---

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

|   |                                                                                                    
|-- | ---------------------------------------------------------------------------------------------------
|o  | REGISTRATION
  STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF
  1934;
|   |                                                                                                    
|OR
|  
|x  | ANNUAL REPORT PURSUANT TO
  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934             
|   |                                                                                                    
|   | For
  the fiscal year ended December 31, 2005;                                                     
|   |                                                                                                    
|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:

None


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

| |                                  | 
| | -------------------------------- | 
| | American Depositary Shares       | 
| |                                  | 
| | Ordinary Shares, NIS 1 par value | 
| |                                  | 
| | (Title of class)                 | 

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

| |                                  | 
| | -------------------------------- | 
| | American Depositary Shares       | 
| |                                  | 
| | Ordinary Shares, NIS 1 par value | 
| |                                  | 
| | (Title of Class)                 | 

As of December 31, 2005, the
registrant had 13,200,000
outstanding ordinary shares, NIS 1 par value, of which 412,472_were represented
by American depositary shares as of such date.

---

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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.

Yeso   Nox

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

Yeso   Nox

Note  Checking the box above will not relieve any registrant required
to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 from their obligations under those Sections.

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.

Yesx   Noo

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 filero | Accelerated filerx | Non-accelerated filero

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

Item 17o   Item 18x

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

Yeso   Nox

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

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

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

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

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

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

2

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TABLE OF CONTENTS

|                                                                                      |    
|------------------------------------------------------------------------------------- | ---
|ITEM 1. IDENTITY OF DIRECTORS, SENIOR
MANAGEMENT AND ADVISERS                         | 4  
|                                                                                      |    
|ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE                                       | 4  
|                                                                                      |    
|ITEM 3. KEY INFORMATION                                                               | 4  
|                                                                                      |    
|ITEM 4. INFORMATION ON THE COMPANY                                                    | 18 
|                                                                                      |    
|ITEM 4A. UNRESOLVED STAFF COMMENTS                                                    | 44 
|                                                                                      |    
|ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                  | 44 
|                                                                                      |    
|ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                    | 60 
|                                                                                      |    
|ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                             | 71 
|                                                                                      |    
|ITEM 8. FINANCIAL INFORMATION                                                         | 76 
|                                                                                      |    
|ITEM 9. THE OFFER AND LISTING                                                         | 77 
|                                                                                      |    
|ITEM 10. ADDITIONAL INFORMATION                                                       | 79 
|                                                                                      |    
|ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS                  | 93 
|                                                                                      |    
|ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       | 94 
|                                                                                      |    
|ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                              | 94 
|                                                                                      |    
|ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND
USE OF PROCEEDS | 94 
|                                                                                      |    
|ITEM 15. CONTROLS AND PROCEDURES                                                      | 94 
|                                                                                      |    
|ITEM 16. [RESERVED]                                                                   | 95 
|                                                                                      |    
|ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT                                            | 95 
|                                                                                      |    
|ITEM 16B. CODE OF ETHICS                                                              | 95 
|                                                                                      |    
|ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES                                      | 95 
|                                                                                      |    
|ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES                  | 96 
|                                                                                      |    
|ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
PURCHASERS      | 96 
|                                                                                      |    
|ITEM 17. FINANCIAL STATEMENTS                                                         | 97 
|                                                                                      |    
|ITEM 18. FINANCIAL STATEMENTS                                                         | 97 
|                                                                                      |    
|ITEM 19. EXHIBITS                                                                     | 97 
|                                                                                      |    
|Exhibit Index                                                                         | 100

3

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ITEM 1.
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

ITEM 2. OFFER
STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3.
KEY INFORMATION

|   |                        
|-- | -----------------------
|A. | Selected Financial Data

The
following tables present our consolidated statement of operations and balance
sheet data for the periods and as of the dates indicated. We derive the
consolidated statement of operations data for the years ended December 31,
2003, 2004 and 2005, and the
balance sheet data as at December 31, 2004 and 2005from our
consolidated financial statements included elsewhere in this annual report. Our
consolidated financial statements have been audited by Ziv Haft registered public accountants (Isr.) BDO member
firm. The consolidated income statement data for the years ended December 31, 2001 and 2002 and the consolidated balance sheet data
for the years ended December 31, 2001, 2002 and 2003 is derived from
our audited financial statements not included in this annual report. You should
read the selected consolidated financial data together with our consolidated
financial statements included elsewhere in this annual report. See Item 5.
Operating and Financial Review and Prospects.

We prepare our consolidated financial statements in
conformity with U.S. GAAP. Under U.S. GAAP, we cannot use adjusted NIS
reflecting changes in the Israeli consumer price index, as we have used in the
past. Instead, we use
nominal values
of the NIS translated into
dollars as described in Item 5 below.
As a result, we have restated
certain financial figures relating to 2001.

4

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|                                                 |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|------------------------------------------------ |  | ------------------------------------- | ------- | ---- | - | ------- | - | ---- | ------- | ---- | - | ------- | - | - | ------- | -
|                                                 |  | Year Ended December 31,               |        
|                                                 |  |                                       |        
|                                                 |  |                                       |        
|                                                 |  |                                       |        
|                                                 |  | 2005                                  |         | 2004 |   | 2003    |   | 2002 |         | 2001 |  
|                                                 |  |                                       |         |      |   |         |   |      |         |      |  
|                                                 |  | $                                     |        
|                                                 |  |                                       |        
|                                                 |  | (In thousands, except per share data) |        
|Consolidated Statement of
  Operations Data:     |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|                                                 |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Revenues                                         |  | $                                     | 506,371 |      | $ | 456,610 |   | $    | 366,830 |      | $ | 283,310 |   | $ | 387,682 |  
|Cost of revenues                                 |  |                                       | 333,536 |      |   | 284,961 |   |      | 230,500 |      |   | 186,908 |   |   | 261,346 |  
|                                                 |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Gross profit                                     |  |                                       | 172,835 |      |   | 171,649 |   |      | 136,330 |      |   | 96,402  |   |   | 126,336 |  
|Research and development costs, net              |  |                                       | 22,429  |      |   | 25,036  |   |      | 17,368  |      |   | 15,967  |   |   | 21,287  |  
|Selling, general and administrative expenses     |  |                                       | 133,049 |      |   | 128,537 |   |      | 107,103 |      |   | 85,292  |   |   | 151,345 |  
|Restructuring and non-recurring costs            |  |                                       | 1,455   |      |   |        |   |      |        |      |   | 1,829   |   |   | 10,998  |  
|                                                 |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Operating income (loss)                          |  |                                       | 15,902  |      |   | 18,076  |   |      | 11,859  |      |   | (6,686  | ) |   | (57,294 | )
|Financial income (expenses), net                 |  |                                       | (9,206  | )    |   | (8,904  | ) |      | (3,676  | )    |   | 3,605   |   |   | 2,680   |  
|Gain on realization of shareholdings, net        |  |                                       | 4,107   |      |   | 8,893   |   |      | 2,756   |      |   | 4,668   |   |   | 773     |  
|Other expenses, net                              |  |                                       | 820     |      |   | 332     |   |      | 90      |      |   | 2,100   |   |   | 36,719  |  
|                                                 |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Income (loss) before taxes on income             |  |                                       | 9,983   |      |   | 17,733  |   |      | 10,849  |      |   | (513    | ) |   | (90,560 | )
|Taxes on income                                  |  |                                       | 5,200   |      |   | 4,631   |   |      | 2,540   |      |   | 2,014   |   |   | 6,239   |  
|Equity in losses of affiliated companies, net    |  |                                       | (3,109  | )    |   | (2,523  | ) |      | (1,071  | )    |   | (2,327  | ) |   | (9,926  | )
|Minority interest in losses (profit), net        |  |                                       | (1,491  | )    |   | (2,480  | ) |      | (4,118  | )    |   | 2,448   |   |   | 46,864  |  
|                                                 |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Net income (loss)                                |  |                                       | 183     |      |   | 8,099   |   |      | 3,120   |      |   | (2,406  | ) |   | (59,861 | )
|Earnings (loss) per share:                       |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Basic earnings (loss)                            |  |                                       | 0.01    |      |   | 0.73    |   |      | 0.29    |      |   | (0.24   | ) |   | (6.42   | )
|Diluted earnings (loss)                          |  |                                       | 0.01    |      |   | 0.65    |   |      | 0.24    |      |   | (0.24   | ) |   | (6.42   | )
|Weighted
  average number of shares outstanding: |  |                                       |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Basic                                            |  |                                       | 12,800  |      |   | 10,800  |   |      | 10,037  |      |   | 10,171  |   |   | 9,325   |  
|Diluted                                          |  |                                       | 12,800  |      |   | 10,800  |   |      | 10,285  |      |   | 10,171  |   |   | 9,325   |  

|                                   |  |                    |          |      |  |         |  |      |         |      |  |         |  |  |         | 
|---------------------------------- |  | ------------------ | -------- | ---- |  | ------- |  | ---- | ------- | ---- |  | ------- |  |  | ------- | 
|                                   |  | As of December 31, |         
|                                   |  | 2005               |          | 2004 |  | 2003    |  | 2002 |         | 2001 | 
|                                   |  |                    |          |      |  |         |  |      |         |      | 
|                                   |  | $                  |         
|                                   |  | (In thousands)     |         
|                                   |  |                    |         
|Consolidated
  Balance Sheet Data: |  |                    |          |      |  |         |  |      |         |      | 
|Total assets                       |  |                    | 630,085  |      |  | 641,020 |  |      | 544,008 |      |  | 467,245 |  |  | 454,544 | 
|Total liabilities                  |  |                    | 357, 959 |      |  | 357,663 |  |      | 299,773 |      |  | 241,766 |  |  | 192,532 | 
|Shareholders equity               |  |                    | 163,445  |      |  | 186,778 |  |      | 176,004 |      |  | 153,349 |  |  | 166,421 | 

|                |                                          
|--------------- | -----------------------------------------
|B.              | Capitalization and Indebtedness          
|                |                                          
|Not applicable.
|               
|C.              | Reasons for the Offer and Use of Proceeds
|                |                                          
|Not applicable.

5

---

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

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

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

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

| |   |                                                                                    
| | - | -----------------------------------------------------------------------------------
| |  | acquisitions and dispositions of companies and consolidation of our
  subsidiaries;
| |   |                                                                                    
| |  | the
  size, time and recognition of revenue from significant contracts;            
| |   |                                                                                    
| |  | timing
  of product releases;                                                      
| |   |                                                                                    
| |  | timing
  of contracts;                                                             
| |   |                                                                                    
| |  | timing of completion of
  specified milestones and delays in implementation;       
| |   |                                                                                    
| |  | changes
  in the proportion of service and license revenues;                       
| |   |                                                                                    
| |  | price
  and product competition;                                                   
| |   |                                                                                    
| |  | increases
  in selling and marketing expenses, as well as other operating expenses;
| |   |                                                                                    
| |  | 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.

6

---

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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. 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 our
operating results. Although we believe that during the last two 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.

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

7

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

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

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

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

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

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

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.

8

---

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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 past, including in the last year, 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.

If Formula Vision
does not generate sufficient cash in 2006 in order to repay the entire amount
of the debentures, we might be required to delay the maturity date of a portion
of the amount.

In 2001 and 2002, in connection with the purchase by
Formula Vision Technologies (F.V.T.)
Ltd., or Formula Vision,
of Formulas interests in certain privately-held companies, Formula Vision
issued to Formula a
series of debentures of a principal aggregate amount of $78.3
million. Under their original
terms, the debentures were required to be repaid in five
annual installments, subject to certain conditions. Following the exchange in January 2004, of an aggregate principal amount of $35
million of the debentures for a 59.4%
interest in Formula Vision, the outstanding amount of the debentures was $43.2 million. In December 2005, the general meeting of
Formulas shareholders approved an amendment to the debentures pursuant to which the
repayments due in 2005 and 2006 would be deferred to December 31, 2006, subject to certain
conditions. The amendment to the debentures was made since
Formula Vision anticipated that it may not have sufficient liquid cash assets to satisfy the
repayment under the debentures.
The realization of Formula Visions assets and its timing are subject to market
conditions and other factors. As a result, we cannot be sure that Formula
Vision will have sufficient cash to repay the entire amount of the debenture by
the maturity date. If the cash generated by Formula Vision will not cover the
full amount of the debentures, we may need to delay the maturity date with
respect to a portion of the debentures. Such delay may have a negative effect on our business, operating results and
financial condition.

9

---

---



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., BluePhoenix Solutions 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.

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 2004 and 2005, we received approximately 53% and 52% 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.                                                                                                

10

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

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

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

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

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.

11

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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.

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.

12

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

Some of the
products and services we provide involve key aspects of customers information systems. These systems are frequently critical to
our
customers operations. As a result, our customers have a greater sensitivity to
failures in these systems than do customers of other software products
generally. 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.

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

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

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

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

13

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

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

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

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

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

The stock
market in general has experienced during recent years extreme price and volume
fluctuations. The market prices of securities of technology companies have been
extremely volatile, and have experienced fluctuations that have often been
unrelated or disproportionate to the operating performance of those companies.
These broad market fluctuations could adversely affect the market price of our
ordinary shares and American Depositary Shares, or ADSs. During 2004, for example, the market price of our ADSs fluctuated between
$13.44 and $21.80, and in
2005, the market price of our ADSs fluctuated between $9.92 and $20.44. The market
price of the ordinary shares and the ADSs may fluctuate substantially due to a
variety of factors, including:

14

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

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

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

A
significant portion of our assets is comprised of equity securities of publicly
and non-publicly traded companies. Our publicly traded subsidiaries are
BluePhoenix Solutions Ltd. (formerly known as Crystal Systems Solutions Ltd.), Magic Software Enterprises Ltd., Matrix IT Ltd., Sapiens
International Corporation N.V. and Formula Vision Technologies (F.V.T.) Ltd. 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. On
June 5, 2006, Sapiens was been notified by the NASDAQ National Market that it fails to comply
with the minimum shareholders equity requirement for continued listing on the NASDAQ. In connection therewith, Sapiens has
been requested to submit a specific plan to achieve and
sustain compliance with NASDAQ listing requirements. We
cannot assure you that Sapiens will be able to maintain its listing on NASDAQ.
The failure to maintain the NASDAQ listing could have a material adverse impact
on the share price of Sapiens. 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.

15

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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, 2006, we had
13,200,000 ordinary shares outstanding, of which 442,529 were represented by ADSs. Of the 13,200,000 shares outstanding, 4,731, 521
shares are held by
affiliates. If a large number of our ordinary shares held by affiliates are sold in
a short period, the price of our ordinary shares would likely decrease.

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

Although we
do not believe that we were a passive foreign investment company, or PFIC, for
U.S. federal income tax purposes during 2005, we cannot assure you that we will not be treated as a passive foreign
investment company in 2006 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.

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

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

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

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

16

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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.

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

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

Risks Relating to Operations in
Israel

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

Our
headquarters and principal research and development facilities are located in
Israel. Although we generate approximately 52% of our
revenues from international markets, we are, nonetheless, directly influenced by the political, economic
and military conditions affecting Israel. The execution
of Israels plan of unilateral disengagement from the Gaza Strip and some parts
of the West Bank and Hamas gaining a majority of the
seats on the Palestinian Legislative Council in the elections held recently in
the Palestinian Authority, may affect Israels security and the stability of the region. Major hostilities
involving Israel or the interruption or curtailment of trade between Israel and
its present trading partners could have a material adverse effect on our
business, operating results and financial condition. Furthermore, several
countries restrict business with Israeli companies. In addition, nonexempt male
adult citizens of Israel, including some of our officers and employees, are
obligated to perform military reserve duty until the age of 40 or 45 depending on their
function in the army, and are subject to being called for
active duty under emergency circumstances. While we have operated effectively
under these requirements since our incorporation, we cannot predict the full
impact of such conditions on us in the future, particularly if emergency circumstances
occur. If many of our employees are called for active duty, our operations in
Israel and our business may be adversely affected.

17

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

Certain
of our subsidiaries received grants in the past and receive tax benefits under
Israeli government programs, particularly as a result of the Approved
Enterprise status of certain operations in Israel. Approved Enterprise
status is granted by the Israeli Investment Center of the Ministry of Industry
and Trade and entitles the grantee to a variety of tax incentives. The
incentives awarded to certain of our subsidiaries include reduced tax rates and
a tax holiday. Certain of our subsidiaries were granted a two year tax
exemption, followed by a five year tax reduced tax rate of 25% instead of 34%
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,
2006, 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.

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.                                                                                

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

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

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

18

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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 2004 and
2005, see Item 5.B. Liquidity and Capital Resources.

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 our subsidiary, Formula Vision Technologies (F.V.T.)
Ltd., referred to as Formula Vision. Following these transactions, FIMGold LP
holds 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.

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

19

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

In
January 2004, Formula exchanged approximately $35 million of the aggregate
amount of the debentures for 38,000,000 shares of Formula Vision issued to
Formula and constituting 59.4% of the outstanding share capital of Formula
Vision. The price per share was NIS 4.11 ($0.93) which reflects the average
closing price of Formula Visions shares on the TASE during the 30 days
preceding Formulas resolution approving the transaction. Following the
exchange of a portion of the debentures, the outstanding amount of the
debentures was $43.2 million.

In
December 2005, the general meeting of Formulas shareholders approved an
amendment to the debentures pursuant to which, all repayments under the
debentures due in 2005 and 2006 would be deferred to December 31, 2006,
provided that the amount of cash and cash equivalents that Formula Vision holds
does not exceed the amount of its bank loans. For more information, see Item
5.B. Liquidity and Capital Resources - Related Party Transactions -
Transactions between Us and Formula Vision.

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

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Proprietary Software Solutions

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

The Formula Group

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

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;                                                          

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|  |                                                                                        
|- | ---------------------------------------------------------------------------------------
| | combining
  skills for specific projects;                                              
|  |                                                                                        
| | formation of
  critical mass for large projects; and                                   
|  |                                                                                        
| | marketing
  and selling the groups products and services to the groups customer base.

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

Our Subsidiaries

Matrix

Matrix
IT Ltd., or Matrix, is one of Israels leading integration and information
technology services companies, according to Duns 100 Israel Largest
Enterprises 2005. Matrix employs over 2,400 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
customers requirements; (iii) systems assimilation; and (iv) integration of all
or part of these components. The scope of the work invested in each individual
component varies from one customer to the other, based on each customers
specific requirements.

Software Products. Matrixs operations in
this area include the marketing and assimilation of software products in
various categories, mainly customer relationship management (CRM) software
products, systems management and service management products, software products
for content management, software products for business intelligence (BI), data
warehouses and extract/transform/load (ETL), software products for integration,
database systems, open-code operating systems, software products for knowledge
management, and software development 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
VMS operating systems, and sales and marketing of storage and backup systems
for mainframe computers such as HP and IBM; and (iii) maintenance for computers
and peripheral equipment, lab services and a help desk.

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

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

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

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

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Customers

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

Magic

Magic
Software Enterprises Ltd., or Magic, develops, markets and supports composite
application development and deployment platforms with a service-oriented
architecture (SOA), including application integration and business process
management (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 tens of thousands 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 consulting, 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 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 BAM. 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 ROI 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.

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Professional Services

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

Strategic Alliances

Magic
forms strategic alliances to help deliver complete solutions to customers.
These solutions encompass application integration, development, vertical domain
expertise and hardware implementation. Magic maintains strategic alliances with
leading vendors, like SAP, IBM, Iway, IDS Scheer and Pervasive Software.
Magics partnership with SAP, entered into in 2004, focuses on providing a special
edition of iBOLT 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, criminal justice, and
multi-facility car and truck rental management solutions.

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

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.

Rental car leasing - CarPro Systems Ltd.
develops, markets and sells CarPro, a solution that includes more than 90% of
the functions usually required by multi-facility car and truck rental companies
worldwide. CarPro can manage such varied functions as purchasing and selling
vehicles, reservations management, leasing and rental arrangements, and fleet
control and management.

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Banking - Nextstep Infotech PVT Ltd.
develops and markets Cheq Mate, a banking application that provides most of the
functionality needed to run a retail branch, including support for various deposit
types, advances, time deposits, bank guarantees, letters of credit and
portfolio management.

Professional Services - CoreTech is an
information technology consulting firm offering flexible and creative solutions
in the areas of infrastructure design and delivery, application development,
technology planning and implementation services, and supplemental staffing.

