         | 18   |      |  | 18   |   |  | 83   |  
|                                                         
|Dividend received from another company                    |  |                         | 269  |      |  | -    |   |  | 770  |  
|                                                         
|Impairment in value of investment in affiliates companies |  |                         | (423 | )    |  | (20  | ) |  | (246 | )
|                                                         
|Other                                                     |  |                         | (684 | )    |  | 706  |   |  | (686 | )
|                                                          |  |                         |      |      |  |      |   |  |      |  
|Total                                                     |  |                         | (820 | )    |  | 704  |   |  | (79  | )
|                                                          |  |                         |      |      |  |      |   |  |      |  

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

|                                                                                  |  |                         |       |      |  |       |   |  |       | 
|--------------------------------------------------------------------------------- |  | ----------------------- | ----- | ---- |  | ----- | - |  | ----- | 
|                                                                                  |  | Year ended December 31, |      
|                                                                                  |  |                         |      
|                                                                                  |  | 2006                    |       | 2005 |  | 2004  |  
|                                                                                  |  |                         |       |      |  |       |  
|                                                                                  |  | (U.S. $ in
  thousands) |      
|                                                                                  |  |                         |      
|Gain from
  realization of investment in Level 8                                  |  |                         | -     |      |  | -     |   |  | 171   | 
|                                                                                 
|Gain (loss)
  from sale and decrease in shareholding percentage in Magic          |  |                         | (118  | )    |  | (48   | ) |  | 1,151 | 
|                                                                                 
|Gain from
  realization of investment in the News Company                         |  |                         | -     |      |  | -     |   |  | 142   | 
|                                                                                 
|Gain (loss)
  from sale and decrease in shareholding percentage in Formula Vision |  |                         | (74   | )    |  | (15   | ) |  | 383   | 
|                                                                                 
|Gain (loss)
  from sale and decrease in
  shareholding percentage in Matrix       |  |                         | (395  | )    |  | 3,357 |   |  | 3,557 | 
|                                                                                 
|Gain from decrease in shareholding  percentage in
Bluephoenix                     |  |                         | 31    |      |  | -     |   |  | -     | 
|                                                                                 
|Gain from sale and decrease in shareholding
  percentage in Tiltan                |  |                         | 1,547 |      |  | -     |   |  | -     | 
|                                                                                 
|Realization of
  investment in warrants in Matrix                                 |  |                         | -     |      |  | (102  | ) |  | -     | 
|                                                                                 
|Capital gain from realization of Matrix One                                       |  |                         | 2,485 |      |  | -     |   |  | -     | 
|                                                                                 
|Realization of
  unrealized gain in Matrix (see Note 2A)                          |  |                         | -     |      |  | -     |   |  | 2,820 | 
|                                                                                 
|Gain (loss) on
  realization of other investments                                 |  |                         | 279   |      |  | (6    | ) |  | 58    | 
|                                                                                  |  |                         |       |      |  |       |   |  |       | 
|Total                                                                             |  |                         | 3,755 |      |  | 3,186 |   |  | 8,282 | 
|                                                                                  |  |                         |       |      |  |       |   |  |       | 

F  53

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|----------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 16    | Supplementary Financial Statement Information (cont.):                                                                                                                                                                                                                                                                                                                                                                       
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|H.          | Operating Segments:                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | The Company
  operates in two principal business segments, IT Services and proprietary
  software solutions.                                                                                                                                                                                                                                                                                                                 
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | Software Services                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | The
  following is a list of the Groups principal activities: applications
  development, systems integration, migration of IT platforms, IT consulting,
  e-services, outsourcing, conversion services, application and implementation
  of ERP & CRM systems, imported software products and a training school.                                                                                                           
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | The Group
  provides these IT services across the full system development lifecycle,
  including the definition of business requirements, system analysis, technical
  specifications, coding, testing, training, implementation and maintenance.
  The Company performs its projects on-site or at its own facilities.                                                                                                      
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | Proprietary Software Products                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | The Group
  designs, develops and markets proprietary software solutions for sale in
  selected niche markets worldwide. The following is a list of the proprietary
  software solutions that are marketed by the Group:                                                                                                                                                                                                     
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | Modernization
  solutions, Magic-technology, Magic eMerchant, solutions for law enforcement,
  Application software for long term care industry, car rental solutions,
  solutions for banking and finance, solutions for telecommunications, CRM
  systems, Sapiens eMerge, re-engineering and AppBuilder, solutions for
  insurance industry.                                                                              
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | All of the
  Companys subsidiaries, including IT services companies and proprietary
  software solutions companies, recognize revenues from the delivery of
  software services, and most of them recognize revenues in both revenue
  categories. The Companys subsidiaries were classified into the following
  categories in accordance with the category in which most of the revenues of
  each subsidiary was earned.
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | The
  following is a list of the companies included in each operating segment, as
  of December 31, 2005:                                                                                                                                                                                                                                                                                                                    
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | Software Services:                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | Matrix IT
  Ltd.                                                                                                                                                                                                                                                                                                                                                                                                             
|            | NextSource
  Inc.                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | Proprietary Software Products:                                                                                                                                                                                                                                                                                                                                                                                               
|            |                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | BluePhoenix
  Solutions Ltd.                                                                                                                                                                                                                                                                                                                                                                                                 
|            | Magic
  Software Enterprises Ltd.                                                                                                                                                                                                                                                                                                                                                                                            
|            | Sapiens
  International Corporation N.V.                                                                                                                                                                                                                                                                                                                                                                                     