Markets and Customers

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

|  |                      |   |                 |   |                    
|- | -------------------- | - | --------------- | - | -------------------
| | Adidas-Solomon       |  | 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

BluePhoenix
Solutions Ltd., or 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.

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BluePhoenixs
solution portfolio includes software products, software tools and services that
address the most pressing challenges organizations and companies face today.
Its modernization solutions are offered to customers in all business market
sectors, particularly financial services, banking, insurance and automotive.

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 19 years, establishing its credibility and achieving international
recognition and presence. Based on BluePhoenixs technology and that of its
affiliates, BluePhoenix develops and markets software products, tools, and
related methodologies. BluePhoenix delivers its tools and methodologies
together with training and support in order to provide enterprises with
comprehensive solutions, primarily for the modernization of existing IT
systems.

In
1997, BluePhoenix gained international recognition and global presence by
introducing its C-MILL conversion tool, which was developed based on
BluePhoenixs generic modernization technology. BluePhoenix delivered C-MILL
together with consulting services, training, and support as a comprehensive
conversion solution to solve the millennium problem. Until 1999, BluePhoenix
derived substantially all of its revenues from the performance of year 2000
conversion projects. In 1999, it began focusing on the development and
marketing of new automated software renovation tools.

BluePhoenix
provides its modernization solutions directly and through its strategic
partners, such as IBM, EDS, Cook Systems, TEMENOS, Matrix, and TACT.
Additionally, from time to time, other IT services companies license its
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:

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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.                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | 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, 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.                                                                        

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|                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                       | BluePhoenix DataMigratorA
  Windows-based tool for migrating data between various data system
  environments. Coupled with a step-by-step proven methodology, the tool
  provides a fully structured but still versatile automated data migration
  process. 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.                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                       | BluePhoenix WS4LegacyThis
  post-migration, SOA-ready enabling 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. The
  WS4Legacy comprehensive solution provides Web services and Web clients 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. Our tool 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 ReBuilderBased on AppBuilder, ReBuilder
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
  ReBuilder 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), ReBuilder
  uses a model based approach. ReBuilder 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

In
2003, BluePhoenix completed the acquisition of the entire outstanding share
capital of Liraz Systems Ltd. Lirazs business included the operations of
BluePhoenix Solutions B.V. and its international subsidiaries. Following the
acquisition, BluePhoenix has benefited from Lirazs large installed base that
includes leading international banks and financial institutions, whose
information systems operate in various legacy environments.

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

Customers

BluePhoenix
provides its modernization solutions directly or through its strategic partners,
such as IBM, EDS, Cook Systems, TEMENOS, 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:

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In the financial services sector - Banca
Carige S.p.A., Citibank , Credit Suisse, Fidelity International Resource
Management, Rabobank Netherland BV, Rural Servicios Informaticos (Spain), SDC
Udvikling (Denmark) and Temenos Group;

In the insurance sector. - DesJardins
General Insurance Group Inc., Europe Assistance, Friends Provident Management
Services Ltd, Legal and General Resources, Mutual of America, Scottish
Equitable Plc.

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, Computer Associates Islandia, CSC Denmark A/S, Daimler Chrysler AG,
Erhervs-og Selskabsstyrelsen, Fudicia Informationszentrale AG, Global Exchange
Services Inc., Group One/Sagent Technology, Lawson Products, Mentor Graphics
Corporation, Ministry of Defense (Israel).

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,
Fortis, Principal Financial Group, Prudential, Abbey National, ING, Occidental
Fire & Casualty and Menorah Insurance in Israel. Sapiens service offerings
include a standard consulting offering that helps customers make better use of
IT in order to achieve their business objectives.

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

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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 an Advanced Partner of IBM
and works with IBM on solutions, joint development, testing, validation and
marketing. Through this and other business alliances, Sapiens has developed
extensive knowledge in mainframe and mid-range systems, including CICS, DB2,
MQSeries and the WebSphere e-business platform. Sapiens is also a member of
IBMs insurance application architecture (IAA) group and the ISV advantage
program for the small and medium business insurance market segment.

Sapiens Business Solutions for the Insurance
Industry

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

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

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

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|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | INSIGHT for Reinsurance (formerly
  Reinsurance INSIGHT) is a sophisticated solution for the insurance market,
  designed to support carriers and reinsurers in the management of all types of
  reinsurance for the general (property and casualty) and life insurance
  markets, according to the rapidly changing requirements of the international
  reinsurance market. This state-of-the-art, web-enabled solution streamlines
  and reduces the cost of handling all reinsurance functions through
  automation, is based on ACORD standards and B2B XML technology, and is
  designed for a multi- language, multi- currency, multi- company environment.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | INSIGHT for Claims (formerly Claims
  INSIGHT) is a solution that effectively manages and streamlines the
  information flow of claim handling across an insurance providers entire
  organization. This solution uses highly accessible business rules and messaging
  standards and allows the use of a companys existing information assets.                                                                                                                                                                                                                                                                                                                
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | INSIGHT for Closed Books (formerly Closed
  Books INSIGHT), also known as LifeLite, is a solution for life insurance
  companies and pension funds seeking ways to reduce the cost of maintaining
  long-term closed books of business, that is, lines of business that are no
  longer current. Sapiens provides customizable solutions that enable companies to efficiently
  and more effectively administer policies and claims relating to closed books.
  In September 2004, Sapiens purchased the technologies underlying the INSIGHT
  for Closed Books solution from Liverpool Victoria.                                                               

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

Services

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

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

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Customers

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

nextSource Inc.

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

nextSources
human capital management solutions include:

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

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|  |                                                                                                                                                                                                                                                                                                                                                                                                                                              
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Human resources, or HR, services, include
  services of a professional employer organization for payroll processing,
  benefits administration, recruiting, and other HR related services.
  nextSource also offers payrolling services to minimize the co-employment
  risks and eliminate the administrative burdens associated with the employment
  of independent contractors, retirees, summer interns and other temporary
  workers.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | A wide range
  of procurement services and vendor management services to complement
  the implementation of nextSources TAMS solutions and People Ticker
  solutions. Through its value-added procurement service, nextSource offers a
  fully outsourced procurement/vendor management solution to customers looking
  for a complete solution.                                                                                            

Formula
Vision

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

Formula
Visions affiliated companies provide IT solutions for diversified sectors,
including telecom and broadcast, airports, travel, insurance, retail, customer
relations management, 3D-modeling, predictive modeling applications for
Web-based systems, legacy mainframe and mobile networks. Formula Vision
provides its subsidiaries and affiliated companies with guidance and support at
all levels  management, strategy, technology, marketing, business intelligence
and finance.

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

Formula
Visions principal affiliated companies include:

Babylon

Babylon is
the leading provider of single-click translation and information access
solutions. Babylon version 6 is desktop software available for private individuals as well as
corporations. Babylon also offers add-on premium content from world-renowned
dictionary publishers, including Oxford University Press, Britannica,
Merriam-Webster, Larousse, Vox, Langenscheidt, Pons, Van Dale, Melhoramentos,
and Taishukan. Babylon 6 offers single-click results from Wikipedia
encyclopedia in 9 languages.

The
Babylon-Pro user base exceeds 35 million desktop installations. Babylon
corporate customers include industry leaders such as Avnet, BASF, Daimler
Chrysler, Ericsson, Ernst & Young, Fujitsu Siemens, Gillette/Braun,
IBM, John Deere, Lufthansa, Motorola, Nestlé France, Océ, Petrobras, Philips,
UBS and Xerox.

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Babylon
has leveraged its patented technology in Babylon-Enterprise. Babylon-Enterprise
is an information delivery system that gives users instant access to
information from enterprise applications and data sources. Babylon-Enterprise
integrates easily and improves productivity in any IT environment.
Babylon-Enterprise gives users one-click access to enterprise information from
ERP, CRM, HRM and other enterprise information systems. With a second
click, users can immediately drill-down to the data in its source application.

Babylon-Enterprise
users spend less time looking for information and make greater use of existing
enterprise information systems, giving businesses a strong return on the costs
and efforts already invested in information systems.
Babylon-Enterprise works within any Windows application, and enables both
online and offline access to information in a single click.

FIS

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

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

Formula Telecom Solutions

F.T.S. -
Formula Telecom Solutions Ltd., a publicly traded company on the
AIM stock exchange, is a
leading global provider of billing and CRM solutions for service and content
providers and the telecom industry. With customers in 40 countries, FTS
delivers end-to-end and modular solutions to traditional operators and to
providers of the worlds most advanced next-generation services. The FTS track
record of successfully implementing complex projects enables customers to keep
up with the ever-changing requirements of the industry. Combining on-time,
on-budget project delivery with the extensive resources of the Formula Group,
FTS is a CRM and billing one-stop shop.

FTSs customers include Freenet.de, The MTN
Group, Comverse, MobilTel, Cross-Israel Road No. 6  Israels National Toll
Road, Cameroon Telecom - Camtel and MDC Velcom.

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GigaSpaces

GigaSpaces
provides innovative, high-performance infrastructure software solutions that
deliver dynamic scalability for high-volume transactional applications, without
the overhead and complexity inherent in traditional multi-tier development
and deployment environments.

Its
award-winning solutions have been adopted across multiple vertical industries
and are used by companies such as Nortel, Societe Generale, Hutchison
3G, Virgin Mobile and FXall for mission-critical applications, where the need for extreme
performance, reliability and scalability necessitates an alternative to
traditional tier-based architectures.

GigaSpaces
was founded in 2000 and has offices in New York, London and Israel.
GigaSpaces is a privately
held company, funded by BRM Capital, Formula Vision and Intel Capital.

GigaSpaces Enterprise Edition provides
application developers with a vastly simplified infrastructure for developing
and deploying dynamic, linearly-scalable applications in order to meet the
exponential increase in transaction volumes of high-performance,
business-critical systems. This new version removes, in a single platform, all
the middleware bottlenecks associated with data access, data processing, and
data distribution. Moreover, GigaSpaces product architecture allows application programmers to write
their business logic once and effectively and transparently
scale the application linearly and on-demand across any number of
machines.

IDIT

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

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

IDITs
customers include AON International, Groupama, Delta Lloyd and Winterthur.

SintecMedia

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

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Sintec
Medias customers include the BBC, Canadian Broadcasting Corporation (CBC),
UKTV, Fox, NewsCorp, and Times of India.

Transtech

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

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

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, |  | $
  thousands       |        
| |                         |  |                     |        
|
| | 2005                    |  |                     | 274,901 |                                   |  | 231,470 |  |  | 506,371 | 
|
| | 2004                    |  |                     | 227,262 |                                   |  | 229,348 |  |  | 456,610 | 
|
| | 2003                    |  |                     | 196,782 |                                   |  | 170,048 |  |  | 366,830 | 

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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, |        
| |                                                        |  |                           |        
| |                                                        |  | 2005                      |         | 2004 |  | 2003    | 
| |                                                        |  |                           |         |      |  |         | 
| |                                                        |  | $
  thousands             |        
| |                                                        |  |                           |        
| |                                                        |  |                           |         |      |  |         |  |  |         | 
| | Israel                                                 |  |                           | 245,109 |      |  | 213,020 |  |  | 171,108 | 
| |                                                        |  |                           |         |      |  |         |  |  |         | 
| | International:                                         |  |                           |         |      |  |         |  |  |         | 
| |                                                        |  |                           |         |      |  |         |  |  |         | 
| | United States                                          |  |                           | 105,340 |      |  | 106,849 |  |  | 93,695  | 
| |                                                        |  |                           |         |      |  |         |  |  |         | 
| | Other (includes various countries, mainly
  in Europe) |  |                           | 155,922 |      |  | 136,741 |  |  | 102,027 | 
| |                                                        |  |                           |         |      |  |         |  |  |         | 
| |                                                        |  |                           | 261,262 |      |  | 243,590 |  |  | 195,722 | 
| |                                                        |  |                           |         |      |  |         |  |  |         | 
| | Total                                                  |  |                           | 506,371 |      |  | 456,610 |  |  | 366,830 | 
| |                                                        |  |                           |         |      |  |         |  |  |         | 

Competition

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

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

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

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

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

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

BluePhoenixs
principal competitors consist of system integrators, 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 pillar of its long-term application development
strategy. IBM has a specific, dominant advantage in the underlying application
development infrastructure associated with many legacy environments
(predominantly IBM mainframes) and it has a large service capability.
BluePhoenix cooperates with some of these system integrators in providing
specific solutions. Although all of them provide solutions for the
modernization of enterprise systems, each player focuses on different niches.
Major offshore outsourcers in the market include TCS (Tata Consulting
Services), WIPRO, Patni, and Infosys.

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

41

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

FISs principal competitors are CSC, Sunguard,
Unisys, TIA (The Insurance Application), Aquila, Fineos Corporation, and
RebusIS.

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

GigaSpaces
competitors are distributed caching vendors such as Gemstone and Tangosol, as
well as compute-grid vendors such as DataSynapse and Platform Computing.

IDITs principal competitors are CSC, CGI, TIA
(The Insurance Application), Alice and Accenture.

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

Transtechs
competitors in the area of airfield lighting control and monitoring systems are Siemens and Honeywell. Transtechs
competitors in the area of ground surveillance systems are Raytheon, Northrop Grumman, Thales,
Alenia Marconi, Sensis and HITT.

Software Development

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

Intellectual
Property Rights

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

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

Formula
is the parent company of the Formula Group.

The
following table presents certain information regarding the control and
ownership of our significant subsidiaries, as of June 27, 2006.

| |                                             |  |                                |  |                           |        
| | ------------------------------------------- |  | ------------------------------ |  | ------------------------- | -------
| | Subsidiary                                  |  | Country of Incorporation       |  | Percentage
  Of Ownership
| |                                             |  |                                |  |                          
| | Matrix IT Ltd.                              |  | Israel                         |  |                           | 50.03% 
| |                                             |  |                                |  |                           |        
| | Magic Software Enterprises
  Ltd.           |  | Israel                         |  |                           | 50.11% 
| |                                             |  |                                |  |                           |        
| | BluePhoenix Solutions Ltd.                  |  | Israel                         |  |                           | 59.43% 
| |                                             |  |                                |  |                           |        
| | Sapiens
  International Corporation N.V.    |  | Netherlands Antilles
  Islands |  |                           | 59.81% 
| |                                             |  |                                |  |                           |        
| | nextSource Inc.                             |  | United States                  |  |                           | 100.00%
| |                                             |  |                                |  |                           |        
| | Formula
  Vision Technologies (F.V.T.) Ltd. |  | Israel                         |  |                           | 57.24% 

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

|   |                               
|-- | ------------------------------
|D. | Property, Plants and Equipment

Our
corporate headquarters, as well as the research and development and sales and
marketing headquarters of a majority of our subsidiaries, are located in
Herzlia, Israel. We lease approximately 70,000 square feet of office space in
Herzlia, pursuant to a lease which expires on October 31, 2009. Several of our
subsidiaries lease approximately 85,000 square feet of office space in another
building in Herzlia pursuant to leases ending in December 2006, with an option
to extend for an additional 24 or 48 months. We also lease approximately
160,000 square feet of office space in several other locations in Israel.

We
own a 38,590 square feet facility in Or-Yehuda, Israel used for office space of
Magic.

In
addition, Sapiens leases approximately 50,000 square feet of office space in
Rechovot, Israel and several of our subsidiaries lease approximately 184,000
square feet of office space and sales and support premises in the United
States, Europe and Asia.

The
aggregate amount we paid pursuant to our lease agreements in 2005 was
approximately $15.7 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.

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

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 chief executive officer
and chairman of the board, and FIMI Opportunity Fund (which is managed by a
company in which our 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.

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Our functional and reporting
currency

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

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, 2005, no such estimated losses were identified.

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

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

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

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

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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 subsidiatries 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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|   |                  
|-- | -----------------
|A. | Operating Results

Years Ended December 31, 2004 and 2005

Revenues.
Revenues increased 11% from $456.6 million in 2004 to $506.4 million in 2005.
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 in 2005 were
relatively at the same level as in 2004, $231.5 million and $229.3 million,
respectively. This was due to an increase in Formula Vision revenues which was
offset by a decrease in Sapiens and Magic revenues. BluePhoenixs revenues
remained relatively the same in 2004 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 17% from $285.0 million in 2004 to
$333.5 million in 2005. As a perecentage of revenues, cost of revenues
increased from 62% in 2004 to 66% in 2005. The increase was caused primarily by
an increase in sales of our software services, which are generally
characterized by a lower gross margin than sales of proprietary software
solutions. Cost of revenues for proprietary software solutions increased 7.6%
to $113.4 million in 2005 from $105.4 million in 2004, primarily due to the
increase in the cost of revenues of Formula Vision. Cost of revenues for
software services increased 23% from $179.6 in 2004 to $220.2 million in 2005,
primarily due to the increase in the cost of revenues of our subsidiaries
Matrix and nextSource.

Software Development Costs, net.Software
development costs consist primarily of wages and related expenses and, to a
lesser degree, consulting fees we pay to independent contractors engaged in
research and development. Software development costs, net, consist of software
development costs, gross, less capitalized software costs. Software
developments costs, gross, in 2005 and 2004 were $40.1 million and $40.4
million, respectively. In 2005, we capitalized software costs of $17.7 million
compared to $15.4 million in 2004. Capitalization of software costs in 2005 was
attributable to our proprietary software solutions subsidiaries. Software
development costs, net, decreased from $25.0 million in 2004 to $22.4 million
in 2005. As a percentage of revenues, software development costs, net decreased
from 5.5% in 2004 to 4.4% in 2005. The decrease in software development costs
was attributable primarily to the cessation of consolidation of Transtech
during 2005 which resulted in a decrease in software development costs of
Formula Vision which had research and development expenditures of $6.5 million.
Amortization of capitalized software costs were $12.8 million in 2005 and $10.1
million in 2004, which amounts were included in cost of revenues.

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Selling, General and Administrative Expenses.
Selling, general and administrative expenses consist primarily of salaries,
severance and related expenses, travel expenses, selling expenses, rent,
utilities, depreciation, amortization and professional fees. Selling, general
and administrative expenses increased from $128.5 million in 2004 to $133.0
million in 2005. As a percentage of revenues, selling, general and
administrative expenses remained relatively the same in 2004 and 2005. The
increase in selling, general and administrative expenses was primarily
attributable to an increase in selling, general and administrative expenses of
Matrix and Magic which was offset by a decrease in selling, general and administrative
expenses in Formula Vision and Sapiens.

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

Operating Income. Our operating income
decreased from $18.1 million in 2004 to $15.9 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, Formula Vision which had operating income of $5.2 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 was attributable to the improvement in the operating
results of our subsidiaries, in particular Matrix which had operating income of
$15.5 million and BluePhoenix which had operating income of $3.5 million. This
improvement was partially offset by the operating loss of $1.7 million of
Formula Vision.

Financial Expenses, net. Financial
expenses, net increased from $8.9 million in 2004 to $9.2 million in 2005.
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. This increase resulted from interest expenses incurred by
our subsidiaries, and in particular, Matrix, BluePhoenix, Sapiens and Formula
Vision, due to higher interest rates and higher loan balances.

Other Expenses, net. Other expenses, net
in 2005 and 2004 were $820,000 and $332,000, respectively.

Gain
on Realization of Shareholdings. Gain on realization
of shareholdings in 2005 was $4.1 million compared to $8.9 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. In addition, gain on realization
of shareholdings in 2005 included gain of $988,000 of Formula Vision due to a
decrease in its shareholdings in its subsidiary FTS which issued shares to the
public. Gain on realization of shareholdings in 2004 was attributable to the
sale of a portion of the shares of Magic, Matrix and Formula Vision in the open
market which resulted in gain to Formula of $1.1 million, $3.6 million and
$383,000, respectively. In addition, gain on realization of shareholdings in
2004 included gain from realization of unrealized gains in Matrix of $2.8
million and a gain of $651,000 in Formula Vision due to a decrease in its
shareholdings in its subsidiary Babylon.

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Taxes
on Income. Taxes on income in 2005 were $5.2 million
compared to $4.6 million in 2004. The increase in taxes on income in 2005 was
mainly attributable to the increase in taxes of Sapiens which had $1.8 million
of income tax. This increase was partly offset by a decrease in taxes of
Formula Vision.

Companys
Equity in Results of Affiliates, net. Our equity in
losses of affiliates, net were $3.1 million in 2005 compared to $2.5 million in
2004. Our equity in losses of affiliates, net relates primarily to affiliates
of Formula Vision.

Minority
Interest, net. Minority interest, net, includes the
minority interest in companies which are not wholly owned by the Formula Group
during each of the periods indicated. Minority interest in profits of
subsidiaries in 2005 was $1.5 million compared to $2.5 million in 2004. This
decrease in minority interest, net is attributable to the net loss of Sapiens,
Magic and Formula Vision which had net loss of $9.1 million, $4.6 million and
$9.1 million, respectively. These losses were offset by the increase in the net
profit of Matrix which had net income of $11.3 million, and nextSource.

Years
Ended December 31, 2003 and 2004

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

Cost
of Revenues.Cost of revenues increased 24% from
$230.5 million in 2003 to $285.0 million in 2004. As a percentage of revenues,
cost of revenues remained relatively the same in 2003 and 2004. Cost of
revenues for proprietary software solutions increased 37% to $105.4 million in
2004 from $76.9 million in 2003, primarily due to the consolidation of Formula
Vision which had cost of revenues of $31.5 million in 2004. This increase was
slightly offset by a decrease in Sapiens cost of revenues. Cost of revenues
for software services increased 17% from $153.6 million in 2003 to $179.6
million in 2004, primarily due to the increase in the cost of revenues of our
subsidiaries Matrix and nextSource.

Software
Development Costs, net. Software developments costs,
gross, in 2004 and 2003 were $40.4 million and $27.6 million, respectively. In
2004, we capitalized software costs of $15.4 million compared to $10.2 million
in 2003. Capitalization of software costs in 2004 was attributable to our
proprietary software solutions subsidiaries. Software development costs, net,
increased 44% from $17.4 million in 2003 to $25.0 million in 2004. As a
percentage of revenues, software development costs, net increased from 4.7% in
2003 to 5.5% in 2004. The increase in software development costs was attributed
primarily to the consolidation of Formula Vision which had research and
development expenditures of $9.7 million in 2004. The increase was partially
offset by a decrease in the research and development expenditures of Sapiens
and Magic of $1.0 million and $930,000, respectively. Amortization of
capitalized software costs were $10.1 million in 2004 and $8.1 million in 2003,
which amounts were included in cost of revenues.

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

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

Financial
Expenses, net. Financial expenses, net increased 140%
from $3.7 million in 2003 to $8.9 million in 2004. The increase in financial
expenses, net was mainly attributable to the consolidation of Formula Vision
which incurred financial expenses of $3.1 million in 2004, as well as to the
influence of the interest expenses paid on the debentures issued by us to the
public and interest expenses incurred by our subsidiaries, Matrix, Sapiens and
BluePhoenix.

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

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

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

51

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

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

Impact of Inflation
and Currency Fluctuations on Results of Operations

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

|  |                                                                                                           
|- | ----------------------------------------------------------------------------------------------------------
| | that the
  inflation rate in Israel will exceed the NIS devaluation rate against the
  dollar or the euro;
|  |                                                                                                           
| | that the
  devaluation process will lag behind the NIS inflation timing; or                               
|  |                                                                                                           
| | that the
  euro 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$ |  
|                                  |  | %                          |      | %                                      |  | %                                       |  
|2003                              |  |                            | (1.9 | )                                      |  | (7.6                                    | ) |  | (17.0 | ) | 
|2004                              |  |                            | 1.2  |                                        |  | (1.6                                    | ) |  | (7.4  | ) | 
|2005                              |  |                            | 2.4  |                                        |  | 6.8                                     |   |  | 13.3  |   | 

52

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Political, Economic
and Military Conditions in Israel

Our
headquarters and principal research and development facilities are located in
Israel. Although we generate approximately 52% of our revenues from
international markets, we are, nonetheless, directly influenced by the political,
economic and military conditions affecting Israel. The execution of Israels
plan of unilateral disengagement from the Gaza Strip and some parts of the West
Bank and Hamas gaining a majority of the seats on the Palestinian Legislative
Council in the elections held recently in the Palestinian Authority, may affect
Israels security and the stability of the region. Major hostilities involving
Israel or the interruption or curtailment of trade between Israel and its
present trading partners could have a material adverse effect on our business,
operating results and financial condition. Furthermore, several countries
restrict business with Israeli companies. In addition, nonexempt male adult
citizens of Israel, including some of our officers and employees, are obligated
to perform military reserve duty until the age of 40 or 45 depending on their
function in the army, and are subject to being called for active duty under
emergency circumstances. While we have operated effectively under these requirements
since our incorporation, we cannot predict the full impact of such conditions
on us in the future, particularly if emergency circumstances occur. If many of
our employees are called for active duty, our operations in Israel and our
business may be adversely affected.

|   |                                
|-- | -------------------------------
|B. | Liquidity
and Capital Resources

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

Cash

At
December 31, 2005 we had cash and cash equivalents and short-term investments
of $118.0 million and at December 31, 2004, we had cash and cash equivalents
and short-term investments of $146.3 million. At December 31, 2005, we had
indebtedness to banks of $158.2 million, of which $105.4 million was current liabilities
and $52.7 million was long-term liabilities. At December 31, 2004, we had
indebtedness to banks and others of $146.3 million, of which $107.0 million was
current liabilities and $17.8 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 $51.7 million. Formulas loan agreements
contain a number of conditions and limitations on the way in which Formula can
operate its business, including limitations on its ability to raise debt and
sell assets. 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, BluePhoenix and Magic.

53

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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 2005 was $6.3 million compared to cash
flow provided by operating activities of $17.8 million in 2004.

Financing
activities

Cash
flow provided by financing activities in 2005 was $3.2 million compared to cash
flow used in financing activities of $12.1 million in 2004. This was mainly the
result of the following transactions:

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.

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.

54

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

In
March 2004, BluePhoenix completed a $5 million private placement of convertible
debentures and warrants to institutional investors.

Recent
financing activities

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
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.

Investment
activities

Net
cash used in investing activities in 2005 was $23.8 million and in 2004, $17.1
million. These investing activities were comprised of the following
transactions:

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.

In
2005, we converted warrants of Matrix into 5,300,000 shares of Matrix for a
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 in an aggregate
amount of $17.5 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).

55

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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.

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

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

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

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

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

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

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

Recent
investment activities

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.

In
April 2006, Formula Vision paid to FIMI and IDB $5.4 million in connection with
the agreements with FIMI and IDB to purchase from them shares of Transtech held
by them.

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, BluePhoenix and Magic.

56

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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.B. Related Party
TransactionsIndemnification of Office Holders.

Related Party
Transactions

Transactions between Us and Formula
Vision

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

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

In
December 2005, the general meeting of shareholders approved an amendment to the
debentures issued by Formula Vision to Formula in 2001 and 2002, 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. The amendment to the debentures was
made since Formula Vision anticipated that it may not have sufficient liquid
cash assets to satisfy the repayment under the debentures. If Formula Vision would be required to make the
cash repayments under the debentures, it would be forced to sell its assets,
which include securities of its portfolio companies. Selling assets under that
kind of pressure would likely result in lower proceeds for such assets than
otherwise could be obtained if the sale was done at a suitable time in terms of
such asset and the applicable market. Since Formula is the holder of
approximately 57% of the outstanding share capital of Formula Vision,
management believes that it was in our best interests to enable Formula Vision
to maximize the value of its assets and its own overall value. Since our
liquidity is sufficient for our purposes for the foreseeable future, we had the
ability to hold repayments of the debentures until an appropriate selling
opportunity arises. In addition, Formula has a strategic interest in remaining,
indirectly through Formula Vision, a major shareholder in certain of the
portfolio companies of Formula Vision. Therefore, if Formula Vision would be
forced to sell all or a portion of its holdings in such companies in order to
repay the debentures to Formula, our strategic interests would be harmed.

57

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Private
Placement to FIMGold LP

In
February 2005, the general meeting of shareholders approved a private placement
of 2,400,000 ordinary shares issued to FIMGold LP for an aggregate
consideration of $33.0 million. FIMGold LP is an entity owned in equal shares
by Dan Goldstein, our chief executive officer and chairman of the board, and
FIMI Opportunity Fund (which is managed by a company in which our directors,
Ishay Davidi and Yarom Oren serve as officers). Prior to the approval by our
shareholders, the private placement was approved by our audit committe and
board of directors. The purchase price per share in the transaction was $15,
which was the approximate closing price per Formulas share on the NASDAQ
National Market and the TASE on December 28, 2004, the date on which an
agreement in principal was reached. We believe that the price per Formulas
share paid by FIMGold LP in the private placement reflects a fair value of the
shares. We do not believe that the price per share would have been different if
the transaction would have been made with a third party not affiliated with us.

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

Effective Corporate
Tax Rates in Israel

Certain
of the companies in the Formula Group have been granted Approved Enterprise
status under the 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. In addition, our equity in
affiliated companies net income is not subject to tax in Israel. Gains from
changes in holdings in subsidiaries and affiliated companies resulting from
issuances to third parties are also not taxable in Israel. These exemptions
cause our effective tax rate to fluctuate from period to period.

58

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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.

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
2005, we spent $22.4 million on research and development activities, in 2004 we
spent $25.0 million and in 2003 we spent $17.4 million. The decrease in the
amount spent on research and development activities in 2005 compared to 2004
relates primarily to a decrease in research and development expenditures in
Formula Vision. The increase in the amount spent on research and development
activities in 2004 compared to 2003, relates primarily to the consolidation of
Formula Vision which had research and development expenditures of $9.7 million
in 2004. For a description of our research and development activities, see
Item 4.B. Business Overview-Software Development.

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

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

We
have been affected by global economic changes, in particular the sharp decline
in 2001 and 2002, in capital spending in the information technology sector and
the overall business slow-down in North America and Europe, as well as in
Israel. Uncertainties in the North American, European and Israeli markets have
influenced the purchasing patterns of leading software developers who delayed
their planned orders and caused developers to reduce the amount of their
planned license commitment. These changes in purchasing patterns in the IT
industry directly affected the operating results of some of our subsidiaries,
which in turn affected our consolidated operating results. Our revenues
decreased from $402.5 million in 2000 to $387.7 million in 2001 and to $283.3
million in 2002. In the last three years, as a result of a slight recovery of
the market, and the impact of the consolidation of the results of operations of
Sapiens (beginning with 2003) and Formula Vision (beginning with 2004), this
trend changed, and our revenues increased to $366.8 million in 2003, $456.6
million in 2004 and $506.4 million in 2005. We cannot know whether the global
market will recover in the future and how the economic conditions will continue
to affect our business.

59

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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 wether the global market will continue to
recover in the future, and how the economic conditions will continue to affect
our business. We strive to use our best efforts to take advantage of the
current slow-down to prepare our infrastructure to maximize the long-term growth
potential of the software market.

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

We
do not have any off-balance sheet arrangements.

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

The
following table summarizes our contractual obligations and commitments as of
December 31, 2005.

|                                                                             |  |                       |         |           |   |        |  |       |        |         |   |           |  |   |       |  |   |       | 
|---------------------------------------------------------------------------- |  | --------------------- | ------- | --------- | - | ------ |  | ----- | ------ | ------- | - | --------- |  | - | ----- |  | - | ----- | 
|                                                                             |  | Payment due by period |        
|                                                                             |  |                       |        
|                                                                             |  |                       |         |           |   |        |  |       |        | More    |   |           | 
|                                                                             |  |                       |         | Less than |   | 1-3    |  | 3-5   |        | than    |   |           | 
|                                                                             |  | Total                 |         | 1 year    |   | years  |  | years |        | 5 years |   | Other (1) | 
|                                                                             |  |                       |         |           |   |        |  |       |        |         |   |           | 
|                                                                             |  | $ in thousands        |        
|                                                                             |  |                       |        
|Long term debt obligations                                                   |  |                       | 89,331  |           |   | 17,506 |  |       | 46,574 |         |   | 23,490    |  |   | 1,761 |  |   | -     | 
|                                                                             |  |                       |         |           |   |        |  |       |        |         |   |           |  |   |       |  |   |       | 
|Lease obligations                                                            |  |                       | 38,857  |           |   | 13,507 |  |       | 18,386 |         |   | 5,570     |  |   | 1,394 |  |   | -     | 
|                                                                             |  |                       |         |           |   |        |  |       |        |         |   |           |  |   |       |  |   |       | 
|Liability in respect of the acquisition of activities                        |  |                       | 1,761   |           |   | 210    |  |       | 420    |         |   | 420       |  |   | 711   |  |   | -     | 
|                                                                             |  |                       |         |           |   |        |  |       |        |         |   |           |  |   |       |  |   |       | 
|Other long-term liabilities reflected on our balance sheet under U.S.
  GAAP |  |                       | 6,100   |           |   | -      |  |       | -      |         |   | -         |  |   | -     |  |   | 6,100 | 
|                                                                             |  |                       |         |           |   |        |  |       |        |         |   |           |  |   |       |  |   |       | 
|                                                                             |  |                       |         |           |   |        |  |       |        |         |   |           |  |   |       |  |   |       | 
|Total                                                                        |  | $                     | 136,049 |           | $ | 31,223 |  | $     | 65,380 |         | $ | 29,480    |  | $ | 3,866 |  | $ | 6,100 | 
|                                                                             |  |                       |         |           |   |        |  |       |        |         |   |           |  |   |       |  |   |       | 

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

The
safe harbor provided in Section 27A of the Securities Act and Sections 21E of
the Exchange Act shall apply to forward-looking information provided in Items
5.E and F.

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, 2006.

60

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|                          |  |     |  |                                                 
|------------------------- |  | --- |  | ------------------------------------------------
|Name                      |  | Age |  | Position                                        
|                          |  |     |  |                                                 
|Dan
  Goldstein           |  | 52  |  | Chairman of
  the Board, Chief Executive Officer
|Gad
  Goldstein           |  | 47  |  | President,
  Director                           
|Shlomo Nass               |  | 46  |  | Director                                        
|Ishay Davidi              |  | 44  |  | Director                                        
|Yarom Oren                |  | 35  |  | Director                                        
|Gil Weiser
  (1)          |  | 64  |  | Director                                        
|Daphna
  Sharir (1)       |  | 38  |  | Director                                        
|Bruria Gross
  Prushansky |  | 54  |  | Secretary
  and General Counsel                 
|Naamit
  Salomon          |  | 42  |  | Vice
  President, Finance                       

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

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

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

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

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

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

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

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

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

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

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

In
2005, we paid to our directors and officers (nine persons) aggregate direct
remuneration of approximately $931,850. This amount includes amounts set aside
or accrued to provide post-employment benefits.

62

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This
amount does not include the following:

| |   |                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------
| |  | amounts
  expended by us for automobiles made available to our officers;                                                                 
| |   |                                                                                                                                          
| |  | expenses,
  including business travel, professional and business association dues and
  expenses, that we reimburse our officers for; and
| |   |                                                                                                                                          
| |  | other fringe
  benefits that companies in Israel commonly reimburse or pay to their
  officers.                                          

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

Our
employee directors do not receive fees for their services as directors. In
2005, we paid an aggregate amount of $51,166 for post-employment benefits for
our executive officers and directors. Under Israeli law, we are not required to
disclose, and have not otherwise disclosed, the compensation of our senior
management and directors on an individual basis.

In
November 2000, options to purchase 16,000 ordinary shares were granted to
certain of our officers under the 2000 share option plan. No director has been
granted options under this plan. The exercise price of the options was $30.80
per share, indexed to the Israeli CPI. None of these options have been
exercised and they expired in November 2005.

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

|   |                
|-- | ---------------
|C. | Board Practices

Pursuant
to our articles of association, directors are elected at the annual general
meeting of shareholders by a vote of the holders of a majority of the voting
power represented at the meeting. Our board is comprised of 7 persons of which
the following five have been determined by the board to be independent within
the meaning of the applicable NASDAQ requirements: Shlomo Nass, Ishay Davidi,
Yarom Oren, Gil Weiser and Daphna Sharir. The board includes two outside
directors mandated under Israeli law and subject to additional criteria to help
ensure their independence. See Outside Directors below. Each director, except
for the outside directors, holds office until the next annual general meeting
of shareholders. Officers are appointed by our board of directors. For
information regarding the employment agreements of our officers, see Item 6.B.
Compensation.

63

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Outside
Directors

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

|  |                                                                         
|- | ------------------------------------------------------------------------
| | an
  employment relationship;                                           
|  |                                                                         
| | a business
  or professional relationship maintained on a regular basis;
|  |                                                                         
| | control; and                                                            
|  |                                                                         
| | service as
  an office holder.                                          

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 members,
Gil Weiser and Daphna Sharir, are considered to have the required professional
qualifications and Shlomo Nass has 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 February
2005, Ms. Daphna Sharir and Mr. Gil Weiser were appointed as our outside
directors, each to hold office until February 2008.

64

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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 required to have a majority of
independent directors on our board and to maintain an audit committee, at least
three members of which are independent of management. We have established an
audit committee, consisting of the two outside directors, Gil Weiser and Daphna
Sharir, as well as Shlomo Nass. Each audit committee member qualifies as an
independent director under the applicable NASDAQ rules and those of the
Securities and Exchange Commission. The board has determined that Shlomo Nass
is an audit committee financial expert as defined by applicable SEC
regulations. See Item 16A. Audit Committee Financial Expert. As of July 31,
2005, a majority of the members of our board of directors (including all
members of our audit committee) are required to be independent under enhanced
independence NASDAQ rules.

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 2005
was approximately $320,000.

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.

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

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

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

We
have approximately 5,950 full-time employees, of whom approximately 5,150 are
software professionals. In 2004, we had approximately 5,300 full-time
employees, of whom approximately 4,650 were software professionals. In 2003, we
had approximately 3,500 full-time employees, of whom approximately 3,100 were
software professionals. The increase in the number of employees in 2005
compared to 2004 related primarily to the increase in the number of employees
in Matrix, nextSource and in some of the subsidiaries and affiliates of Formula
Vision. The increase in the number of employees in 2004 compared to 2003
relates primarily to the consolidation of Formula Vision and its affiliates,
which employed in the aggregate approximately 1,000 employees. The increase
also stems from an increase in the number of employees of other members of the
group as a result of the growth in their activities, in particular Matrix and
nextSource.

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.

69

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

The
following table presents information regarding the ownership of our ordinary
shares by the persons listed in the table under Directors and Senior Management,
as of June 20, 2006.

|                                                        |  |                           |           |                                                    |  |  |      |   | 
|------------------------------------------------------- |  | ------------------------- | --------- | -------------------------------------------------- |  |  | ---- | - | 
|                                                        |  | Shares beneficially owned |          
|                                                        |  |                           |          
|Name                                                    |  | Number                    |           | Percentage of 
  outstanding 
  ordinary shares(1) | 
|                                                        |  |                           |           |                                                    | 
|Dan
  Goldstein (2)                                     |  |                           | 4,406,271 |                                                    |  |  | 33.4 | % | 
|Gad
  Goldstein                                         |  |                           | 325,000   |                                                    |  |  | 2.5  | % | 
|Ishay Davidi (3)                                        |  |                           |          |                                                    |  |  |     |   | 
|Yarom Oren (4)                                          |  |                           |          |                                                    |  |  |     |   | 
|All
  directors and officers as a group (9 persons) (5) |  |                           | 4,736,521 |                                                    |  |  | 35.9 | % | 

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) | Percentages in the above
  table are based on 13,200,000 ordinary shares outstanding as of June 20,
  2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|(2) | Dan Goldstein holds a 50%
  interest in FIMGold Limited Partnership, which owns approximately 33.3% of
  Formulas outstanding ordinary shares. Dan Goldstein may be deemed to
  beneficially own 4,406,237 of such shares by virtue of shared voting and
  dispositive power pursuant to a shareholders agreement entered between Dan
  Goldstein, through his wholly owned company, Ildani Holdings Ltd., and FIMI
  Opportunity Fund (which is managed by a company in which our directors, Ishay
  Davidi and Yarom Oren serve as officers) with respect to FIMGold Ltd., the
  general partner of FIMGold LP. However, Mr. Goldstein disclaims beneficial
  ownership from one half of such shares. For more information about the
  shareholders agreement, see Item 7.A. Major Shareholders.
|   
|(3) | Ishay Davidi serves
  as chief executive officer of FIMI 2001 Ltd. which is the managing
  general partner of FIMI Opportunity Fund, a party to the shareholders
  agreement described in note (2) above. Accordingly, Ishai Davidi may be
  deemed to beneficially own 4,406,237 shares of Formula by virtue of shared
  voting and dispositive power pursuant to the shareholders agreement described
  above. However, Mr. Davidi disclaims beneficial
  ownership of such shares except to the extent of his pecuniary
  interest in such shares. For more information about the shareholders
  agreement, see Item 7.A. Major Shareholders.                                                                                                                                                   
|   
|(4) | Yarom Oren serves as
  a senior partner of FIMI 2001 Ltd. which is the managing
  general partner of FIMI Opportunity Fund, a party to the shareholders
  agreement described in note (2) above. Accordingly, Yarom Oren may be deemed
  to beneficially own 4,406,237 shares of Formula by virtue of shared voting
  and dispositive power pursuant to the shareholders agreement described
  above. However, Mr. Oren disclaims beneficial ownership of such
  shares except to the extent of his pecuniary interest in such shares.
  For more information about the shareholders agreement, see Item 7.A. Major
  Shareholders.                                                                                                                                                                
|   
|(5) | Each of the directors and
  executive officers not separately identified in the above table beneficially
  owns less than one percent of our outstanding ordinary shares and have
  therefore not been separately disclosed.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

70

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Arrangements Involving the Issue or Grant of
Options to Purchase Shares

The 2000 Share Option Plan

In
November 2000, we adopted a share option plan covering an aggregate of 300,000
ordinary shares to be granted to employees and members of our management. Of
these options, we granted in November 2000, options to purchase 64,500 ordinary
shares to certain of our employees, including options to purchase 16,000 shares
granted to certain of our officers and directors. The exercise price of these
options was $30.8 per share, indexed to the Israeli CPI. The options vested
over a three-year period from the date of grant. None of these options has been
exercised and they expired in November 2005.