F  54

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|            |                                                                                                                                                                                                                            
|----------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 16    | Supplementary Financial Statement Information (cont.):                                                                                                                                                                     
|            |                                                                                                                                                                                                                            
|H.          | Operating Segments (cont.):                                                                                                                                                                                                
|            |                                                                                                                                                                                                                            
|            | The Company
  evaluates the performances of each segment, software services and proprietary
  software products, based on operating income/loss. Headquarters expenses are
  allocated proportionally between the segments:

|                         |  |                       |   |                                   |         |       |  |         |   | 
|------------------------ |  | --------------------- | - | --------------------------------- | ------- | ----- |  | ------- | - | 
|                         |  | Software
  Services   |   | Proprietary
  Software
  Products |         | Total | 
|                         |  |                       |   |                                   |         |       | 
|                         |  | (U.S. $ in thousands) |  
|                         |  |                       |  
|Revenues:                |  |                       |   |                                   |         |       |  |         |   | 
|                        
|2006                     |  | 322,629               |   |                                   | 174,040 |       |  | 496,669 |   | 
|                        
|2005                     |  | 278,808               |   |                                   | 159,341 |       |  | 438,149 |   | 
|                        
|2004                     |  | 230,880               |   |                                   | 170,158 |       |  | 401,038 |   | 
|                         |  |                       |   |                                   |         |       |  |         |   | 
|Inter-segment sales:     |  |                       |   |                                   |         |       |  |         |   | 
|                        
|2006                     |  | 2,690                 |   |                                   | 1,244   |       |  | 3,934   |   | 
|                        
|2005                     |  | 3,907                 |   |                                   | 1,752   |       |  | 5,659   |   | 
|                        
|2004                     |  | 3,618                 |   |                                   | 2,158   |       |  | 5,776   |   | 
|                         |  |                       |   |                                   |         |       |  |         |   | 
|Operating income (loss): |  |                       |   |                                   |         |       |  |         |   | 
|                        
|2006                     |  | 19,054                |   |                                   | 430     |       |  | 19,484  |   | 
|                        
|2005                     |  | 19,127                |   |                                   | (8,402  | )     |  | 10,725  |   | 
|                        
|2004                     |  | 16,273                |   |                                   | 3,711   |       |  | 19,984  |   | 
|                         |  |                       |   |                                   |         |       |  |         |   | 
|Financial expenses:      |  |                       |   |                                   |         |       |  |         |   | 
|                        
|2006                     |  | (2,313                | ) |                                   | (5,784  | )     |  | (8,097  | ) | 
|                        
|2005                     |  | (746                  | ) |                                   | (3,290  | )     |  | (4,036  | ) | 
|                        
|2004                     |  | (3,377                | ) |                                   | (2,399  | )     |  | (5,776  | ) | 
|                         |  |                       |   |                                   |         |       |  |         |   | 
|Net income (loss)        |  |                       |   |                                   |         |       |  |         |   | 
|                        
|2006                     |  | 7,475                 |   |                                   | (3,759  | )     |  | 3,716   |   | 
|                        
|2005                     |  | 11,751                |   |                                   | (6,622  | )     |  | 5,129   |   | 
|                        
|2004                     |  | 11,906                |   |                                   | 2,442   |       |  | 14,348  |   | 

F  55

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|            |                                                       
|----------- | ------------------------------------------------------
|NOTE 16    | Supplementary Financial Statement Information (cont.):
|            |                                                       
|H.          | Operating Segments (cont.):                           

|                                        |  |                       |  |                                   |         |       |  |         |  | 
|--------------------------------------- |  | --------------------- |  | --------------------------------- | ------- | ----- |  | ------- |  | 
|                                        |  | Software
  Services   |  | Proprietary
  Software
  Products |         | Total | 
|                                        |  |                       |  |                                   |         |       | 
|                                        |  | (U.S. $ in thousands) | 
|                                        |  |                       | 
|Identifiable assets including goodwill: |  |                       |  |                                   |         |       |  |         |  | 
|                                       
|2006                                    |  | 248,032               |  |                                   | 267,868 |       |  | 515,900 |  | 
|                                       
|2005                                    |  | 196,321               |  |                                   | 238,715 |       |  | 435,036 |  | 
|                                        |  |                       |  |                                   |         |       |  |         |  | 
|Identifiable liabilities:               |  |                       |  |                                   |         |       |  |         |  | 
|                                       
|2006                                    |  | 132,540               |  |                                   | 77,329  |       |  | 209,869 |  | 
|                                       
|2005                                    |  | 84,025                |  |                                   | 50,283  |       |  | 134,308 |  | 
|                                        |  |                       |  |                                   |         |       |  |         |  | 
|Depreciation and amortization:          |  |                       |  |                                   |         |       |  |         |  | 
|                                       
|2006                                    |  | 2,555                 |  |                                   | 3,123   |       |  | 5,678   |  | 
|                                       
|2005                                    |  | 3,912                 |  |                                   | 17,373  |       |  | 21,285  |  | 
|                                       
|2004                                    |  | 4,724                 |  |                                   | 13,891  |       |  | 18,615  |  | 
|                                        |  |                       |  |                                   |         |       |  |         |  | 
|Investments in segment assets:          |  |                       |  |                                   |         |       |  |         |  | 
|                                       
|2006                                    |  | 2,574                 |  |                                   | 2,004   |       |  | 4,578   |  | 
|                                       
|2005                                    |  | 2,578                 |  |                                   | 7,481   |       |  | 10,060  |  | 
|                                       
|2004                                    |  | 1,888                 |  |                                   | 2,638   |       |  | 4,526   |  | 