Option
Plans of Our Subsidiaries

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

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

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

The
following table presents information regarding the ownership of our ordinary
shares at June 27, 2006 by each person known to us to be the beneficial owner
of more than 5% of our ordinary shares based on information provided to us by
the holders or disclosed in public filings with the Securities and Exchange
Commission. None of the holders of the ordinary shares listed in this table
have voting rights different from other holders of our ordinary shares. Except
where we 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.

|                                               |  |                     |           |            |  |  |      |   | 
|---------------------------------------------- |  | ------------------- | --------- | ---------- |  |  | ---- | - | 
|                                               |  | Shares Beneficially |           | Percent of | 
|Name and
  Address                             |  | Owned               |           | Class (1)  | 
|                                               |  |                     |           |            | 
|                                               |  |                     |           |            |  |  |      |   | 
|FIMGold
  Limited Partnership (2)              |  |                     | 4,406,237 |            |  |  | 33.4 | % | 
|                                               |  |                     |           |            |  |  |      |   | 
|Bank Leumi
  LeIsrael B.M. (3)                |  |                     | 1,243,730 |            |  |  | 9.4  | % | 
|                                               |  |                     |           |            |  |  |      |   | 
|Clal
  Insurance Enterprises Holdings Ltd. (4) |  |                     | 783,466   |            |  |  | 5.9  | % | 

|    |                                                                                                                                                                                                                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(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, 2006, 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, 2006.

71

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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | In March 2005, FIMGold LP
  purchased from Formula in a private placement 2,400,000 ordinary shares.
  FIMGold LP is owned in equal shares by Dan Goldstein, our chief executive
  officer and chairman of the board, and FIMI Opportunity Fund (which is
  managed by a company in which our directors, Ishay Davidi and Yarom Oren
  serve as officers). Concurrently with the closing of the private placement,
  Dan Goldstein sold to FIMGold LP his entire shareholdings in Formula,
  constituting 2,000,000 ordinary shares. Following these transactions, FIMGold
  LP owned 4,400,000 of our ordinary shares, representing approximately 33.3%
  of our outstanding share capital. In connection with the acquisition by
  FIMGold LP of Formulas shares, Dan Goldstein, through his wholly owned
  company, Ildani Holdings Ltd., and FIMI Opportunity Fund, entered into a
  shareholders agreement with respect to FIMGold Ltd., the general partner of
  FIMGold LP, pursuant to which each party has the right to designate one-half
  of the members of the board of directors of FIMGold Ltd. and each resolution
  of the board of directors requires the approval of at least one member designated
  by each party, including resolutions relating to selling, acquiring and
  voting Formulas shares held by FIMGold LP. Notwithstanding the foregoing,
  the shareholders agreement provides that each party has the right to cause
  the sale of up to an aggregate of 20% of the amount of Formulas shares held
  by FIMGold LP without the consent of the other party. Pursuant to the
  shareholders agreement, Formulas shares held by FIMGold LP will be voted for
  the election of two nominees of each party to our board of directors. In
  addition, we granted registration rights to FIMGold LP in respect of
  Formulas shares held by it, on customary terms and conditions.
|   
|(3) | Bank Leumi LeIsrael B.M.
  is publicly traded on the TASE. The major shareholder of Bank Leumi is the
  Government of Israel (11.9%). Each of Shlomo Eliahu Holdings Ltd. and Barnea
  Investees holds a 10% interest in Bank Leumi and Otzar Hityashvut Hayehudim
  holds a 4.9% interest.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|(4) | Clal Insurance Enterprises
  Holdings Ltd. is publicly traded on the TASE. The controlling shareholder of
  Clal Insurance is IDB Development Company Ltd. (51.2%) and Bank Hapoalim Ltd.
  holds a 14.1% interest in Clal Insurance.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

As
of June 20, 2006, 13,200,000 ordinary shares were issued and outstanding,
excluding 24,780 ordinary shares that we purchased during 2002. At that date,
we had approximately 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, 2006, 442,529 ADSs were issued and outstanding pursuant to a
depositary agreement with The Bank of New York, representing 442,529 of our
ordinary shares. As of that date, there were 17 registered holders of ADSs in
the United States.

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

Private
Placement to FIMGold LP

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

72

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

Registration
Rights Agreements

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

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

73

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---



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

Voting
Agreement

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

Transactions
between Formula and Formula Vision

In
connection with the exercise by Formula Vision in Novemebr 2001 of an option to
purchase from Formula its entire interest in Formulas privately held
companies, Formula Vision issued to Formula, in December 2001, a series of
5-year debentures of $58.9 million in the aggregate, linked to the Israeli CPI
and bearing interest at an annual rate of 5%. On March 31, 2002, we lent to
Formula Vision an additional $19.4 million in consideration for a series of
debentures with similar terms of the debentures issued in December 2001. For
more information about the terms of the debentures, see Item 4.A. History and
Development of the Company - Capital Expenditures and Divestitures 
Transactions with Formula Vision.

In
January 2004, Formula Vision issued to Formula 38,000,000 shares representing
59.4% of Formula Visions outstanding share capital in exchange for $35 million
of the amount of the debentures. The 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.

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. For more information
about the reasons for the amendment of the debentures, see Item 5.B. Liquidity
and Capital Resources - Related Party Transactions - Transactions between Us
and Formula Vision.

74

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---



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:

| |       |                                                                                                                                                                                                    
| | ----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (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.                                                                                                                                                       

75

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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
2005 was approximately $320,000.

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.

ITEM 8. FINANCIAL INFORMATION

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

Financial
Statements

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

Legal
Proceedings

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

76

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---



In
July 2003, a former Liraz shareholder filed an application with the Tel Aviv
Jaffa District Court to approve a claim filed by him against BluePhoenix, as a
class action. The claim relates to the acquisition of Liraz shares, which
BluePhoenix completed in March 2003. The shareholder alleges that the share price
BluePhoenix paid to Lirazs shareholders in the tender offer and in a
subsequent mandatory purchase was lower than the fair price of Liraz shares.
The maximum amount of the claim is approximately $5.8 million in the aggregate.
In the lawsuit, the plaintiff has applied for the courts approval to represent
all of the shareholders of Liraz who sold their shareholdings pursuant to the
tender offer and the mandatory acquisition. At a preliminary hearing held on June 7,
2006, the court decided to address the application for approval of the claim as
a class action only after all of the interim applications on other related
matters are resolved. As of the date of the annual report, no additional
hearing has been scheduled. 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
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 new 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.

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

Except
as otherwise disclosed in this annual report, there has been no material change
in our financial position since December 31, 2005.

ITEM 9. THE OFFER AND LISTING

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

Price
Range of Ordinary Shares

The
following table shows the high and low closing price for our ordinary shares on
the TASE, for the periods indicated. The exchange rate reported by the Bank of
Israel on June 20, 2006 was NIS 4.458 = $1.00.

77

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|                       |  |                         |       |     |  |       |       |  | 
|---------------------- |  | ----------------------- | ----- | --- |  | ----- | ----- |  | 
|                       |  | Closing Price Per Share |      
|                       |  |                         |      
|                       |  | in NIS                  |      
|Calendar
  Period      |  | High                    |       | Low | 
|                       |  |                         |       |     | 
|2001                   |  | 151.30                  |       |     |  | 48.11 |       | 
|2002                   |  |                         | 75.80 |     |  |       | 40.12 |  | 
|2003                   |  |                         | 79.40 |     |  |       | 34.03 |  | 
|2004                   |  |                         |       |     |  |       |       |  | 
|First Quarter          |  |                         | 98.40 |     |  |       | 77.30 |  | 
|Second Quarter         |  |                         | 94.70 |     |  |       | 80.80 |  | 
|Third Quarter          |  |                         | 91.07 |     |  |       | 61.83 |  | 
|Fourth Quarter         |  |                         | 74.77 |     |  |       | 62.21 |  | 
|2005                   |  |                         |       |     |  |       |       |  | 
|First Quarter          |  |                         | 89.65 |     |  |       | 74.75 |  | 
|Second Quarter         |  |                         | 85.53 |     |  |       | 51.10 |  | 
|Third Quarter          |  |                         | 59.40 |     |  |       | 49.41 |  | 
|Fourth Quarter         |  |                         | 53.50 |     |  |       | 46.84 |  | 
|2006                   |  |                         |       |     |  |       |       |  | 
|First Quarter          |  |                         | 60.15 |     |  |       | 46.00 |  | 
|January                |  |                         | 50.92 |     |  |       | 46.93 |  | 
|February               |  |                         | 49.82 |     |  |       | 46.74 |  | 
|March                  |  |                         | 49.95 |     |  |       | 47.36 |  | 
|April                  |  |                         | 57.11 |     |  |       | 46.00 |  | 
|May                    |  |                         | 60.15 |     |  |       | 52.88 |  | 
|June (through June 20) |  |                         | 56.17 |     |  |       | 49.19 |  | 

Price
Range of American Depositary Shares

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

|                       |  |                         |       |     |  |  |       |  | 
|---------------------- |  | ----------------------- | ----- | --- |  |  | ----- |  | 
|                       |  | Closing Price Per Share |      
|                       |  |                         |      
|                       |  | in $                    |      
|Calendar
  Period      |  | High                    |       | Low | 
|                       |  |                         |       |     | 
|2001                   |  |                         | 38.00 |     |  |  | 11.25 |  | 
|2002                   |  |                         | 16.92 |     |  |  | 8.16  |  | 
|2003                   |  |                         | 18.05 |     |  |  | 6.71  |  | 
|2004                   |  |                         |       |     |  |  |       |  | 
|First Quarter          |  |                         | 22.08 |     |  |  | 16.61 |  | 
|Second Quarter         |  |                         | 20.61 |     |  |  | 17.33 |  | 
|Third Quarter          |  |                         | 20.00 |     |  |  | 13.44 |  | 
|Fourth Quarter         |  |                         | 17.57 |     |  |  | 14.40 |  | 
|2005                   |  |                         |       |     |  |  |       |  | 
|First Quarter          |  |                         | 20.44 |     |  |  | 16.92 |  | 
|Second Quarter         |  |                         | 11.34 |     |  |  | 19.95 |  | 
|Third Quarter          |  |                         | 10.90 |     |  |  | 13.38 |  | 
|Fourth Quarter         |  |                         | 9.95  |     |  |  | 11.00 |  | 
|2006                   |  |                         |       |     |  |  |       |  | 
|First Quarter          |  |                         | 11.38 |     |  |  | 9.80  |  | 
|January                |  |                         | 11.38 |     |  |  | 10.00 |  | 
|February               |  |                         | 10.98 |     |  |  | 9.80  |  | 
|March                  |  |                         | 10.96 |     |  |  | 10.01 |  | 
|April                  |  |                         | 13.24 |     |  |  | 10.00 |  | 
|May                    |  |                         | 13.50 |     |  |  | 11.16 |  | 
|June (through June 20) |  |                         | 12.57 |     |  |  | 10.66 |  | 

78

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|                  |                       
|----------------- | ----------------------
|B.                | Plan of
  Distribution
|                  |                       
|Not
  applicable.
|                 
|C.                | Markets               

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

|                  |                      
|----------------- | ---------------------
|D.                | Selling Shareholders 
|                  |                      
|Not
  applicable.
|                 
|E.                | Dilution             
|                  |                      
|Not applicable.  
|                 
|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.                                                    

79

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Description
of Our Share Capital

Our
company share capital consists of ordinary shares. Our articles of association
do not restrict in any way the ownership of our ordinary shares by
non-residents, except that these restrictions may exist with respect to
citizens of countries which are in a state of war with Israel.

Dividend
and Liquidation Rights

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

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.

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

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

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

A
shareholder has the general duty to refrain from depriving rights of other
shareholders. Any controlling shareholder, any shareholder who knows that it
possesses the power to determine the outcome of a shareholder vote and any
shareholder that, under the provisions of the articles of association, has the
power to appoint an office holder in the company, is under a duty to act in
fairness towards the company. The 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 private placement completed in March 2005, and the transactions
with Formula Vision as material contracts. For a summary of the terms of these
contracts, see Item 4.A. Information on the Company  Capital Expenditures and
Divestitures.

|   |                  
|-- | -----------------
|D. | Exchange Controls

Under
current Israeli regulations, we may pay dividends or other distributions in
respect of our ordinary shares either in non-Israeli or Israeli currencies. If
we make these payments in Israeli currency, they will be freely transferred in
non-Israeli currencies at the rate of exchange prevailing at the time of
conversion. We expect therefore, that dividends, if any, that we pay to holders
of ADSs, will be paid in dollars, net of conversion expenses of the depositary,
the Bank of New York and Israeli income taxes. Because exchange rates between
the NIS and the dollar fluctuate continuously, a U.S. shareholder will be
subject to the risk of currency fluctuations between the date when we declare
NIS-denominated dividends and the date when we pay them in NIS. See Item 3.D.
Risk Factors.

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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.

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.

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

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

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

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

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

Taxation 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%), provided that
such dividends meet the requirements of qualified dividend income. Dividends
that fail to meet such requirements, and dividends received by corporate United
States holders, are taxed at ordinary income rates. No dividend received by a
United States holder will be a qualified dividend (1) if the United States
holder held the ordinary share or ADS with respect to which the dividend was
paid for less than 61 days during the 121-day period beginning on the date that
is 60 days before the ex-dividend date with respect to such dividend, excluding
for this purpose, under the rules of Code section 246(c), any period during
which the United States holder has an option to sell, is under a contractual
obligation to sell, has made and not closed a short sale of, is the grantor of
a deep-in-the-money or otherwise nonqualified option to buy, or has otherwise
diminished its risk of loss by holding other positions with respect to, such
ordinary share or ADS (or substantially identical securities); or (2) to
the extent that the United States holder is under an obligation (pursuant to a
short sale or otherwise) to make related payments with respect to positions in
property substantially similar or related to the ordinary share or ADS with
respect to which the dividend is paid. If we were to be a passive foreign investment company (as such term
isare defined in the Code) for any year, dividends paid on our ordinary shares
or ADSs in such year or in the following year would not be qualified dividends.
In addition, a non-corporate United States holder will be able to take a
qualified dividend into account in determining its deductible investment
interest (which is generally limited to its net investment income) only if it
elects to do; in such case the dividend will be taxed at ordinary income rates.

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

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

Subject
to the limitations set forth in the Code and the Treasury regulations
thereunder, United States holders may elect to claim as a foreign tax credit
against their United States federal income tax liability the Israeli income tax
withheld from dividends received in respect of the ordinary shares or ADSs. The
limitations on claiming a foreign tax credit include, among others, computation
rules under which foreign tax credits allowable with respect to specific
classes of income cannot exceed the United States federal income taxes
otherwise payable with respect to each such class of income. In this regard,
dividends paid by us will be foreign source passive income for U.S. foreign
tax credit purposes or, in the case of a financial services entity, financial
services income (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 will be foreign source passive income for United States foreign tax
credit purposes.

Taxation of Disposition
of the Ordinary Shares or ADSs

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

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A
United States holder that uses the cash method of accounting calculates the
dollar value of the proceeds received on the sale as of the date that the sale
settles. However, a United States holder that uses the accrual method of
accounting is required to calculate the value of the proceeds of the sale as of
the trade date and may therefore realize foreign currency gain or loss. A
United States holder 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.

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 Internal Revenue Service. The QEF election is made by
  attaching a completed Internal Revenue Service Form 8621, including the PFIC
  annual information statement, to a timely filed United States federal income
  tax return. Even if a QEF election is not made, a U.S. person who is a
  shareholder in a PFIC must file a completed Internal Revenue Service Form
  8621 every year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  
| |   | If a QEF election is made after the first taxable year in which a
  United States holder holds our ordinary shares or ADSs and we are a PFIC,
  then special rules would apply.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | A second
  regime, the mark-to-market regime, may be elected so long as our ordinary
  shares or ADSs are publicly traded. Pursuant to this regime, an electing
  United States holders ordinary shares or ADSs are marked-to-market each year
  and the United States holder recognizes as
  ordinary income or loss an amount equal to the difference as of the close of the taxable year between the fair market value
  of our ordinary shares or ADSs and the United States holders adjusted tax
  basis therein. Losses are allowed only to the extent of net mark-to-market gain
  previously included by the United States holder under the election for prior
  taxable years. An electing United States holders adjusted basis in our
  ordinary shares or ADSs is increased by income recognized under the
  mark-to-market election and decreased by the deductions allowed under the
  election.                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |   | Under the mark-to-market election, gain on the sale of our ordinary
  shares or ADSs is treated as ordinary income, and loss on the sale of our
  ordinary shares or ADSs, to the extent the amount of loss does not exceed the
  net mark-to-market gain previously included, is treated as ordinary loss. The
  mark-to-market election applies to the tax year for which the election is
  made and all later tax years, unless the ordinary shares or ADSs cease to be
  marketable or the Internal Revenue Service consents to the revocation of the
  election.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  
| |   | If the mark-to-market election is made after the first taxable year
  in which a United States holder holds our ordinary shares or ADSs and we are
  a PFIC, then special rules would apply.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | A United
  States holder making neither the QEF election nor the mark-to-market election
  is subject to the excess distribution regime. Under this regime, excess
  distributions are subject to special tax rules. An excess distribution is either
  (1) a distribution with respect to ordinary shares or ADSs that is greater
  than 125% of the average distributions received by the United States holder
  from us over the shorter of either the preceding three years or such United
  States holders holding period for our ordinary shares or ADSs, or (2) 100%
  of the gain from the disposition of our ordinary shares or ADSs (including
  gain deemed recognized if the ordinary shares or ADSs are used as security
  for a loan).                                                                                                                                                                                                                                                                                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |   | Excess distributions must be allocated ratably to each day that a
  United States holder has held our ordinary shares or ADSs. A United States
  holder must include amounts allocated to the current taxable year and to any
  period prior to the first day of the first taxable year for which we are a
  PFIC in its gross income as ordinary income for the current taxable year. All
  amounts allocated to other years of the United States holder would be taxed
  at the highest tax rate for each such prior year applicable to ordinary
  income. The United States holder also would be liable for interest on the
  deferred tax liability for each such other year calculated as if such
  liability had been due with respect to each such other year. A United States
  holder that is an individual is not allowed a deduction for interest on the
  deferred tax liability. The portions of distributions that are not
  characterized as excess distributions are subject to tax in the current
  year under the normal tax rules of the Code.

90

---

---



| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | A United
  States person who inherits shares or ADSs in a foreign corporation that was a
  PFIC in the hands of the decedent (who was not a nonresident alien and did
  not make either of the elections described above), is denied the otherwise
  available step-up in the tax basis of such shares or ADSs to fair market
  value at the date of death. The U.S. person steps into the shoes of the
  decedent and will be subject to the rules described above.