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

|                                        |  |                       |         |      |  |      |         |   |  |  |         |   | 
|--------------------------------------- |  | --------------------- | ------- | ---- |  | ---- | ------- | - |  |  | ------- | - | 
|                                        |  | 2006                  |         | 2005 |  | 2004 |        
|                                        |  |                       |         |      |  |      |        
|                                        |  | (U.S. $ in thousands) |        
|                                        |  |                       |        
|Revenues:                               |  |                       |         |      |  |      |         |   |  |  |         |   | 
|                                       
|Revenues as above                       |  |                       | 496,669 |      |  |      | 438,149 |   |  |  | 401,038 |   | 
|                                       
|Less inter-segment transactions         |  |                       | (3,934  | )    |  |      | (5,659  | ) |  |  | (5,776  | ) | 
|                                        |  |                       |         |      |  |      |         |   |  |  |         |   | 
|Revenues as per statement of operations |  |                       | 492,735 |      |  |      | 432,490 |   |  |  | 395,262 |   | 
|                                        |  |                       |         |      |  |      |         |   |  |  |         |   | 

F  56

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|            |                                                       
|----------- | ------------------------------------------------------
|NOTE 16    | Supplementary Financial Statement Information (cont.):
|            |                                                       
|H.          | Operating Segments (cont.):                           

|                                                                                |  |                       |         |      |  |         |  
|------------------------------------------------------------------------------- |  | --------------------- | ------- | ---- |  | ------- | -
|                                                                                |  | 2006                  |         | 2005 | 
|                                                                                |  |                       |         |      | 
|                                                                                |  | (U.S. $ in thousands) |        
|                                                                                |  |                       |        
|                                                                               
|Identifiable assets:                                                            |  |                       |         |      |  |         |  
|                                                                               
|Total assets of operating segments                                              |  |                       | 515,900 |      |  | 435,036 |  
|                                                                               
|Assets not identifiable to a particular
  segment                               |  |                       | 92,141  |      |  | 116,174 |  
|                                                                               
|Elimination of inter-segment assets and
  other                                 |  |                       | (12,537 | )    |  | (75,742 | )
|                                                                                |  |                       |         |      |  |         |  
|Total assets from continuing operation as
  per consolidated balance sheet      |  |                       | 595,504 |      |  | 475,468 |  
|                                                                                |  |                       |         |      |  |         |  
|                                                                                |  |                       |         |      |  |         |  
|Identifiable liabilities:                                                       |  |                       |         |      |  |         |  
|                                                                               
|Total liabilities of operating segments                                         |  |                       | 209,869 |      |  | 134,308 |  
|                                                                               
|liabilities not identifiable to a
  particular segment                          |  |                       | 232,718 |      |  | 205,270 |  
|                                                                               
|Elimination of inter-segment liabilities
  and other                            |  |                       | (373    | )    |  | (54,956 | )
|                                                                                |  |                       |         |      |  |         |  
|Total liabilities from continuing operation
  as per consolidated balance sheet |  |                       | 442,214 |      |  | 284,622 |  
|                                                                                |  |                       |         |      |  |         |  

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

|       |  |                       |        |      |  |        | 
|------ |  | --------------------- | ------ | ---- |  | ------ | 
|       |  | December 31,          |       
|       |  |                       |       
|       |  | 2006                  |        | 2005 | 
|       |  |                       |        |      | 
|       |  | (U.S. $ in thousands) |       
|       |  |                       |       
|      
|Israel |  |                       | 55,259 |      |  | 48,309 | 
|      
|U.S.A. |  |                       | 11,997 |      |  | 5,723  | 
|      
|Others |  |                       | 4,427  |      |  | 1,094  | 
|       |  |                       |        |      |  |        | 
|Total  |  |                       | 71,683 |      |  | 55,126 | 
|       |  |                       |        |      |  |        | 