We
believe that in 2005 we were not a PFIC and currently we expect that we will
not be a PFIC in 2006. However, PFIC status is determined as of the end of the
taxable year and is dependent on a number of factors, including the value of
our assets and the amount and type of our gross income. Therefore, there can be
no assurance that we will not become a PFIC for the current fiscal year ending
December 31, 2006 or in a future year. We will notify United States holders in
the event we conclude that we will be treated as a PFIC for any taxable year to
enable United States holders to consider whether or not to elect to treat us as
a QEF for United States federal income tax purposes or to mark to market the
ordinary shares or ADSs or to become subject to the excess distribution
regime.

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

Information Reporting and Backup Withholding

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

Non-United States holders of Ordinary Shares
or ADSs

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

91

---

---



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

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

|   |                           
|-- | --------------------------
|F. | Dividend and Paying Agents

Not
applicable.

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

Not
applicable.

92

---

---



|   |                     
|-- | --------------------
|H. | Documents On Display

Formula is
subject to the reporting requirements of the Securities Exchange Act of 1934,
as amended, or 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 public reference facilities maintained
by the SEC, 100 F Street, N.E., Washington, D.C. 20549. You may also obtain
copies of such material from the SEC at prescribed rates by writing to the
Public Reference Section of the SEC, 100 F Street, N.E., Washington, D.C.
20549. Please call the SEC at 1-800-SEC-0330 for further information on the
public reference room.

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

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

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.

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

93

---

---



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

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

Fluctuations in Market Price of Securities We
Hold

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

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN
EQUITY SECURITIES.

Not
applicable.

P A R T II


===========


ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND
DELINQUENCIES.

Not
applicable.

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

Not
applicable.

ITEM 15. CONTROLS AND PROCEDURES

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

94

---

---



(b)
Not applicable.

(c)
Not applicable.

(d)
Changes in Internal Control Over Financial
Reporting. There have been no changes in our internal control over
financial reporting that occured during the the year ended December 31, 2005,
that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.

ITEM 16. [RESERVED]

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

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

ITEM 16B. CODE OF ETHICS

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

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND
SERVICES

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

Our audit committee is responsible for the
oversight of our independent auditors work. The audit committees policy is to
pre-approve all audit and non-audit services provided by Ziv Haft 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.

95

---

---



Principal Accountant
Fees and Services

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

|                     |  |                  |       |      |  |     | 
|-------------------- |  | ---------------- | ----- | ---- |  | --- | 
|                     |  | 2005             |       | 2004 | 
|                     |  |                  |       |      | 
|                     |  | ($ in thousands) |      
|Audit Fees           |  |                  | 863   |      |  | 723 | 
|Audit-Related
  Fees |  |                  | 305   |      |  | 120 | 
|Tax Fees             |  |                  | 184   |      |  | 92  | 
|All Other
  Fees     |  |                  |      |      |  |    | 
|                     |  |                  |       |      | 
|Total                |  |                  | 1,352 |      |  | 935 | 
|                     |  |                  |       |      |  |     | 

The
audit fees for the years ended December 31, 2005 and 2004 were for professional
services rendered for the audits of our annual consolidated financial
statements, review of our consolidated quarterly financial statements,
statutory audits of Formula and certain subsidiaries, issuance of comfort
letters, consents and assistance with review of documents filed with the SEC.

The
audit-related fees for the years ended December 31, 2004 were incurred by one
of our subsidiaries for assurance and related services related to accounting
consultations and audits in connection with acquisitions, issuance of
convertible debentures and warrants and review of a registration statement by
the SEC. The audit-related fees for the year ended December 31, 2005 were
incurred by two of our subsidiaries in connection with a public offering and
audits in connection with acquisitions.

Tax
fees for the years ended December 31, 2005 and 2004 were for services related
to tax compliance, including the preparation of tax returns and claims for
refund, and tax advice.

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

Not
applicable.

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

Not applicable.

96

---

---



PART III


===========


ITEM 17. FINANCIAL STATEMENTS

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

ITEM 18. FINANCIAL STATEMENTS

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

ITEM 19. EXHIBITS

|            |  |                                                                                                                                                                      
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                      
|            |  |                                                                                                                                                                      
|            |  |                                                                                                                                                                      
|1.1         |  | Memorandum
  of Association*                                                                                                                                         
|            |  |                                                                                                                                                                      
|1.2         |  | Articles of
  Association as amended on December 28, 2005                                                                                                            
|            |  |                                                                                                                                                                      
|2           |  | The
  description of terms of debentures issued by the Registrant in May 2002,
  contained in Section 2.3 of the prospectus of the Registrant dated May 23,
  2002 **
|            |  |                                                                                                                                                                      
|4.1         |  | Share
  Purchase Agreement dated February 16, 2005 between the Registrant and FIMGold
  LP***                                                                        
|            |  |                                                                                                                                                                      
|4.2         |  | Registration
  Rights Agreement dated March 3, 2005 between the Registrant and FIMGold LP***                                                                         
|            |  |                                                                                                                                                                      
|4.3         |  | Form of
  Letter of Indemnification, dated December 28, 2005                                                                                                         
|            |  |                                                                                                                                                                      
|4.4         |  | Agreement
  dated December 30, 2001 between the Registrant and Formula Vision
  Technologies (F.V.T.) Ltd. (English summary accompanied by Hebrew
  original)****    
|            |  |                                                                                                                                                                      
|4.5         |  | Agreement dated
  December 15, 2003 between the Registrant and Formula Vision Technologies
  (F.V.T.)Ltd. *****                                                      
|            |  |                                                                                                                                                                      
|4.6         |  | An agreement
  dated November 17, 2005 between the Registrant and Formula Vision
  Technologies (F.V.T) Ltd. (English translation from Hebrew original)              

97

---

---



|            |  |                                                                                                                                                
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                
|            |  |                                                                                                                                                
|            |  |                                                                                                                                                
|8           |  | List of
  Subsidiaries                                                                                                                         
|            |  |                                                                                                                                                
|12.1        |  | Certification
  of the Chief Executive Officer pursuant to §302 of the Sarbanes-Oxley Act                                                      
|            |  |                                                                                                                                                
|12.2        |  | Certification
  of the Principal Financial Officer pursuant to §302 of the Sarbanes-Oxley Act                                                  
|            |  |                                                                                                                                                
|13.1        |  | Certification
  of the Chief Executive Officer pursuant to 18 U.S.C. sec. 1350, as adopted
  pursuant to sec. 906 of the Sarbanes-Oxley Act    
|            |  |                                                                                                                                                
|13.2        |  | Certification
  of the Principal Financial Officer pursuant to 18 U.S.C. sec. 1350, as
  adopted pursuant to sec. 906 of the Sarbanes-Oxley Act

|                                                                                                                                                                         
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                         
|*
  Incorporated by reference to the Registration Statement on Form F-1 (File No.
  333-8858).                                                                           
|                                                                                                                                                                         
|**
  Incorporated by reference to the Form 6-K filed with the Securities and
  Exchange Commission on June 14, 2002.                                                     
|                                                                                                                                                                         
|***
  Incorporated by reference to the Annual Report on Form 20-F filed with the
  Securities and Exchange Commission on June 30, 2005 as amended on December
  20, 2005.
|                                                                                                                                                                         
|****
  Incorporated by reference to the Annual Report on Form 20-F filed with the Securities
  and Exchange Commission on June 28, 2002.                                 
|                                                                                                                                                                         
|*****
  Incorporated by reference to the Annual Report on Form 20-F filed with the
  Securities and Exchange Commission on June 30, 2004.                                

98

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli corporation)

2005 Annual Report

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

2005
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-9  
|                                                         |          
|Notes to Financial Statements                            | F-10-F-63

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, 2005 and 2004 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, 2005. 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
22.27% and 26.86% of total consolidated assets as of December 31, 2005 and 2004,
respectively, and whose consolidated revenues constitute approximately 24.42%, 28.58% and
31.82% of total consolidated revenues for the years ended December 31, 2005, 2004 and
2003, respectively. We did not audit the financial statements of certain affiliated
companies. 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, 2005 and 2004, and the related consolidated results of operations and cash
flows for each of the three years in the period ended December 31, 2005, in conformity
with generally accepted accounting principles as applied in the United States of America.

Tel-Aviv, IsraelJune 29, 2006

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

F-1

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

CONSOLIDATED BALANCE SHEETS

|                                                                                                                                 |  |                       |         |      |  |         | 
|-------------------------------------------------------------------------------------------------------------------------------- |  | --------------------- | ------- | ---- |  | ------- | 
|                                                                                                                                 |  | December 31,          |        
|                                                                                                                                 |  |                       |        
|                                                                                                                                 |  | 2005                  |         | 2004 | 
|                                                                                                                                 |  |                       |         |      | 
|                                                                                                                                 |  | (U.S. $ in thousands) |        
|                                                                                                                                 |  |                       |        
|                                                                                                                                 |  |                       |         |      |  |         | 
|ASSETS                                                                                                                           |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|CURRENT ASSETS:                                                                                                                  |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|Cash and cash equivalents                                                                                                        |  |                       | 81,767  |      |  | 107,174 | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|Short-term investments (Note 3)                                                                                                  |  |                       | 36,185  |      |  | 39,073  | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|Trade receivables (net of allowances for
  doubtful debts of $6,630 and $5,988 as of December 31, 2005 and 2004,
  respectively) |  |                       | 133,390 |      |  | 114,533 | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|Other current assets (Note 16A)                                                                                                  |  |                       | 24,770  |      |  | 26,105  | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|Inventories                                                                                                                      |  |                       | 3,808   |      |  | 4,668   | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       | 279,920 |      |  | 291,553 | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|LONG-TERM INVESTMENTS,
  LOANS AND RECEIVABLES:                                                                                  |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|Loans and other investments (Note 4)                                                                                             |  |                       | 3,091   |      |  | 5,247   | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|Investments in affiliates (Note 5)                                                                                               |  |                       | 20,257  |      |  | 24,389  | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       | 23,348  |      |  | 29,636  | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|SEVERANCE PAY FUND                                                                                                               |  |                       | 33,627  |      |  | 31,943  | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|PROPERTY AND EQUIPMENT,
  NET (Note 6)                                                                                           |  |                       | 23,485  |      |  | 26,529  | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|GOODWILL
  (Note 1I and Note 7)                                                                                                  |  |                       | 200,038 |      |  | 196,921 | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|OTHER ASSETS, NET (Note
  8)                                                                                                     |  |                       | 69,667  |      |  | 64,438  | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       |         |      |  |         | 
|                                                                                                                                 |  |                       | 630,085 |      |  | 641,020 | 
|                                                                                                                                 |  |                       |         |      |  |         | 

F-2

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli
Corporation)


|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------- | ------- | ---- |  | ------- | -
|                                                                                                                                                                                        |  | December 31,          |        
|                                                                                                                                                                                        |  |                       |        
|                                                                                                                                                                                        |  | 2005                  |         | 2004 | 
|                                                                                                                                                                                        |  |                       |         |      | 
|                                                                                                                                                                                        |  | (U.S. $ in thousands) |        
|                                                                                                                                                                                        |  |                       |        
|                                                                                                                                                                                        |  |                       |        
|LIABILITIES AND
  SHAREHOLDERS EQUITY                                                                                                                                                  |  |                       |         |      |  |         |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|CURRENT LIABILITIES:                                                                                                                                                                    |  |                       |         |      |  |         |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Liabilities to banks and others (Notes 10B
  and 16B)                                                                                                                                   |  |                       | 105,420 |      |  | 104,975 |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Trade payables                                                                                                                                                                          |  |                       | 47,534  |      |  | 41,605  |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Other accounts payable (Note 16C)                                                                                                                                                       |  |                       | 74,765  |      |  | 81,105  |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Debentures (Note 9)                                                                                                                                                                     |  |                       | 8,004   |      |  | 32,374  |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Customer advances, net of work in
progress                                                                                                                                              |  |                       | 7,309   |      |  | 6,900   |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|                                                                                                                                                                                        |  |                       | 243,032 |      |  | 266,959 |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|LONG-TERM LIABILITIES:                                                                                                                                                                  |  |                       |         |      |  |         |  
|                                                                                                                                                                                       
|Debentures (Note 11)                                                                                                                                                                    |  |                       | 16,809  |      |  | 27,086  |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Provision for losses in formerly owned
  investee                                                                                                                                       |  |                       | 1,971   |      |  | 1,971   |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Deferred taxes                                                                                                                                                                          |  |                       | 1,282   |      |  | 958     |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Customer advances                                                                                                                                                                       |  |                       | 645     |      |  | 1,114   |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Liabilities to banks and others (Note 10)                                                                                                                                               |  |                       | 52,732  |      |  | 19,789  |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Liability in respect of the acquisition of
  activities                                                                                                                                 |  |                       | 1,761   |      |  | 2,036   |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Accrued severance pay                                                                                                                                                                   |  |                       | 39,727  |      |  | 37,750  |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|                                                                                                                                                                                        |  |                       | 114,927 |      |  | 90,704  |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|MINORITY INTEREST                                                                                                                                                                       |  |                       | 108,681 |      |  | 96,579  |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|COMMITMENTS AND
  CONTINGENCIES (Note 13)                                                                                                                                               |  |                       |         |      |  |         |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|SHAREHOLDERS EQUITY
  (Note 14):                                                                                                                                                       |  |                       |         |      |  |         |  
|                                                                                                                                                                                       
|Share capital - ordinary
shares of NIS 1 par value (authorized - December 31, 2005 and 2004 - 25,000,000 shares;
  issued: December 31, 2005 - 13,224,780 and 2004 - 10,824,780 shares) |  |                       | 3,736   |      |  | 3,215   |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Additional paid-in capital                                                                                                                                                              |  |                       | 132,487 |      |  | 99,535  |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Retained earnings                                                                                                                                                                       |  |                       | 49,164  |      |  | 99,166  |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Accumulated other comprehensive loss                                                                                                                                                    |  |                       | (21,683 | )    |  | (14,879 | )
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|                                                                                                                                                                                        |  |                       | 163,704 |      |  | 187,037 |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Cost of 24,780 treasury shares                                                                                                                                                          |  |                       | (259    | )    |  | (259    | )
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|Total shareholders equity                                                                                                                                                              |  |                       | 163,445 |      |  | 186,778 |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  
|                                                                                                                                                                                        |  |                       | 630,085 |      |  | 641,020 |  
|                                                                                                                                                                                        |  |                       |         |      |  |         |  

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,                         |        
|                                                          |  |                                                 |        
|                                                          |  | 2005                                            |         | 2004 |  | 2003    |  
|                                                          |  |                                                 |         |      |  |         |  
|                                                          |  | (U.S. $ in thousands, except per share amounts) |        
|                                                          |  |                                                 |        
|Revenues
  (Note 16I(2))                                  |  |                                                 |         |      |  |         |   |  |         |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Proprietary
  software products                           |  |                                                 | 231,470 |      |  | 229,348 |   |  | 170,048 |  
|Software
  services                                       |  |                                                 | 274,901 |      |  | 227,262 |   |  | 196,782 |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Total
  revenues                                          |  |                                                 | 506,371 |      |  | 456,610 |   |  | 366,830 |  
|Cost of
  revenues                                        |  |                                                 |         |      |  |         |   |  |         |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Proprietary
  software products                           |  |                                                 | 113,378 |      |  | 105,394 |   |  | 76,862  |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Software
  services                                       |  |                                                 | 220,158 |      |  | 179,567 |   |  | 153,638 |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Total cost
  of revenues                                  |  |                                                 | 333,536 |      |  | 284,961 |   |  | 230,500 |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Gross profit                                              |  |                                                 | 172,835 |      |  | 171,649 |   |  | 136,330 |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Research and
  development costs, net                     |  |                                                 | 22,429  |      |  | 25,036  |   |  | 17,368  |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Selling,
  general and administrative expenses            |  |                                                 | 133,049 |      |  | 128,537 |   |  | 107,103 |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Restructuring
  and non-recurring costs (Note 16D)        |  |                                                 | 1,455   |      |  | -       |   |  | -       |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Operating income                                          |  |                                                 | 15,902  |      |  | 18,076  |   |  | 11,859  |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Financial
  expenses, net (Note 16E)                      |  |                                                 | (9,206  | )    |  | (8,904  | ) |  | (3,676  | )
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Gain on
  realization of shareholdings, net (Note 16G)    |  |                                                 | 4,107   |      |  | 8,893   |   |  | 2,756   |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Other
  expenses, net (Note 16F)                          |  |                                                 | (820    | )    |  | (332    | ) |  | (90     | )
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Income before taxes on income                             |  |                                                 | 9,983   |      |  | 17,733  |   |  | 10,849  |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Taxes on
  income (Note 15)                               |  |                                                 | 5,200   |      |  | 4,631   |   |  | 2,540   |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|                                                          |  |                                                 | 4,783   |      |  | 13,102  |   |  | 8,309   |  
|                                                         
|Equity in
  losses of affiliated companies, net           |  |                                                 | (3,109  | )    |  | (2,523  | ) |  | (1,071  | )
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Minority
  interest in earnings of subsidiaries, net      |  |                                                 | (1,491  | )    |  | (2,480  | ) |  | (4,118  | )
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Net income                                                |  |                                                 | 183     |      |  | 8,099   |   |  | 3,120   |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Earnings per share (Note 16J):                            |  |                                                 |         |      |  |         |   |  |         |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Basic                                                     |  |                                                 | 0.01    |      |  | 0.73    |   |  | 0.29    |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Diluted                                                   |  |                                                 | 0.01    |      |  | 0.65    |   |  | 0.24    |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Weighted average number of shares outstanding (Note 16J): |  |                                                 |         |      |  |         |   |  |         |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Basic                                                     |  |                                                 | 12,800  |      |  | 10,800  |   |  | 10,037  |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  
|Diluted                                                   |  |                                                 | 12,800  |      |  | 10,800  |   |  | 10,285  |  
|                                                          |  |                                                 |         |      |  |         |   |  |         |  