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

|               |  |                         |         |      |  |         |  |  |         | 
|-------------- |  | ----------------------- | ------- | ---- |  | ------- |  |  | ------- | 
|               |  | Year ended December 31, |        
|               |  |                         |        
|               |  | 2006                    |         | 2005 |  | 2004    | 
|               |  |                         |         |      |  |         | 
|               |  | (U.S. $ in thousands)   |        
|               |  |                         |        
|              
|Israel         |  |                         | 273,219 |      |  | 236,826 |  |  | 201,376 | 
|              
|International: |  |                         |         |      |  |         |  |  |         | 
|              
|United States  |  |                         | 117,768 |      |  | 98,770  |  |  | 96,536  | 
|              
|Other          |  |                         | 101,748 |      |  | 96,894  |  |  | 97,350  | 
|               |  |                         |         |      |  |         |  |  |         | 
|               |  |                         | 219,516 |      |  | 195,664 |  |  | 193,886 | 
|               |  |                         |         |      |  |         |  |  |         | 
|Total          |  |                         | 492,735 |      |  | 432,490 |  |  | 395,262 | 
|               |  |                         |         |      |  |         |  |  |         | 

| |  |                                                             
| |  | ------------------------------------------------------------
| |  | Classification
  was based on the location of the customers.

F  57

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|            |                                                                                                                    
|----------- | -------------------------------------------------------------------------------------------------------------------
|NOTE 16    | 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, |       
|                                                                           |  |                         |       
|                                                                           |  | 2006                    |        | 2005 |  | 2004   | 
|                                                                           |  |                         |        |      |  |        | 
|                                                                           |  | (U.S. $ in thousands)   |       
|                                                                           |  |                         |       
|                                                                          
|Amount for
  basic earnings per share - income available to shareholders   |  |                         | 3,928  |      |  | 5,129  |  |  | 14,028 |  
|                                                                           |  |                         |        |      |  |        |  |  |        |  
|Effect of
  dilutive securities of subsidiaries                            |  |                         | (290   | )    |  | -      |  |  | (1,592 | )
|                                                                           |  |                         |        |      |  |        |  |  |        |  
|Amount for
  diluted earnings per share - income available to shareholders |  |                         | 3,638  |      |  | 5,129  |  |  | 12,436 |  
|                                                                           |  |                         |        |      |  |        |  |  |        |  
|                                                                           |  |                         |        |      |  |        |  |  |        |  
|Weighted average
  shares outstanding                                      |  |                         |        |      |  |        |  |  |        |  
|                                                                           |  |                         |        |      |  |        |  |  |        |  
|Denominator for
  basic net earnings per share                             |  |                         | 13,200 |      |  | 12,800 |  |  | 10,800 |  
|                                                                           |  |                         |        |      |  |        |  |  |        |  
|Effect of
  dilutive securities                                            |  |                         | 98     |      |  | *)-    |  |  | *)-    |  
|                                                                           |  |                         |        |      |  |        |  |  |        |  
|Denominator for
  diluted net earnings per share                           |  |                         | 13,298 |      |  | 12,800 |  |  | 10,800 |  
|                                                                           |  |                         |        |      |  |        |  |  |        |  
|                                                                          
|Basic net
  earnings per share of continuing operation                     |  |                         | 0.30   |      |  | 0.27   |  |  | 1.30   |  
|                                                                           |  |                         |        |      |  |        |  |  |        |  
|                                                                           |  |                         |        |      |  |        |  |  |        |  
|Diluted net
  earnings per share of continuing operation                   |  |                         | 0.27   |      |  | 0.27   |  |  | 1.15   |  
|                                                                           |  |                         |        |      |  |        |  |  |        |  

|              |                         
|------------- | ------------------------
|              | *) Anti dilutive.       
|              |                         
|Note 17      | Discontinued operations:

On  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. 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 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. 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, 2005 and
2004 were $9, $15, $11 millions, respectively.

F  58

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|              |                                                               
|------------- | --------------------------------------------------------------
|Note 17      | Discontinued operations (Cont.):                              
|              |                                                               
|A.            | The
  following is the composition of discontinued operations:

|                                                        |  |                         |         |      |  |        |   |  |        |  
|------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ------ | - |  | ------ | -
|                                                        |  | Year Ended December 31, |        
|                                                        |  |                         |        
|                                                        |  | 2006                    |         | 2005 |  | 2004   |  
|                                                        |  |                         |         |      |  |        |  
|                                                        |  | (U.S. $ in  thousands)  |        
|                                                        |  |                         |        
|                                                        |  |                         |         |      |  |        |   |  |        |  
|Revenues                                                |  |                         | 67,491  |      |  | 73,882 |   |  | 61,348 |  
|                                                       
|Cost of
  revenues                                      |  |                         | 36,244  |      |  | 39,892 |   |  | 31,464 |  
|                                                        |  |                         |         |      |  |        |   |  |        |  
|Gross profit                                            |  |                         | 31,247  |      |  | 33,990 |   |  | 29,884 |  
|                                                        |  |                         |         |      |  |        |   |  |        |  
|Research and
  development costs, net                   |  |                         | 9,095   |      |  | 7,008  |   |  | 9,868  |  
|                                                       
|Selling,
  general and administrative expenses          |  |                         | 42,025  |      |  | 21,802 |   |  | 21,922 |  
|                                                       
|Restructuring
  and non-recurring costs                 |  |                         | 258     |      |  | -      |   |  | -      |  
|                                                        |  |                         |         |      |  |        |   |  |        |  
|Operating income                                        |  |                         | (20,131 | )    |  | 5,180  |   |  | (1,906 | )
|                                                        |  |                         |         |      |  |        |   |  |        |  
|Financial
  expenses, net                               |  |                         | (4,132  | )    |  | (5,170 | ) |  | (3,130 | )
|                                                       
|Gain on
  realization of shareholdings, net *,**        |  |                         | 36,254  |      |  | 920    |   |  | 611    |  
|                                                       
|Other losses, net                                       |  |                         | -       |      |  | (1,523 | ) |  | (252   | )
|                                                        |  |                         |         |      |  |        |   |  |        |  
|Income before taxes on income                           |  |                         | 11,991  |      |  | (593   | ) |  | (4,677 | )
|                                                        |  |                         |         |      |  |        |   |  |        |  
|Taxes on
  income                                       |  |                         | (263    | )    |  | 377    |   |  | 1,060  |  
|                                                        |  |                         |         |      |  |        |   |  |        |  
|                                                        |  |                         | 12,254  |      |  | (970   | ) |  | (5,737 | )
|                                                        |  |                         |         |      |  |        |   |  |        |  
|Equity in
  gains (losses) of affiliated companies, net |  |                         | 413     |      |  | (3,170 | ) |  | (2,117 | )
|                                                        |  |                         |         |      |  |        |   |  |        |  
|Minority
  interest in earnings of subsidiaries, net    |  |                         | (6,368  | )    |  | (806   | ) |  | 1,605  |  
|                                                        |  |                         |         |      |  |        |   |  |        |  
|Net income                                              |  |                         | 6,299   |      |  | (4,946 | ) |  | (6,249 | )
|                                                        |  |                         |         |      |  |        |   |  |        |  

|  |                                                                                                                                                                                     
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|* | On 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.
|  |                                                                                                                                                                                     
|  | With the
  completion of the transaction, Formula Vision held 24.58% of Gigas
  outstanding shares.                                                                                
|  |                                                                                                                                                                                     
|  | The gain
  from realization totaled to $10.6 million.                                                                                                                               

|   |                                                                                                                                                                                                                                                                                                                                                                                      
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|** | On 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 to $ 13.6 million.

F  59

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|              |                                                                                                                                            
|------------- | -------------------------------------------------------------------------------------------------------------------------------------------
|Note 17      | Discontinued operations (Cont.):                                                                                                           
|              |                                                                                                                                            
|B.            | The
  breakdown of assets and liabilities attributed to discontinued operations of
  Formula Vision as of December 31, 2005 was as follows:

|                                                        |  |                        |  |         | 
|------------------------------------------------------- |  | ---------------------- |  | ------- | 
|                                                        |  | December 31, 2005      | 
|                                                        |  |                        | 
|                                                        |  | (U.S. $ in  thousands) | 
|                                                        |  |                        | 
|ASSETS                                                  |  |                        |  |         | 
|                                                        |  |                        |  |         | 
|CURRENT ASSETS:                                         |  |                        |  |         | 
|                                                        |  |                        |  |         | 
|Cash and cash equivalents                               |  |                        |  | 17,919  | 
|                                                       
|Short-term investments                                  |  |                        |  | 18,474  | 
|                                                       
|Trade receivables                                       |  |                        |  | 20,996  | 
|                                                       
|Other current assets                                    |  |                        |  | 6,546   | 
|                                                       
|Inventories                                             |  |                        |  | 78      | 
|                                                        |  |                        | 
|                                                        |  |                        |  | 64,013  | 
|                                                        |  |                        | 
|LONG-TERM INVESTMENTS, LOANS AND RECEIVABLES:           |  |                        |  |         | 
|                                                        |  |                        |  |         | 
|Loans and other investments                             |  |                        |  | 1,070   | 
|                                                       
|Investments in affiliates                               |  |                        |  | 19,801  | 
|                                                        |  |                        | 
|                                                        |  |                        |  | 20,871  | 
|                                                        |  |                        | 
|                                                        |  |                        |  |         | 
|SEVERANCE PAY FUND                                      |  |                        |  | 3,064   | 
|                                                        |  |                        | 
|                                                        |  |                        |  |         | 
|PROPERTY AND EQUIPMENT, NET                             |  |                        |  | 4,352   | 
|                                                        |  |                        | 
|                                                        |  |                        |  |         | 
|GOODWILL                                                |  |                        |  | 55,038  | 
|                                                        |  |                        | 
|                                                        |  |                        |  |         | 
|OTHER ASSETS, NET                                       |  |                        |  | 7,279   | 
|                                                        |  |                        | 
|                                                        |  |                        |  |         | 
|Total assets from discontinued operation,
net           |  |                        |  | 154,617 | 
|                                                        |  |                        | 
|                                                        |  |                        |  |         | 
|LIABILITIES AND SHAREHOLDERS
  EQUITY                  |  |                        |  |         | 
|                                                        |  |                        |  |         | 
|CURRENT LIABILITIES:                                    |  |                        |  |         | 
|                                                        |  |                        |  |         | 
|Credit from banks and others                            |  |                        |  | 40,524  | 
|                                                       
|Trade payables                                          |  |                        |  | 6,886   | 
|                                                       
|Other accounts payable                                  |  |                        |  | 13,610  | 
|                                                       
|Customer advances, net of work in
progress              |  |                        |  | 7,309   | 
|                                                        |  |                        | 
|                                                        |  |                        |  | 68,329  | 
|                                                        |  |                        | 
|LONG-TERM LIABILITIES:                                  |  |                        |  |         | 
|                                                        |  |                        | 
|Liabilities to banks and others                         |  |                        |  | 318     | 
|                                                       
|Severance pay                                           |  |                        |  | 4,306   | 
|                                                       
|Deferred taxes                                          |  |                        |  | 385     | 
|                                                        |  |                        | 
|                                                        |  |                        |  | 5,009   | 
|                                                        |  |                        | 
|                                                        |  |                        |  |         | 
|MINORITY INTEREST                                       |  |                        |  | 15,527  | 
|                                                        |  |                        | 
|                                                       
|TOTAL LIABILITIES ATTRIBUTED TO DISCONTINUED OPERATIONS |  |                        |  | 88,865  | 
|                                                        |  |                        | 

F  60

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|            |                                     
|----------- | ------------------------------------
|NOTE 18    | Transactions
  with Related Parties:

In   March  2005,   Formula  completed  a  private
placement  of 2,400,000  Formula  shares for an aggregate  consideration  of $33 million.  The shares were
issued to FIMGold  LP, an entity  owned in equal  shares by Dan  Goldstein  (the  former  chief  executive
officer and chairman of the board of Formula) and FIMI Opportunity Fund (see note 2F).

|              |                                                                                                                                                                                                                                                                                             
|------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note 19      | Subsequent Events:                                                                                                                                                                                                                                                                          
|              |                                                                                                                                                                                                                                                                                             
|A.            | On June,
  2007 the company sold its entire holdings in BluePhoenix, to international
  institutional investor for consideration of approximately $64 million. The
  company is expected to recognize approximately M $18 in capital gains upon
  completion of the sale of ordinary shares.
|              |                                                                                                                                                                                                                                                                                             
|              | Following is
  selected information of BluePhoenixs financial statements:                                                                                                                                                                                                                  

|                                |  |                      |  | 
|------------------------------- |  | -------------------- |  | 
|                                |  | December 31, 2006    | 
|                                |  |                      | 
|                                |  | (U.S. $ inthousands) | 
|                                |  |                      | 
|                                |  |                      |  | 
|Total
  current assets          |  | 42,265               |  | 
|                                |  |                      |  | 
|Total
  non-current assets      |  | 85,201               |  | 
|                                |  |                      |  | 
|Total
  current liabilities     |  | 24,404               |  | 
|                                |  |                      |  | 
|Total
  non-current liabilities |  | 37,765               |  | 

F  61

---

---



|                     |  |                        |                              |  |                    |                     
|-------------------- |  | ---------------------- | ---------------------------- |  | ------------------ | --------------------
|(ERNST & YOUNG LOGO) |  | 3⁄4                      | Kost Forer Gabbay & Kasierer |  | 3⁄4                  | Phone: 972-3-6232525
|                     |  | 3 Aminadav St.         |                              |  | Fax: 972-3-5622555
|                     |  | Tel-Aviv 67067, Israel |                              |  |                   

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, 2005 and 2006 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, 2006. 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, 2005 and 2006 and the consolidated results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2006, in conformity with U.S. generally accepted accounting
principles.

|                 |                                 
|---------------- | --------------------------------
|                 |                                 
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER    
|June 26,
  2007  | A Member of Ernst & Young Global



---

---



(ERNST & YOUNG LOGO)

REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To
the Shareholders of

MAGIC
SOFTWARE ENTERPRISES LTD.

We
have audited the accompanying consolidated balance sheets of Magic Software
Enterprises Ltd. (the Company) and its subsidiaries as of December 31, 2005
and 2006, 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, 2006. 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 10% and 18% as of December 31, 2005 and 2006,
respectively, and total revenues of 39%, 18% and 33% for each of the three
years in the period ended December 31, 2006. Those statements were audited by
other auditors whose reports have been furnished to us, and our opinion,
insofar as it relates to the amounts included for those subsidiaries, is based
solely on the reports of the other auditors.

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

In
our opinion, based on our audits and the reports of the other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company and its
subsidiaries at December 31, 2005 and 2006, and the related consolidated results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2006, in conformity with U.S. generally accepted
accounting principles.