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                    |            |                                |  |       |                     |  |                                        |  |                             |         |      
|                                                                                           |  |                                  |            | Additional
  paid-in
  Capital |  |       |                     |  |                                        |  |                             |         |      
|                                                                                           |  | Number of
  Shares               |            | Amount                         |  |       | 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, 2003                                                              |  |                                  | 10,000,000 |                                |  | 3,101 |                     |  | 89,396                                 |  |                             | 87,947  |       | (23,697 | ) |  | (3,398 | ) |  | 153,349 |  
|Changes during 2003:                                                                       |  |                                  |            |                                |  |       |                     |  |                                        |  |                             |         |       |         |   |  |        |   |  |         |   | 
|Net Income                                                                                 |  |                                  | -          |                                |  | -     |                     |  | -                                      |  |                             | 3,120   |       | -       |   |  | -      |   |  | 3,120   |  
|Currency translation adjustments                                                           |  |                                  | -          |                                |  | -     |                     |  | -                                      |  |                             | -       |       | 6,403   |   |  | -      |   |  | 6,403   |  
|                                                                                           |  |                                  |            |                                |  |       |                     |  |                                        |  |                             |         |       |         |   |  |        |   |  |         |   | 
|Total comprehensive income                                                                 |  |                                  | -          |                                |  | -     |                     |  | -                                      |  |                             | -       |       | -       |   |  | -      |   |  | 9,523   |  
|Deferred compensation                                                                      |  |                                  | -          |                                |  | -     |                     |  | 406                                    |  |                             | -       |       | -       |   |  | -      |   |  | 406     |  
|Proceeds from sale of treasury stock                                                       |  |                                  | 300,000    |                                |  | -     |                     |  | 1,657                                  |  |                             | -       |       | -       |   |  | 3,139  |   |  | 4,796   |  
|Exercise of share options                                                                  |  |                                  | 500,000    |                                |  | 114   |                     |  | 7,816                                  |  |                             | -       |       | -       |   |  | -      |   |  | 7,930   |  
|                                                                                           |  |                                  |            |                                |  |       |                     |  |                                        |  |                             |         |       |         |   |  |        |   |  |         |   | 
|Balance as of December 31, 2003                                                            |  |                                  | 10,800,000 |                                |  | 3,215 |                     |  | 99,275                                 |  |                             | 91,067  |       | (17,294 | ) |  | (259   | ) |  | 176,004 |  
|Changes during 2004:                                                                       |  |                                  |            |                                |  |       |                     |  |                                        |  |                             |         |       |         |   |  |        |   |  |         |   | 
|Net Income                                                                                 |  |                                  | -          |                                |  | -     |                     |  | -                                      |  |                             | 8,099   |       | -       |   |  | -      |   |  | 8,099   |  
|Unrealized gains from available-for-sale
securities, net                                   |  |                                  | -          |                                |  | -     |                     |  | -                                      |  |                             | -       |       | (50     | ) |  | -      |   |  | (50     | )
|Currency translation adjustments                                                           |  |                                  | -          |                                |  | -     |                     |  | -                                      |  |                             | -       |       | 2,465   |   |  | -      |   |  | 2,465   |  
|                                                                                           |  |                                  |            |                                |  |       |                     |  |                                        |  |                             |         |       |         |   |  |        |   |  |         |   | 
|Total comprehensive income                                                                 |  |                                  | -          |                                |  | -     |                     |  | -                                      |  |                             | -       |       | -       |   |  | -      |   |  | 10,514  |  
|Beneficial conversion features                                                             |  |                                  | -          |                                |  | -     |                     |  | 106                                    |  |                             | -       |       | -       |   |  | -      |   |  | 106     |  
|Deferred compensation                                                                      |  |                                  | -          |                                |  | -     |                     |  | 101                                    |  |                             | -       |       | -       |   |  | -      |   |  | 101     |  
|Capital fund arising from elimination of gain on
realization of
  development stage entity |  |                                  | -          |                                |  | -     |                     |  | 53                                     |  |                             | -       |       | -       |   |  | -      |   |  | 53      |  
|                                                                                           |  |                                  |            |                                |  |       |                     |  |                                        |  |                             |         |       |         |   |  |        |   |  |         |   | 
|Balance as of December 31, 2004                                                            |  |                                  | 10,800,000 |                                |  | 3,215 |                     |  | 99,535                                 |  |                             | 99,166  |       | (14,879 | ) |  | (259   | ) |  | 186,778 |  
|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 other comprehensive income                                                           |  |                                  | -          |                                |  | -     |                     |  | -                                      |  |                             | -       |       | -       |   |  | -      |   |  | (6,826  | )
|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 |  
|                                                                                           |  |                                  |            |                                |  |       |                     |  |                                        |  |                             |         |       |         |   |  |        |   |  |         |   | 
|Accumulated unrealized gain from available - for-sale
securities                           |  |                                  |            |                                |  |       |                     |  |                                        |  |                             |         |       | (128    | ) |  |        |   |  |         |  
|Accumulated currency translation adjustments                                               |  |                                  |            |                                |  |       |                     |  |                                        |  |                             |         |       | (21,577 | ) |  |        |   |  |         |  
|                                                                                           |  |                                  |            |                                |  |       |                     |  |                                        |  |                             |         |       |         |   |  |        |   |  |         |   | 
|Accumulated other comprehensive loss                                                       |  |                                  |            |                                |  |       |                     |  |                                        |  |                             |         |       | (21,705 | ) |  |        |   |  |         |  
|                                                                                           |  |                                  |            |                                |  |       |                     |  |                                        |  |                             |         |       |         |   |  |        |   |  |         |   | 

* 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, |        
|                                                                                    |  |                         |        
|                                                                                    |  | 2005                    |         | 2004 |  | 2003   |  
|                                                                                    |  |                         |         |      |  |        |  
|                                                                                    |  | (U.S. $ in thousands)   |        
|                                                                                    |  |                         |        
|CASH
  FLOWS FROM OPERATING ACTIVITIES:                                             |  |                         |         |      |  |        |   |  |         |  
|                                                                                    |  |                         |         |      |  |        |   |  |         |  
|Net income                                                                          |  |                         | 183     |      |  | 8,099  |   |  | 3,120   |  
|                                                                                    |  |                         |         |      |  |        |   |  |         |  
|Adjustments to reconcile net income to net cash
provided by operating
  activities: |  |                         |         |      |  |        |   |  |         |  
|                                                                                   
|Impairment and write down of investments in
investees and loans                     |  |                         | 138     |      |  | 471    |   |  | 915     |  
|                                                                                   
|Minority interest in earnings of consolidated
subsidiaries                          |  |                         | 1,491   |      |  | 2,480  |   |  | 4,118   |  
|                                                                                   
|Equity in losses of affiliated companies,
net                                       |  |                         | 3,109   |      |  | 2,523  |   |  | 1,071   |  
|                                                                                   
|Depreciation and amortization                                                       |  |                         | 25,130  |      |  | 20,597 |   |  | 18,547  |  
|                                                                                   
|Impairment of software development costs                                            |  |                         | -       |      |  | 901    |   |  | -       |  
|                                                                                   
|Increase (decrease) in accrued severance pay,
net                                   |  |                         | 108     |      |  | 287    |   |  | (620    | )
|                                                                                   
|Gain from sale of property and equipment                                            |  |                         | (20     | )    |  | (60    | ) |  | (26     | )
|                                                                                   
|Gain on realization of shareholdings                                                |  |                         | (4,107  | )    |  | (8,893 | ) |  | (2,756  | )
|                                                                                   
|Amortization of deferred option
compensation                                        |  |                         | 134     |      |  | 194    |   |  | 456     |  
|                                                                                   
|Change in accrued interest and capital loss on
debentures                           |  |                         | 1,699   |      |  | 3,471  |   |  | 3,583   |  
|                                                                                   
|Changes in value of long term loans and deposits,
net                               |  |                         | 247     |      |  | 715    |   |  | (1,659  | )
|                                                                                   
|Deferred taxes                                                                      |  |                         | (391    | )    |  | (1,101 | ) |  | 827     |  
|                                                                                   
|Accrued interest on redeemable shares in a
subsidiary                               |  |                         | -       |      |  | 64     |   |  | 320     |  
|                                                                                   
|Gain (loss) on payment of convertible subordinated
notes                            |  |                         | -       |      |  | 50     |   |  | (61     | )
|                                                                                   
|Sale of trading marketable securities,
net                                          |  |                         | (393    | )    |  | (3,533 | ) |  | (2,665  | )
|                                                                                   
|Increase (decrease) in trade marketable
securities                                  |  |                         | 1,785   |      |  | (26    | ) |  | (991    | )
|                                                                                   
|Capital loss (gain) on sale of available for sale
marketable
  securities           |  |                         | 206     |      |  | (64    | ) |  | -       |  
|                                                                                   
|Changes in operating assets and
liabilities:                                        |  |                         |         |      |  |        |   |  |         |  
|                                                                                   
|Decrease (increase) in inventories                                                  |  |                         | 237     |      |  | (1,850 | ) |  | (265    | )
|                                                                                   
|Increase in trade receivables                                                       |  |                         | (20,717 | )    |  | (8,044 | ) |  | (12,649 | )
|                                                                                   
|Decrease (increase) in other accounts
receivable                                    |  |                         | (472    | )    |  | (2,146 | ) |  | 7,913   |  
|                                                                                   
|Increase in trade payables                                                          |  |                         | 5,038   |      |  | 3,033  |   |  | 2,927   |  
|                                                                                   
|Decrease in other accounts payable and
restructuring accrual                        |  |                         | (7,265  | )    |  | (4,641 | ) |  | (12,475 | )
|                                                                                   
|Increase in customer advances, net of work in
progress                              |  |                         | 146     |      |  | 5,279  |   |  | -       |  
|                                                                                    |  |                         |         |      |  |        |   |  |         |  
|                                                                                   
|Net cash provided by operating
activities                                           |  |                         | 6,286   |      |  | 17,806 |   |  | 9,630   |  
|                                                                                    |  |                         |         |      |  |        |   |  |         |  

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, |        
|                                                                                               |  |                         |        
|                                                                                               |  | 2005                    |         | 2004 |  | 2003    |  
|                                                                                               |  |                         |         |      |  |         |  
|                                                                                               |  | (U.S. $ in thousands)   |        
|                                                                                               |  |                         |        
|CASH
  FLOWS FROM INVESTING ACTIVITIES:                                                        |  |                         |         |      |  |         |   |  |         |  
|Acquisition of newly-consolidated subsidiaries
(Appendix C)                                    |  |                         | (5,342  | )    |  | 13,724  |   |  | 20,481  |  
|Proceeds from realization of investment in
previously-consolidated
  subsidiaries (Appendix D) |  |                         | -       |      |  | (353    | ) |  | 12      |  
|Proceeds from repayment of debentures                                                          |  |                         | (41     | )    |  | -       |   |  | 301     |  
|Loans to employees                                                                             |  |                         | -       |      |  | (235    | ) |  | -       |  
|Restricted short term deposit, net                                                             |  |                         | (3,918  | )    |  | (600    | ) |  | -       |  
|Restricted long term deposit, net                                                              |  |                         | 1,434   |      |  | 2,554   |   |  | -       |  
|Purchase of property and equipment                                                             |  |                         | (6,006  | )    |  | (5,718  | ) |  | (4,887  | )
|Purchase of available for sale marketable
securities, net                                      |  |                         | 6,100   |      |  | (16,413 | ) |  | -       |  
|Proceeds from sale of property and
equipment                                                   |  |                         | 1,963   |      |  | 1,827   |   |  | 1,246   |  
|Investment in and loans to affiliated and other
companies                                      |  |                         | (1,582  | )    |  | (6,162  | ) |  | (1,685  | )
|Proceeds from sale of investments in and loans to
affiliated
  companies                       |  |                         | 813     |      |  | 4,160   |   |  | 1,581   |  
|Purchase of an activity by a consolidated
company                                              |  |                         | (111    | )    |  | -       |   |  | (429    | )
|Purchase of intangible assets by consolidated
companies                                        |  |                         | -       |      |  | (449    | ) |  | -       |  
|Investment in long term bank deposits,
net                                                     |  |                         | (698    | )    |  | (639    | ) |  | 18      |  
|Capitalization of software development and other
costs                                         |  |                         | (17,743 | )    |  | (15,367 | ) |  | (10,172 | )
|Purchase of minority interest in
subsidiaries                                                  |  |                         | (2,253  | )    |  | (5,710  | ) |  | (23,599 | )
|Proceeds from realization of investment in
subsidiaries                                        |  |                         | 4,331   |      |  | 11,025  |   |  | 2,846   |  
|Proceeds from investments in short term bank
deposits, net                                     |  |                         | (1,118  | )    |  | 1,245   |   |  | 9,400   |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|Net cash used in investing
activities                                                          |  |                         | (24,171 | )    |  | (17,111 | ) |  | (4,887  | )
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|CASH
  FLOWS FROM FINANCING ACTIVITIES:                                                        |  |                         |         |      |  |         |   |  |         |  
|Proceeds from sale of subsidiary call
warrants                                                 |  |                         | -       |      |  | -       |   |  | 1,386   |  
|Issuance of convertible debt                                                                   |  |                         | -       |      |  | 4,357   |   |  | 20,977  |  
|Issuance of shares                                                                             |  |                         | 33,307  |      |  | -       |   |  | -       |  
|Issuance of treasury stock                                                                     |  |                         | -       |      |  | -       |   |  | 4,796   |  
|Exercise of share options in subsidiaries                                                      |  |                         | 2,217   |      |  | -       |   |  | 7,930   |  
|Dividend distribution                                                                          |  |                         | (50,185 | )    |  | -       |   |  | -       |  
|Dividend to minority shareholders in
subsidiaries                                              |  |                         | (8,352  | )    |  | (88     | ) |  | (4,831  | )
|Short-term bank credit, net                                                                    |  |                         | 5,467   |      |  | 20,410  |   |  | (41,344 | )
|Repayment of long-term loans                                                                   |  |                         | (19,629 | )    |  | (29,521 | ) |  | (5,061  | )
|Receipt of long-term loans                                                                     |  |                         | 51,156  |      |  | 12,681  |   |  | 19,581  |  
|Issuance in a subsidiary to minority shareholders,
net                                         |  |                         | 5,344   |      |  | 4,405   |   |  | 479     |  
|Convertible debt issuance expenses in a
subsidiary                                             |  |                         | -       |      |  | (32     | ) |  | (1,496  | )
|Payment of convertible subordinated notes in a
subsidiary                                      |  |                         | -       |      |  | -       |   |  | (4,144  | )
|Payment of issuance expenses in a
subsidiary                                                   |  |                         | -       |      |  | (20     | ) |  | (361    | )
|Debenture redemption                                                                           |  |                         | (18,357 | )    |  | -       |   |  | (2,484  | )
|Purchase of treasury stock in a subsidiary by a
subsidiary thereof                             |  |                         | (4,134  | )    |  | (102    | ) |  | -       |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|Net cash provided by (used in) financing
activities                                            |  |                         | (3,166  | )    |  | 12,090  |   |  | (4,572  | )
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|Effect of exchange rate changes on cash and
  cash equivalents                                 |  |                         | (4,356  | )    |  | 933     |   |  | 2,724   |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|NET
  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                         |  |                         | (25,407 | )    |  | 13,718  |   |  | 2,895   |  
|CASH AND
  CASH EQUIVALENTS AT BEGINNING OF YEAR                                               |  |                         | 107,174 |      |  | 93,456  |   |  | 90,561  |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  
|CASH AND CASH EQUIVALENTS AT END OF
YEAR                                                       |  |                         | 81,767  |      |  | 107,174 |   |  | 93,456  |  
|                                                                                               |  |                         |         |      |  |         |   |  |         |  

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

F-7

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

CONSOLIDATED STATEMENTS OF CASH FLOWS

Appendix A  Supplemental cash flow
information:

|                                         |  |                         |        |      |  |       |  |  |       | 
|---------------------------------------- |  | ----------------------- | ------ | ---- |  | ----- |  |  | ----- | 
|                                         |  | Year ended December 31, |       
|                                         |  |                         |       
|                                         |  | 2005                    |        | 2004 |  | 2003  | 
|                                         |  |                         |        |      |  |       | 
|                                         |  | (U.S. $ in thousands)   |       
|                                         |  |                         |       
|                                         |  |                         |        |      |  |       |  |  |       | 
|Cash paid during the year in respect
of: |  |                         |        |      |  |       |  |  |       | 
|Interest                                 |  |                         | 10,052 |      |  | 7,066 |  |  | 6,547 | 
|                                         |  |                         |        |      |  |       |  |  |       | 
|                                         |  |                         |        |      |  |       |  |  |       | 
|Income tax                               |  |                         | 7,467  |      |  | 6,357 |  |  | 4,652 | 
|                                         |  |                         |        |      |  |       |  |  |       | 

Appendix B  Non-cash activities:

|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|--------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ----- | ---- |  | ----- |  |  | ----- | 
|                                                                                                                            |  | Year ended December 31, |      
|                                                                                                                            |  |                         |      
|                                                                                                                            |  | 2005                    |       | 2004 |  | 2003  | 
|                                                                                                                            |  |                         |       |      |  |       | 
|                                                                                                                            |  | (U.S. $ in thousands)   |      
|                                                                                                                            |  |                         |      
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Purchase of fixed assets against trade
  payables                                                                           |  |                         | 343   |      |  | 39    |  |  | 80    | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Investment in a consolidated company
  against issuance of share capital to minority shareholders of consolidated
  company |  |                         | 1,577 |      |  | -     |  |  | 5,101 | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Investment in affiliates and other
  companies, recorded against accounts payable                                           |  |                         | -     |      |  | -     |  |  | 807   | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Purchase of shares from minority
  shareholders of subsidiary, against accounts payable                                     |  |                         | 100   |      |  | -     |  |  | -     | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Realization of convertible debenture in a
  subsidiary                                                                      |  |                         | -     |      |  | -     |  |  | 229   | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Exchange of assets in a subsidiary                                                                                          |  |                         | 70    |      |  | -     |  |  | -     | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Purchase of technology from affiliated
  company against loan                                                               |  |                         | -     |      |  | 1,695 |  |  | 1,917 | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Purchase of intellectual property rights
  against settlement of loan                                                       |  |                         | -     |      |  | -     |  |  | 642   | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Warrants issued as consideration for
  purchase of activity                                                                 |  |                         | -     |      |  | -     |  |  | 121   | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Dividend in kind in subsidiary                                                                                              |  |                         | 66    |      |  | -     |  |  | -     | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 
|Current maturities of royalties liabilities
  against account receivables                                                   |  |                         | 13    |      |  | -     |  |  | -     | 
|                                                                                                                            |  |                         |       |      |  |       |  |  |       | 

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

F-8

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

CONSOLIDATED STATEMENTS OF CASH FLOWS

Appendix C    Acquisition of
newly-consolidated subsidiaries:

|                                                                              |  |                           |        |      |  |         |   |  |         |  
|----------------------------------------------------------------------------- |  | ------------------------- | ------ | ---- |  | ------- | - |  | ------- | -
|                                                                              |  | Year ended
  December 31, |       
|                                                                              |  |                           |       
|                                                                              |  | 2005                      |        | 2004 |  | 2003    |  
|                                                                              |  |                           |        |      |  |         |  
|                                                                              |  | (U.S. $ in thousands)     |       
|                                                                              |  |                           |       
|Assets and liabilities of subsidiaries consolidated as of acquisition
  date: |  |                           |        |      |  |         |   |  |         |  
|                                                                             
|Working capital (other than cash and cash
  equivalents)                      |  |                           | 5,446  |      |  | 11,670  |   |  | 12,726  |  
|                                                                             
|Liabilities arising from the acquisition                                      |  |                           | 209    |      |  | -       |   |  | -       |  
|                                                                             
|Investment in affiliates and others
  including loans                         |  |                           | 801    |      |  | (27,436 | ) |  | 19,014  |  
|                                                                             
|Property and equipment                                                        |  |                           | (813   | )    |  | (4,671  | ) |  | (4,074  | )
|                                                                             
|Other assets and deferred expenses                                            |  |                           | (4,697 | )    |  | (13,085 | ) |  | (23,748 | )
|                                                                             
|Goodwill arising upon acquisition                                             |  |                           | (7,981 | )    |  | (60,524 | ) |  | (14,379 | )
|                                                                             
|Long-term liabilities                                                         |  |                           | 533    |      |  | 18,507  |   |  | 8,887   |  
|                                                                             
|Debentures                                                                    |  |                           | -      |      |  | 45,336  |   |  | 12,099  |  
|                                                                             
|Unrealized gain                                                               |  |                           | -      |      |  | (1,508  | ) |  | -       |  
|                                                                             
|Issuance of shares by a subsidiary                                            |  |                           | 1,408  |      |  | -       |   |  | -       |  
|                                                                             
|Minority interest at acquisition date                                         |  |                           | (248   | )    |  | 9,182   |   |  | 9,956   |  
|                                                                             
|Exchange of debentures against shares                                         |  |                           | -      |      |  | 36,253  |   |  | -       |  
|                                                                              |  |                           |        |      |  |         |   |  |         |  
|Total                                                                         |  |                           | (5,342 | )    |  | 13,724  |   |  | 20,481  |  
|                                                                              |  |                           |        |      |  |         |   |  |         |  

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

|                                                                                |  |                           |   |      |  |         |   |  |        |  
|------------------------------------------------------------------------------- |  | ------------------------- | - | ---- |  | ------- | - |  | ------ | -
|                                                                                |  | Year ended
  December 31, |  
|                                                                                |  |                           |  
|                                                                                |  | 2005                      |   | 2004 |  | 2003    |  
|                                                                                |  |                           |   |      |  |         |  
|                                                                                |  | (U.S. $ in thousands)     |  
|                                                                                |  |                           |  
|Assets and liabilities of consolidated subsidiaries as of date of
  realization |  |                           |   |      |  |         |   |  |        |  
|                                                                               
|Working capital (other than cash and cash
  equivalents)                        |  |                           | - |      |  | (14,204 | ) |  | 330    |  
|                                                                               
|Investment in affiliate (including loans)                                       |  |                           | - |      |  | 1,139   |   |  | (2,613 | )
|                                                                               
|Property and equipment                                                          |  |                           | - |      |  | 2,081   |   |  | 360    |  
|                                                                               
|Other assets and deferred expenses                                              |  |                           | - |      |  | -       |   |  | 67     |  
|                                                                               
|Goodwill                                                                        |  |                           | - |      |  | 7,756   |   |  | 2,133  |  
|                                                                               
|Long-term liabilities                                                           |  |                           | - |      |  | (392    | ) |  | (201   | )
|                                                                               
|Loss (gain) from realization of investments
  in subsidiaries                   |  |                           | - |      |  | -       |   |  | 27     |  
|                                                                               
|Minority interest                                                               |  |                           | - |      |  | 3,267   |   |  | (91    | )
|                                                                                |  |                           |   |      |  |         |   |  |        |  
|Total                                                                           |  |                           | - |      |  | (353    | ) |  | 12     |  
|                                                                                |  |                           |   |      |  |         |   |  |        |  

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

F-9

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

Note 1  Summary of Significant Accounting
Policies:

|   |                                                                                                                                                                                                                                                                                                                                                                             
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | General:                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                             
|   | Formula
  Systems (1985) Ltd. (Formula) was incorporated in Israel in 1985. Since
  1991, 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 31,2005                    |  | December 31,2004 | 
|                                                                                          |  |                                     |  |                  | 
|Name of subsidiary:                                                                       |  | %                                   | 
|                                                                                          |  |                                     |  |                 
|                                                                                          |  |                                     |  |                  |  |  |  |  |       |  | 
|Matrix IT Ltd.  (Matrix)                                                                |  |                                     |  | 51.11            |  |  |  |  | 58.63 |  | 
|                                                                                          |  |                                     |  |                  |  |  |  |  |       |  | 
|BluePhoenix
  Solutions Ltd. (BluePhoenix)(formerly - Crystal Systems Solutions Ltd.) |  |                                     |  | 59.22            |  |  |  |  | 58.66 |  | 
|                                                                                          |  |                                     |  |                  |  |  |  |  |       |  | 
|Magic Software Enterprises Ltd. (Magic)                                                 |  |                                     |  | 50.27            |  |  |  |  | 50.1  |  | 
|                                                                                          |  |                                     |  |                  |  |  |  |  |       |  | 
|nextSource Inc.                                                                           |  |                                     |  | 100              |  |  |  |  | 100   |  | 
|                                                                                          |  |                                     |  |                  |  |  |  |  |       |  | 
|Sapiens International Corporation N.V.  (Sapiens )                                      |  |                                     |  | 59.22            |  |  |  |  | 52.37 |  | 
|                                                                                          |  |                                     |  |                  |  |  |  |  |       |  | 
|Formula Vision Technologies (F.V.T.) Ltd.  (Formula Vision)                             |  |                                     |  | 56.9             |  |  |  |  | 56.2  |  | 

| |                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The above list consists only of active companies that
  are held directly by
  Formula.                                                                             
| |                                                                                                                                                                     
| | Accounting Principles                                                                                                                                               
| |                                                                                                                                                                     
| | The
  consolidated financial statements have been prepared in accordance with
  generally accepted accounting principles (GAAP) as applied in the United
  States.