As
discussed in Note 2 to the consolidated financial statements, the company
adopted the provision of Statement of Financial Accounting Standard No. 123(R),
Share-Based Payment, effective January 1, 2006.

As
discussed in Note 2 to the consolidated financial statements, on December 31,
2006, the Company initially applied the provisions of Staff Accounting Bulletin
No. 108, Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements, and recorded a cumulative
effect adjustment to beginning accumulated deficit at January 1, 2006 and
adjustments to property and equipment as of December 31, 2005.

|                 |                                   
|---------------- | ----------------------------------
|                 | -s- KOST FORER GABBAY & KASIERER  
|Tel-Aviv, Israel | KOST FORER GABBAY &
  KASIERER    
|June 26, 2007    | A Member of Ernst &
  Young Global



---

---



Independent
auditors report to the shareholders of

HERMES
LOGISTICS TECHNOLOGIES LIMITED

We have audited the financial statements of Hermes
Logistics Technologies Limited for the year ended 31 December 2006 which
comprise of the profit and loss account, the balance sheet and the related notes. These financial statements have been prepared under the
accounting policies set out therein and the
requirements of the Financial Reporting Standard for Smaller Entities
(Effective January 2007).

This report is made solely to the companys members as
a body, in accordance with S235 of the Companies Act 1985. Our audit work has
been undertaken so that we might state to the companys members those matters we
are required to state to them in an auditors report and for no other purpose.
To the fullest extent permitted by law, we do not accept or assume
responsibility to anyone other than the company and the companys members as a a body
for our audit work, for this report, or for the opinions we have formed.

RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS

The directors responsibilities for preparing the
financial statements in accordance with applicable law and United Kingdom Accounting
Standards (United Kingdom Generally Accepted Accounting Practice) are set out
in the Statement of Directors Responsibilities.

Our responsibility is to audit the financial
statements in accordance with relevant legal and regulatory requirements and International
Standards on Auditing (UK and Ireland).

We report to you our opinion as to whether the
financial statements give a true and fair view and are properly prepared in
accordance with the Companies Act 1985. We also report to you  whether in our opinion the information given in the Directors Report is consistent with the financial
statements.

In addition we report to you if, in our opinion, the
company has not kept proper accounting records, if we have not received all the
information and explanations we require for our audit, or if information
specified by law regarding directors remuneration and other transactions is
not disclosed.

We read the Directors Report and consider the
implications for our report if we become aware of any apparent misstatements
within it.

BASIS OF AUDIT OPINION

We conducted our audit in accordance with international
Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board.
An audit includes examination, on a test basis, of evidence relevant to the
amounts and disclosures in the financial statements. It also includes an
assessment of the significant estimates and judgments made by the directors in
the preparation of the financial statements, and whether the accounting policies
are appropriate to the companys circumstances, consistently applied and
adequately disclosed.

We planned and performed our audit so as to obtain all
the information and explanations which we considered necessary in order to
provide us with sufficient evidence to give reasonable assurance that the
financial statements are free from material misstatement, whether caused by fraud or
other irregularity or error. In forming our opinion we also evaluated the
overall adequacy of the presentation of information in the financial
statements.

OPINION

In our opinion:

|  |                                                                                                                                                                                                                                                                         
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|- | the financial statements give a true and fair view,
  In accordance with United Kingdom Generally Accepted Accounting Practice
  applicable to Smaller Entities, of the state of the companys
  affairs as at 31 December 2006 and of its loss for the year then ended;
|  |                                                                                                                                                                                                                                                                         
|- | the financial statements have been properly prepared
  in accordance with the Companies Act 1985; and                                                                                                                                                                   
|  |                                                                                                                                                                                                                                                                         
|- | the information given in the Directors Report is
  consistent with the financial statements.                                                                                                                                                                           

-s- LEVY COHEN & CO.

LEVY COHEN & CO.
REGISTERED AUDITOR
37 Broadhurst Gardens
London NW6 3QT


8 February 2007



---

---



Independent
Auditors Report to the Shareholders of

MAGIC
SOFTWARE ENTERPRISES (UK) LIMITED

We have audited the financial statements of Magic
Software Enterprises (UK) Limited for the year ended 31 December 2006 which
comprise of the profit and loss account, the balance sheet and the related
notes. These financial statements have been prepared under the accounting
policies set out therein and the requirements of the Financial Reporting
Standard for Smaller Entities (Effective January 2007).

This report is made solely to the companys members, as a body,
in accordance with S235 of the Companies Act 1985. Our audit work has been
undertaken so that we might state to the companys members those matters we are
required to state to them in an auditors report and for no other purpose. To
the fullest extent permitted by law, we do not accept or assume responsibility
to anyone other than the company and the companys members as a body for our
audit work, for this report, or for the opinions we have formed.

RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS

The directors responsibilities for preparing the
financial statements in accordance with applicable law and United Kingdom
Accounting Standards (United Kingdom Generally Accepted Accounting Practice) are
set out in the Statement of Directors Responsibilities.

Our responsibility is to audit the financial
statements in accordance with relevant legal and regulatory requirements and
International Standards on Auditing (UK and Ireland).

We report to you our opinion as to whether the
financial statements give a true and fair view and are properly prepared in
accordance with the Companies Act 1985. We also report to you whether in our
opinion the information given in the Directors Report is consistent with the
financial statements.

In addition we report to you if, in our opinion, the
company has not kept proper accounting records, if we have not received all the
information and explanations we require for our audit, or if information
specified by law regarding directors remuneration and other transactions is
not disclosed.

We read the Directors Report and consider the
Implications for our report if we become aware of any apparent misstatements
within it.

BASIS OF AUDIT OPINION

We conducted our audit in accordance with
International Standards on Auditing (UK and Ireland) issued by the Auditing
Practices Board. An audit includes examination, on a test basis, of evidence
relevant to the amounts and disclosures in the financial statements. It also
includes an assessment of the significant estimates and judgments made by the
directors in the preparation of the financial statements, and whether the
accounting policies are appropriate to the companys circumstances,
consistently applied and adequately disclosed.

We planned and performed our audit so as to obtain all
the information and explanations which we considered necessary in order to
provide us with sufficient evidence to give reasonable assurance that the
financial statements are free from material misstatements, whether caused by fraud
or other irregularity or error. In forming our opinion we also evaluated the
overall adequacy of the presentation of information in the financial
statements.

OPINION

In our opinion:

|  |                                                                                                                                                                                                                                                                         
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|- | the financial statements give a true and fair view,
  in accordance with United Kingdom Generally Accepted Accounting Practice
  applicable to Smaller Entities, of the state of the companys affairs as at
  31 December 2006 and of its loss for the year then ended;
|  |                                                                                                                                                                                                                                                                         
|- | the financial statements have been properly prepared
  in accordance with the Companies Act 1985; and                                                                                                                                                                   
|  |                                                                                                                                                                                                                                                                         
|- | the information given in the Directors Report is
  consistent with the financial statements.                                                                                                                                                                           

-s- LEVY COHEN & CO.


LEVY COHEN & CO.
REGISTERED AUDITOR
37 Broadhurst Gardens
London NW6 3QT


8 February 2007



---

---



MOCK
& PARTNERS INTERNATIONAL
registeraccountants

AUDITORS
REPORT

Introduction

We have audited the financial statements of Magic Beheer B.V., for the
period until December 31st, 2006. 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.

Scope

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

Opinion

In our opinion, the financial statements give a true and fair view of
the financial position of the company as at December 31st, 2006 and
of the result for the year then ended in accordance with accounting principles
generally accepted in the United States of America.

Amsterdam, February 27th 2007

|                             
|-----------------------------
|Mock & Partners International
|-s- H.J.S. Mock              
|Drs. H.J.S. Mock RA          

Rapenburgerstreat 109, 1011 VL, Amsterdam. Tel: 020 6381881, Fax: 020 6272624

---

---



(K.D.A. LOGO)

KDA Audit Corporation

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 sheet of Magic Software Japan K.K. (the
Company) as of December 31, 2006, and the related statements of income and
cash flows for the year then ended. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements based on our audit.

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

In
our opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of the Company as of December 31,
2006, and the results of its operations and its cash flows for the year then
ended in conformity with accounting principles generally accepted in the United
States of America.

|                 |  |                                          
|---------------- |  | -----------------------------------------
|Tokyo, Japan     |  | -s- KDA Audit Corporation                
|January 26, 2007 | 
|                 |  | KDA
  Audit Corporation                  
|                 |  | (A
  Member of Baker Tilly International)



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(ERNST & YOUNG LOGO)

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM

To the Board of Directors and Shareholders of

N.I.P. NIKUV INTERNATIONAL PROJECTS LTD.

We
have audited the accompanying consolidated balance sheets of N.I.P. Nikuv
International Projects Ltd. (the Company) and its subsidiaries as of December
31, 2006 and 2005, and the related consolidated statements of income, changes
in shareholders equity and cash flows for each of the two years in the period
ended December 31, 2006. These consolidated financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

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

In
our opinion, the consolidated financial statements referred to above, present
fairly, in all material respects, the consolidated financial position of the
Company and its subsidiaries as of December 31, 2006 and 2005, and the
consolidated statements of income and its cash flows for each of the two years
in the period ended December 31, 2006, in conformity with United States
generally accepted accounting principles.

|                 |                                   
|---------------- | ----------------------------------
|                 | -s- KOST FORER GABBAY & KASIERER  
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER      
|June 27, 2006    | A Member of Ernst &
  Young Global



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# 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/ Gad Goldstein 
Gad Goldstein President andChief Executive Officer |  | June 29, 2007 Date
|------------------------------------------------------------------------------------------------------------------ |  | ------------------



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# 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 |  | An
agreement dated November 17, 2005 between the Registrant and Formula Vision Technologies
(F.V.T) Ltd. (English translation                               from Hebrew original)(2)
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 |  | International
Securities Purchase Agreement dated June 15, 2007 between the Registrant and each of the
purchasers identified on the signature pages of the agreement
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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(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.



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