F-10

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

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

F-11

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|D. | Investments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Investments
  in non-marketable securities of companies in which the Company does not have
  the ability to exercise significant influence over operating and financial
  policy are recorded at cost. The Company accounts for investments in
  marketable equity securities and debt securities in accordance with SFAS No.
  115, Accounting for Certain Investments in Debt and Equity Securities (SFAS
  No. 115). Management determines the appropriate classification of its
  investments in marketable equity securities and debt securities at the time
  of purchase and reevaluates such determinations at each balance sheet date.
  Marketable equity securities and debt securities that are classified as
  trading or as available-for-sale are reported at fair value.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Unrealized
  gains and losses from marketable securities classified as available for
  sale are excluded from earnings and are reported as a component of
  accumulated other comprehensive income (loss) in 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|E. | Provision for Doubtful Accounts:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | The
  provision for doubtful accounts was calculated on the basis of specific
  receivables, where, in the opinion of Group management, doubt exists as to
  their collectability.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|F. | Inventory:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Inventory is comprised of hardware and software.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Inventory is valued at the lower of cost or market value. Cost is
  determined on the first in - first out basis.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|G. | 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-12

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                                                                                                                                                                                
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|H. | 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 life of the assets, whichever is
  shorter.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|I. | Goodwill:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | In July
  2001, the Financial Accounting Standards Board (FASB) issued Statement of
  Financial Accounting Standards No. 142, Goodwill and Other Intangible
  Assets (SFAS 142). SFAS 142 requires goodwill to be tested for impairment
  on an annual basis and more frequently in certain circumstances, and written
  down when impaired rather than being amortized as required by previous
  accounting standards. Furthermore, SFAS 142 requires purchased intangible
  assets other than goodwill to be amortized over their useful lives unless
  those lives are determined to be indefinite.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | SFAS 142 was
  effective for fiscal years beginning after December 15, 2001. In accordance
  with SFAS 142, the Company ceased amortizing goodwill totaling $105 million
  as of the beginning of 2002. During 2002 the Company completed its
  transitional impairment review of goodwill. Based on the impairment tests
  performed, there was no impairment of goodwill as of January 1, 2002. The
  Company has selected December 31st as the date on which it will
  perform its annual goodwill impairment test.                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | Goodwill
  related to equity method investees and cost investees are not amortized (as
  of January 1, 2002 and thereafter) but is tested for impairment under the
  provisions of APB 18.                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | As of
  December 31, 2005, 2004 and 2003, no impairment was required. There can be no
  assurance that future goodwill impairment tests will not result in a charge
  to net income.                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|J. | 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 of the FASB.                                                                                                                                                             

F-13

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|J. | 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, 2005, consolidated subsidiaries capitalized software
  development costs aggregating $17.7 million (2004 - $15.4 million, 2003 -
  $10.2 million) and amortized capitalized software development costs
  aggregating $12.7 million (2004 - $10.1 million, 2003 - $8.1 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, 2005 no impairment
  was recorded (During 2004 an impairment of capitalized software development
  costs in the amount of $901,000 was recorded).                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|K. | Other Intangible Assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | Other intangible assets are comprised of related intangible assets of
  customers and acquired technology and are amortized over their useful lives
  using a method of amortization that reflects the pattern in which the
  economic benefits of the intangible assets are consumed or otherwise used up.
  Related intangible assets of 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|L. | 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, 2005, 2004 and
  2003, no impairment losses have been identified.

F-14

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|M. | 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, 2005, 2004 and 2003 were $7,728 thousand, $5,121 thousand and $5,216
  thousand, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|N. | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                   

F-15

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|N. | Revenue Recognition (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | For these
  multiple elements, SOP 97-2 requires that the fair value of each component in
  a multiple element arrangement will be determined based on the vendors
  specific objective evidence (VSOE) for that element, and revenue is allocated
  to each component based on its fair value. SOP 98-9 requires that revenue be
  recognized under the residual method when VSOE does not exist for all the
  delivered elements, VSOE of fair value exists for all undelivered elements,
  and all other SOP 97-2 critera are met. Under the residual method, any
  discount in the arrangement is allocated to the delivered elements. The
  specific objective evidence for the PCS is established by the price charged
  on separate PCS renewal contracts. The VSOE for the consulting services is
  established by the price charged on other time based consulting service
  contracts where no sale of other elements is involved, considering, among
  other things, the territory where the service is performed, the size of the
  customer, the quantity of the purchased services and the professional
  expertise of the consultants. The revenue associated with the delivered
  elements is recognized using the residual method discussed above.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | The Company
  recognizes revenues from consulting fees with respect to projects billed on a
  time and material basis, based on the number of hours performed.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | In some of
  the agreements with the Companys customers, the customers have the right to
  receive unspecified upgrades on an if-and-when available basis (the Company
  does not provide specific upgrades). These upgrades are considered PCS.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | Revenue
  allocated to the PCS is recognized ratably over the term of the PCS.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | The Company
  recognizes revenues from projects as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | (i)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Revenue from
  projects billed on a time and material basis is recognized in accordance with
  SOP 81-1 Accounting for Performance of Construction - Type and Certain
  Production - Type Contracts, using contract accounting on a percentage of
  completion method, on the basis of the relationship between actual costs
  incurred and the total costs that are expected to be incurred over the
  duration of the contract. Provision is made for estimated losses and
  uncompleted contracts, in the amount of the estimated losses on the entire
  contract in the period in which such losses first become evident. As of
  December 31, 2005, 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-16

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|N. | 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.                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | Revenues from certain agreements are recorded on a
  gross basis under the provisions of EITF No. 99-19, Reporting Revenue
  Gross as a Principal versus Net as an Agent as the Company is the primary
  obligor under the arrangements and the Company takes credit risk.                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|O. | 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.                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|P. | Provision for
  Warranty:                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | In light of the past experience, Formula and the majority of its
  subsidiaries do not record any provision for warranties in respect of their products
  and services.                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|Q. | Advertising Costs:                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | The Company
  records advertising expenses as incurred. Advertising cost for the year ended
  December 31, 2005 was $2,009 thousand.                                                                                                                                                                                                                                                                                                                 

F-17

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|R. | 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.                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|S. | 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 the future years.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|T. | 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.                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|U. | Treasury Shares Held by the Company:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   | Shares of the Company that are held by the Company (treasury shares)
  are presented as a reduction of shareholders equity, at their cost to the
  Company. Gains and losses upon the sale of these shares, net of related
  income taxes, are carried to additional paid-in capital and to retained
  earnings, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                    

F-18

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|V. | 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, 2005 and 2004 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 hedging arrangements as of
  December 31, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | The provision for doubtful accounts charged to general and
  administrative expenses amounted to $2.7 million, $1.2 and $14 million in the
  years 2005, 2004 and 2003, respectively, and was determined for specific
  debts where doubt existed as to their collectability.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|W. | Options Granted to Employees:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | The Company
  accounts for its Employee Stock Option Plans using the treatment prescribed
  by Accounting Principles Board Opinion No. 25, Accounting for Stock
  Issued to Employees (APB 25) and FASB issued Interpretation No. 44,
  Accounting for Certain Transactions Involving Stock Compensation (FIN
  44). Under APB 25, the cost of compensation for employee stock option
  plans is measured using the intrinsic value based method of accounting.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | In October
  1995, the FASB issued Statement No. 123, Accounting for Stock-Based
  Compensation (SFAS 123). This Statement, effective as of the 1997
  financial statements, established a fair value based method of accounting for
  employee stock options or similar equity instruments, and encourages the
  adoption of that method for stock compensation plans. SFAS 148 Accounting
  for Stock Based Compensation amended SFAS 123 to provide alternative methods
  of transition for a voluntary change to the fair value based method of
  accounting for such plans.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

F-19

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|W. | Options Granted to Employees (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | However, it
  also allows companies to account for those plans, with respect to options
  granted to employees, using the accounting treatment prescribed by
  APB 25.                                                                                                                                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | The Company
  has elected to account for share option plans according to APB 25 and
  FIN 44 and has accordingly complied with the disclosure requirements set
  forth in SFAS 123 for companies electing to apply APB 25.                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | Compensation
  costs in respect of such plans in the net amounts of $70 thousand, $65
  thousand and $193 thousand, respectively, were charged to income in 2005,
  2004 and 2003. 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 |  | 2003   |  
| |                                                                                                                                                    |  |                                                  |        |      |  |        |  
| |                                                                                                                                                    |  | (U.S. $ in thousands except per share
  amounts) |       
| |                                                                                                                                                    |  |                                                  |       
|
| | Net income, as reported                                                                                                                            |  |                                                  | 183    |      |  | 8,099  |   |  | 3,120  |  
| |                                                                                                                                                    |  |                                                  |        |      |  |        |   |  |        |  
| | Add: Stock-based employee compensation
  expenses included in reported net income, net of related tax effects                                      |  |                                                  | 70     |      |  | 65     |   |  | 193    |  
| |                                                                                                                                                    |  |                                                  |        |      |  |        |   |  |        |  
| | 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 | ) |  | (1,832 | )
| |                                                                                                                                                    |  |                                                  |        |      |  |        |   |  |        |  
| | Pro-forma net income (loss)                                                                                                                        |  |                                                  | (4,017 | )    |  | 6,549  |   |  | 1,481  |  
| |                                                                                                                                                    |  |                                                  |        |      |  |        |   |  |        |  
| | Earnings (loss) per share:                                                                                                                         |  |                                                  |        |      |  |        |   |  |        |  
| |                                                                                                                                                    |  |                                                  |        |      |  |        |   |  |        |  
| | Basic - as reported                                                                                                                                |  |                                                  | 0.01   |      |  | 0.73   |   |  | 0.29   |  
| |                                                                                                                                                    |  |                                                  |        |      |  |        |   |  |        |  
| |                                                                                                                                                    |  |                                                  |        |      |  |        |   |  |        |  
| | Basic - pro forma                                                                                                                                  |  |                                                  | (0.31  | )    |  | 0.58   |   |  | 0.12   |  
| |                                                                                                                                                    |  |                                                  |        |      |  |        |   |  |        |  
| |                                                                                                                                                    |  |                                                  |        |      |  |        |   |  |        |  
| | Diluted - as reported                                                                                                                              |  |                                                  | 0.01   |      |  | 0.65   |   |  | 0.24   |  
| |                                                                                                                                                    |  |                                                  |        |      |  |        |   |  |        |  
| |                                                                                                                                                    |  |                                                  |        |      |  |        |   |  |        |  
| | Diluted - pro forma                                                                                                                                |  |                                                  | (0.31  | )    |  | 0.51   |   |  | 0.09   |  
| |                                                                                                                                                    |  |                                                  |        |      |  |        |   |  |        |  

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|X. | Derivatives and Hedging:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | The Company accounts for derivatives and hedging based on Financial
  Accounting Standards Board Statement No. 133, Accounting for Derivative
  Instruments and Hedging Activities as amended (SFAS No. 133). SFAS 133
  requires companies to recognize all of its derivative instruments on the
  balance sheet at fair value. The accounting for changes in the fair value of
  a derivative instrument depends on whether it has been designated and qualifies
  as part of a hedging relationship and further, on the type of hedging
  relationship.

F-20

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|X. | 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.                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|Y. | 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 $17,259 thousand as of December 31, 2005 according to the quoted price in
  the TASE is $14,546 thousand. The fair value of the traded warrants does not
  significantly differ from their carrying amount.                                                                                                                                                                                                                                                                                                                                                                                                        

F-21

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|AA. | Recently Issued Accounting Pronouncements:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|    | In December
  2004, the FASB issued FAS No. 123R, Share Based Payment. SFAS No. 123R
  requires that compensation costs related to share based payment transactions
  to be recognized in the financial statements. In most cases the amount of
  compensation cost will be measured based on the grant date fair value of the
  equity or liability issued. SFAS No. 123R requires all share-based payments
  to employees, including grants of employee stock options, to be recognized in
  the financial statements based on their fair values. Awards classified, as
  liabilities will be remeasured to fair value each reporting period. The
  compensation cost will be recognized over the period that the employee
  provides service in exchange for the award. Under SFAS No. 123R, the pro forma
  disclosures previously permitted no longer will be an alternative to
  financial statements recognition. SFAS No. 123R replaces SFAS No. 123,
  Accounting for Stock-Based Compensation and supersedes APB 25, Accounting
  for Stock Issued to Employees. SFAS No. 123R is effective for public entities
  as of the beginning of the first interim or annual reporting period that
  begins after June 15, 2005.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|    | In April
  2005, the Securities and Exchange Commission announced the adoption of a new
  rule that amends the effective date for Statement No. 123R. The new rule does
  not change any of the accounting provisions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|    | In March
  2005, the SEC issued Staff Accounting Bulletin No.107 (SAB 107) regarding
  the SECs interpretation of SFAS 123R and the valuation of share-based
  payments for public companies. After assessing the potential impact of the
  provisions of SFAS No. 123R on the consolidated financial statements in fiscal
  year 2006, the Company
  decided to minimize
  its exposure to the accounting pronouncement by accelerating the vesting period of several outstanding
  unvested options. Effective December 27, 2005, the Company accelerated several outstanding unvested
  options as to be fully-vested as of such date. The Company will apply the modified prospective
  method, which requires that compensation expenses be recorded for all
  unvested share options upon adoption of SFAS No. 123R. The Company does not
  expect that the adoption of SFAS No. 123R will have a material impact on its
  consolidated results of operations and financial condition beginning in 2006.                                                                                                                                                                                                                     

F-22

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                        
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------
|AA. | Recently Issued Accounting Pronouncements (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|    | In May 2005,
  the FASB issued SFAS No. 154, Accounting Changes and Error Corrections
  (SFAS 154), which replaces APB Opinion No. 20 Accounting Changes and SFAS
  No. 3, Reporting Accounting Changes in Interim Financial Statements  An
  Amendment of APB Opinion No. 28. SFAS 154 provides guidance on the
  accounting for and reporting of accounting changes and error corrections. It
  establishes retrospective application, or the latest practicable date, as the
  required method for reporting a change in accounting principle and the
  reporting of a correction of an error. SFAS 154 is effective for accounting
  changes and corrections of errors made in fiscal years beginning after
  December 15, 2005 and is required to be adopted by the Company in the first
  quarter of fiscal 2006. The Company is currently evaluating the effect that
  the adoption of SFAS 154 will have on its consolidated results of operations
  and financial condition but does not expect it to have a material impact.      
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|    | In November
  2005, the FASB issued FSP FAS 115-1 and FAS 124-1, The Meaning of
  Other-Than-Temporary Impairment and Its Application to Certain Investments
  (FSP 115-1), which provides guidance on determining when investments in
  certain debt and equity securities are considered impaired, whether that
  impairment is other-than-temporary, and on measuring such impairment loss.
  FSP 115-1 also includes accounting considerations subsequent to the
  recognition of an other-than-temporary impairment and requires certain
  disclosures about unrealized losses that have not been recognized as
  other-than-temporary impairments. FSP 115-1 is required to be applied to reporting
  periods after December 15, 2005 and is required to be adopted by the Company
  in the first quarter of fiscal 2006. The Company is currently evaluating the
  effect that the adoption of FSP 115-1 will have on its consolidated results
  of operations and financial condition but does not expect it to have a
  material impact.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|    | The adoption
  of the following recent accounting pronouncements did not have a material
  impact on the Companys results of operations and financial condition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | SFAS No.
  153, Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29,
  and                                          
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                        
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | FASB
  Interpretation No. 47, Accounting for Conditional Asset Retirement
  Obligations, an interpretation of FASB Statement No. 143.

F-23

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|AA. | Recently Issued Accounting Pronouncements (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|    | 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. Earlier adoption is permitted as of the beginning of an
  entitys fiscal year, provided that no interim period financial statements
  have bee issued for the financial year. Management is currently evaluating
  the impact of this statement, if any, on the Companys financial statements
  or its results of operations.

Note 2  Certain
Transactions:

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | In December 2001, in connection
  with the purchase by F.V.T of Formulas interests in certain privately-held
  companies, F.V.T issued to Formula a series of debentures of $58.9 million in the aggregate, linked to the
  Israeli CPI and bearing interest at an annual rate of 5%. Under their terms, the debentures are required
  to be repaid in five annual installments, subject to
  adjustments based on the income of F.V.T during each of the five years. The debentures provide that the payments on account of the
debentures
  plus linkage differences will be no less than 30% and no more than 70% of the
  income arising from the sale of the transferred companies in any calendar
  year. Income for these purposes is defined as the amounts received by F.V.T, if any, in consideration for a sale of
  any of the transferred companies in any given calendar year, less selling
  expenses, as well as amounts received by F.V.T from distributions to be made by any of the
  transferred companies in any given calendar year. Payments to be made on
  account of the debentures, in any given calendar year, will be no less than
  20% of the annual profit as recorded in the financial statements of
  F.V.T. Any amounts which remain
  outstanding will be payable at the end of the 5-year period. In connection
  with this transaction, Formula lent to F.V.T on March
  31, 2002 an additional $19.4 million and F.V.T issued to us an additional series of debentures
  for this amount, with similar terms as the debentures issued in December
  2001. In the event that during the term of the indebtedness, F.V.T issues to a third party convertible
  debentures, Formula is entitled to convert the indebtedness into the same class
  of convertible debentures, having the same terms of the convertible
  debentures issued to the third party.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   | In January 2004, Formula exchanged
  approximately $35 million of the aggregate amount of the debentures for
  38,000,000 shares of F.V.T issued to Formula and constituting 59.4% of the outstanding share capital
  of F.V.T. The price per
  share was NIS 4.11 ($0.93) which reflects the average closing price of F.V.Ts
  shares on the TASE during the 30
  days preceding Formulas resolution approving the transaction. Following the
  exchange of a portion of the debentures, the outstanding amount of the
  debentures was $43.2 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

F-24

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2  Certain
Transactions (cont.):

|   |                                                                                                                                                                                                                                                                                                                                            
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | (cont.):                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                            
|   | All
  unrealized gains which were resulted out of the original transaction in 2001,
  were eliminated during the 2004 transaction.                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                            
|   | F.V.T is a managing and
  holding company, guiding a group of privately held IT companies with
  innovative, proprietary technologies and solutions targeting international
  markets. Formula Vision holds a controlling interest in some of these
  privately held companies and a minority interest in the other members of the
  group.
|   |                                                                                                                                                                                                                                                                                                                                            
|   | The results of operations
  of F.V.T are included in the results of operations of the Company for all of
  2004.                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                            
|   | Following
  are the amounts assigned to major components of 2004 acquisitions balance
  sheets in the aggregate as of the date of purchase (in thousands):                                                                                                                                                                                 

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

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

F-25

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2  Certain
Transactions (cont.):

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

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

|   |                                                                                                                                                                                                                                                                                                                                                         
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | In
  December 2005, the general meeting of Formulas shareholders approved an
  amendment to the debentures pursuant to which, all repayments under the
  debentures due in 2005 and 2006 would be deferred to December 31, 2006,
  provided that the amount of cash and cash equivalents that F.V.T holds does not exceed the amount of its bank
loans.
|   |                                                                                                                                                                                                                                                                                                                                                         
|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. | On July 30, 2002, Matrix
  consummated a public offering in Israel of $21 million debentures linked to
  the CPI and bearing interest at an annual rate of 4.95%, to be repaid on
  August 5, 2005.                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                         
|   | The debentures are convertible into ordinary shares of Matrix
  at any time until July 17, 2005.                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                         
|   | Matrix received a request for 96,194
  packages in the aggregate amount of $19.6 million of which 30,000 packages
  were requested by Matrix I.T. Systems Ltd. (a subsidiary of Matrix).                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                         
|   | Options to
  purchase an aggregate of 10,000,000 ordinary shares of Matrix, were attached
  to the debentures.                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                         
|   | The associated options
  have a term of 3 years and are exercisable at a price of $1.69 (linked to the
  CPI) per Matrix ordinary share.                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                         
|   | The proceeds from the
  public offering were $13.4 million, of which $12.3 million were allocated to
  the debentures and $1.1 million were allocated to the options. The allocation
  was done on the basis of the average market price of the option in the first
  3 trading days.                                                                   

F-26

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2  Certain Transactions (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|C. | (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | The
  debentures were issued at a discount, which is being amortized over the life
  of the debentures.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | During 2003,
  Matrix IT Systems Ltd. sold all of Matrixs convertible debentures held by it
  for an aggregate consideration of $4.5 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | During the
  period of account all of the debentures were converted into Matrixs shares
  except for $1,800 thousands which were paid by Matrix.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|D. | 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.

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|E. | In April 2000, Sapiens
  completed a private placement of 600,000 shares of common stock (investors
  shares) in its wholly-owned subsidiary, eZoneXchange.com, Inc.
  (eZoneXchange), for $15 million. The investors also received a warrant to
  purchase an additional 2.25% of the Common stock of eZoneXchange at the same
  private placement share price of $25 per share. As part of the transaction,
  Sapiens entered into a Put/Call Agreement pursuant to which the investors
  were granted the right (exercisable in whole or in part) to cause Sapiens
  during the put option exercise period (May 4, 2004 through May 3, 2005)
  to repurchase the investors shares at the principal amount of the investors
  investment plus 5% annual interest accrued thereon from May 4, 2000.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   | During February 2001,
  Sapiens decided to close the operations of eZoneXchange, and repurchased
  173,100 of the investors shares with a cash repayment of $4.5 million for
  principal and interest, according to an amendment to the Put/Call Agreement.
  As a result, the amount of the principal portion of the redeemable shares in
  a subsidiary to be repaid in cash was decreased by $4.2 million, net of
  expenses. In addition, in accordance with the amendment, if the market price
  of the Sapienss Common share reaches $10 per share, the investors will have
  the right to sell 192,333 shares of its eZoneXchange stocks in return for the
  Sapienss 363,776 Common shares at a price of $13.75 per share.                                                                      

F-27

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2  Certain Transactions (cont.):

|   |                                                                                                                                                                                                                                                                                                                                
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|E. | (cont.):                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                
|   | No interest is accrued for
  the amended portion of the investment. The remaining portion of the
  investment to be repaid in shares (approximately $2.5 million) would continue
  to be subject to the original terms of the Put/Call Agreement. The amendment
  also terminated a call option previously held by the Sapiens.
|   |                                                                                                                                                                                                                                                                                                                                
|   | As of March 16, 2004, the
  balance of the Redeemable Shares in a Subsidiary totaled approximately $11.6
  million, including interest accrued through that date.                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                
|   | On
  March 16, 2004, Sapiens and the investors signed an agreement according to
  which, among other terms specified in the agreement,
  Sapiens would redeem the remaining eZoneXchange common shares and
  eZoneXchange warrants held by the investors by three means:                                                       

| |    |                                                                                                                                                                                                                                                                                                                                                                                                 
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. | Issuance of shares:
  Sapiens issued to the investors an aggregate of 750,000 of the Sapienss
  Common shares on March 26, 2004.                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | As of the date of these
  financial statements, the investors did not exercise their demand right to
  register the Common shares issued.                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The Common shares issued
  were valued at approximately $2.7 million, based on Sapienss stock market
  price on the date of issuance (March 26, 2004).                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                 
| | 2. | Loan payable: Sapiens
  agreed to pay an amount of $8.6 million to the investors, bearing annual
  interest of 7.5% compounded annually on the outstanding principal from
  January 1, 2004, to be paid semi-annually, with principal payments of $4.6
  million by no later than May 1, 2004, and $4.0 million by no later than May
  1, 2005. The May 1, 2004 payment was made by the Sapiens.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The 7.5% interest rate was
  considered as market interest rate for debt with similar risk, and
  accordingly, the fair value of the loan payable was determined to be its
  carrying value.                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                 
| | 3. | Warrants: Sapiens issued
  to the investors warrants to purchase 350,000 Common shares at an exercise
  price of $4.00 per Common share of Sapiens, exercisable at any time and from
  time to time during the period from issuance to December 31, 2007.                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The warrants were valued
  at $560,000 using the Black-Scholes option pricing model with the following
  assumptions: exercise price $4.00, fair value of the underlying shares of
  $3.65, interest rate 2.5%, dividend yield 0%, and volatility of 60%.                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The difference between the
  fair value of the three components, equal to $11,868,000, and the carrying
  amount of the liability before the modification of $11,569,000, in the amount
  of $299,000, was recorded as a Settlement of Redeemable Shares in a
  Subsidiary deemed dividend in the 2004 consolidated statements of operations.                                                   

F-28

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2  Certain
Transactions (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|E. | (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | Pursuant to an evaluation
  of the terms of the agreement under the provisions of EITF 00-19, Accounting
  for Derivative Financial Instruments Indexed to, and potentially settled in,
  a Companys Own Stock, Sapiens has classified all the above derivative
  financial instruments issued in connection with the private placement as
  liabilities.                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | On May 29, 2005, Sapiens
  entered into an agreement with the investors regarding the payment of the
  remaining $4.0 million originally due on May 1, 2005. It was agreed that the
  Sapiens would pay $2.0 million on May 1, 2005, $1.0 million on April 1, 2006
  and $1.0 million on August 1, 2006. The investors may, at their sole
  discretion, convert all or any portion of the $1.0 million payable on August
  1, 2006 into Sapienss Common shares, at a conversion price per each share of
  $3.20. In addition, the interest due on the remaining amount was changed to
  Libor + 2.5%(6.5% as of December 31, 2005). The first installment of $2.0
  million was paid.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | The modification of the
  loan terms was accounted for as debt extinguishment due to the addition of a
  conversion option to the debt instrument which was considered substantial.
  The difference between the fair value of the amended loan and the book value
  of old loan was immaterial                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|F. | On September 23, 2004,
  F.V.T and Transtech, a subsidiary of F.V.T, Giza and Accel, entered into an
  agreement with funds under which the Funds and F.V.T. invested in Transtech
  $19 million (of which $14 million were invested by Giza and Accel) for
  preferred shares representing 47% in the equity of Transtech. The funds were
  also granted an option to purchase 50% of their original investment for a
  price of 150% of the current purchase price. The option is for 5 years.                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | Furthermore, the funds
  were granted an option for 3 months to increase the total investment to $25
  million under the above terms.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | No gain or loss arose from
  the transaction since the preferred shares cannot be treated as an investment
  in common shares (per SAB 51).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | Pursuant to the
  transaction, F.V.T. held 36.7% of Transtech voting rights. In February 2005,
  the Funds exercised their option and invested an additional $6 million.
  Following the investment, F.V.T. holds 31.14% of Transtech voting rights.                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | In April 2006, in
  connection with the agreements with FIMI and IDB to purchase from them shares of
  Transtech held by them, Formula Vision paid to FIMI and IDB $5.4 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

F-29

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note
2  Certain Transactions (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|G. | 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 F.V.T. Following these
  transactions, FIMGold LP holds 33.3% controlling interest in Formula and
  approximately 24% interest in F.V.T.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|H. | In August, 2005 a
  subsidiary of F.V.T (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.                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|I. | 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,
  2005 |      |                       |     
| |                               |  |                     | 2005 |                       | 2004 |       
| |                               |  |                     |      |                       |      |        | 
| |                               |  | %                   |      | (U.S. $ in thousands) |     
| |                               |  |                     |      |                       |     
| |                               |  |                     |      |                       |      |        |  |  |        | 
| | Trading securities            |  | -                   |      |                       |      | 13,136 |  |  | 13,556 | 
| |                               |  |                     |      |                       |      |        |  |  |        | 
| | Available-for-sale securities |  | -                   |      |                       |      | 9,718  |  |  | 16,380 | 
| |                               |  |                     |      |                       |      |        |  |  |        | 
| | Short-term deposits           |  | 0.03-3.66           |      |                       |      | 876    |  |  | -      | 
| |                               |  |                     |      |                       |      |        |  |  |        | 
| | Restricted deposits           |  | 0.75-3.52           |      |                       |      | 12,455 |  |  | 9,137  | 
| |                               |  |                     |      |                       |      |        |  |  |        | 
| | Total                         |  |                     |      |                       |      | 36,185 |  |  | 39,073 | 
| |                               |  |                     |      |                       |      |        |  |  |        | 

F-30

---

---



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,          |      
| |                                                  |  |                       |      
| |                                                  |  | 2005                  |       | 2004                          | 
| |                                                  |  |                       |       |                               | 
| |                                                  |  | (U.S. $ in thousands) |      
| |                                                  |  |                       |      
| |                                                  |  | Amortized
  cost      |       | Unrealized
  gains
  (losses) |  | Market
  value |   | Amortized
  costs |       | Unrealized
  gains
  (losses) |  | Market
  value | 
| |                                                  |  |                       |       |                               |  |                |   |                   |       |                               |  |                | 
|
| | Available-for-sale:                              |  |                       |       |                               |  |                |   |                   |       |                               |  |                |  |  |      |   |  |        | 
| | Government
  debentures                          |  |                       | 1,732 |                               |  | (71            | ) |                   | 1,661 |                               |  | 3,513          |  |  | (11  | ) |  | 3,502  | 
| | Commercial
  debentures                          |  |                       | 7,698 |                               |  | (91            | ) |                   | 7,607 |                               |  | 11,960         |  |  | (103 | ) |  | 11,857 | 
| | Equity
  funds                                   |  |                       | 486   |                               |  | (36            | ) |                   | 450   |                               |  | 980            |  |  | 41   |   |  | 1,021  | 
| |                                                  |  |                       |       |                               |  |                |   |                   |       |                               |  |                |  |  |      |   |  |        | 
| | Total available-for-sale
  marketable securities |  |                       | 9,916 |                               |  | (198           | ) |                   | 9,718 |                               |  | 16,453         |  |  | (73  | ) |  | 16,380 | 
| |                                                  |  |                       |       |                               |  |                |   |                   |       |                               |  |                |  |  |      |   |  |        | 

| |                                                                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | During 2005,
  the Company recorded proceeds from sales of marketable securities in the
  amount of $11,249 thousands and related gains of $255 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, 2005. 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,
  2005, by contractual maturity, are as follows:                                                                                                                                                                                                                        

| |                                   |  |                       |  |                |  |                   |        |                |        | 
| | --------------------------------- |  | --------------------- |  | -------------- |  | ----------------- | ------ | -------------- | ------ | 
| |                                   |  | December 31,          | 
| |                                   |  |                       | 
| |                                   |  | 2005                  |  | 2004           | 
| |                                   |  |                       | 
| |                                   |  | (U.S. $ in thousands) | 
| |                                   |  |                       | 
| |                                   |  | Cost                  |  | Market
  value |  | Amortized
  costs |        | Market
  value |       
| |                                   |  |                       |  |                |  |                   |        |                |       
| |                                   |  |                       |  |                |  |                   |        |                |       
| | Available-for-sale:               |  |                       |  |                |  |                   |        |                |       
| | Matures in one year               |  | 5,781                 |  | 5,787          |  |                   | 980    |                | 1,021  | 
| | Matures in one to five
years      |  | 3,251                 |  | 3,076          |  |                   | 9,835  |                | 9,684  | 
| | Matures in more than five
  years |  | 884                   |  | 855            |  |                   | 5,638  |                | 5,675  | 
| |                                   |  |                       |  |                |  |                   |        |                |        | 
| |                                   |  | 9,916                 |  | 9,718          |  |                   | 16,453 |                | 16,380 | 
| |                                   |  |                       |  |                |  |                   |        |                |        | 

F-31

---

---



FORMULA
SYSTEMS (1985) LTD.

(An Israeli
Corporation)

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

Note 4  Loans and Other
Investments:

Comprise:

|                             |  |               |  |         |        |                       |       |      |       | 
|---------------------------- |  | ------------- |  | ------- | ------ | --------------------- | ----- | ---- | ----- | 
|                             |  |               |  |         |        | December 31,          |      
|                             |  |               |  |         |        |                       |      
|                             |  | Interest rate |  |         |        | 2005                  |       | 2004 |      
|                             |  |               |  | Linkage |        |                       |       |      |      
|                             |  | %             |  | basis   |        | (U.S. $ in thousands) |      
|                             |  |               |  |         |        |                       |      
|Cost
  of shares (1)         |  |               |  |         |        |                       | 940   |      | 1,788 | 
|                             |  |               |  |         |        |                       |       |      |       | 
|Long-term
  prepaid expenses |  |               |  |         |        |                       | 561   |      | 640   | 
|                             |  |               |  |         |        |                       |       |      |       | 
|                             |  |               |  |         |        |                       |       |      |       | 
|Restricted
  deposit         |  | -             |  |         | Dollar |                       | -     |      | 1,532 | 
|                            
|Deposit                      |  | -             |  |         | Dollar |                       | 244   |      | 55    | 
|                            
|Deposit                      |  | -             |  |         | CPI    |                       | 344   |      | 348   | 
|                            
|Deposit                      |  | 0-3           |  |         | Yen    |                       | 544   |      | 378   | 
|                            
|Deposit                      |  | -             |  |         | Euro   |                       | 2     |      | -     | 
|                            
|Deposit                      |  | -             |  |         | GBP    |                       | 15    |      | -     | 
|                            
|Loan
  (2)                   |  | -             |  |         | CPI    |                       | 441   |      | 506   | 
|                             |  |               |  |         |        |                       |       |      |       | 
|                             |  |               |  |         |        |                       | 1,590 |      | 2,819 | 
|                             |  |               |  |         |        |                       |       |      |       | 
|                             |  |               |  |         |        |                       |       |      |       | 
|Total                        |  |               |  |         |        |                       | 3,091 |      | 5,247 | 
|                             |  |               |  |         |        |                       |       |      |       | 

|    |                                                                                                                                                     
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | During
  2005 and 2004 impairment losses on cost investments have been
  identified in the amounts of $0 thousand
  and $93 thousand
  respectively.
|    |                                                                                                                                                     
|(2) | No
  repayment date has been set.                                                                                                                   

F-32

---

---



FORMULA
SYSTEMS (1985) LTD.

(An Israeli
Corporation)

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

Note 5 
Investments in Affiliates:

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

| |                                                                 |  |                       |   |         |  
| | --------------------------------------------------------------- |  | --------------------- | - | ------- | -
| |                                                                 |  | December 31,          |  
| |                                                                 |  |                       |  
| |                                                                 |  | 2005                  |   | 2004    |  
| |                                                                 |  |                       |   |         |  
| |                                                                 |  | (U.S. $ in thousands) |  
| |                                                                 |  |                       |  
| | Investment in shares:                                           |  |                       |   |         |  
| |                                                                 |  |                       |   |         |  
| | Cost                                                            |  | 24,873                |   | 28,188  |  
|
| | Goodwill
  and allocated original excess cost **                |  | (9,547                | ) | (12,174 | )
| |                                                                 |  |                       |   |         |  
| | Net asset value as of
  acquisition date                        |  | 15,326                |   | 16,014  |  
|
| | Equity
  in post-acquisition undistributed retained losses, net |  | (4,935                | ) | (4,159  | )
| |                                                                 |  |                       |   |         |  
| | Net asset value as of the
balance sheet date                    |  | 10,391                |   | 11,855  |  
|
| | Balance
  of goodwill                                           |  | 9,668                 |   | 12,297  |  
| |                                                                 |  |                       |   |         |  
| |                                                                 |  | 20,059                |   | 24,152  |  
| |                                                                 |  |                       |   |         |  
| | Loans to affiliates:                                            |  |                       |   |         |  
| | Index-linked
  and interest-free *                              |  | 98                    |   | 117     |  
|
| | Linked
  to the dollar and bearing annual interest of 3.71%*    |  | 100                   |   | 120     |  
| |                                                                 |  |                       |   |         |  
| | Total                                                           |  | 20,257                |   | 24,389  |  
| |                                                                 |  |                       |   |         |  

| |    |                                                                                                                                                                                                     
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | *  | No repayment date has been set.                                                                                                                                                                     
| |    |                                                                                                                                                                                                     
| | ** | 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).

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

| |                     |  |                       |   |         |  
| | ------------------- |  | --------------------- | - | ------- | -
| |                     |  | December 31,          |  
| |                     |  |                       |  
| |                     |  | 2005                  |   | 2004    |  
| |                     |  |                       |   |         |  
| |                     |  | (U.S. $ in thousands) |  
| |                     |  |                       |  
| |                     |  |                       |  
| | Total
  assets      |  | 103,693               |   | 92,849  |  
| |                     |  |                       |   |         |  
|
| | Total
  liabilities |  | (34,311               | ) | (31,984 | )
| |                     |  |                       |   |         |  
|
| | Net
  loss          |  | (13,823               | ) | (7,784  | )
| |                     |  |                       |   |         |  

F-33

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

Note 6  Property and Equipment, net:

Comprise:

| |                             |  |                       |  |        | 
| | --------------------------- |  | --------------------- |  | ------ | 
| |                             |  | December 31,          | 
| |                             |  |                       | 
| |                             |  | 2005                  |  | 2004   | 
| |                             |  |                       |  |        | 
| |                             |  | (U.S. $ in thousands) | 
| |                             |  |                       | 
| | Cost:                       |  |                       |  |        | 
|
| | Computers and
equipment     |  | 74,166                |  | 63,228 | 
|
| | Motor vehicles              |  | 2,869                 |  | 5,538  | 
|
| | Buildings                   |  | 4,569                 |  | 11,614 | 
|
| | Leasehold
improvements      |  | 16,491                |  | 8,434  | 
| |                             |  |                       |  |        | 
| |                             |  | 98,095                |  | 88,814 | 
| |                             |  |                       |  |        | 
| | Accumulated
  Depreciation: |  |                       |  |        | 
|
| | Computers and
equipment     |  | 63,172                |  | 51,933 | 
|
| | Motor vehicles              |  | 1,180                 |  | 2,058  | 
|
| | Buildings                   |  | 1,214                 |  | 2,973  | 
|
| | Leasehold
improvements      |  | 9,044                 |  | 5,321  | 
| |                             |  |                       |  |        | 
| |                             |  | 74,610                |  | 62,285 | 
| |                             |  |                       |  |        | 
| | Depreciated
  balance       |  | 23,485                |  | 26,529 | 
| |                             |  |                       |  |        | 

| |                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | Depreciation
  expense totaled $7,031 thousand; $7,810 thousand and $7,251 thousand for the
  years ended December 31, 2005, 2004 and 2003, respectively.
| |                                                                                                                                                          
| | See Note
  13.B with respect to pledges.                                                                                                                 

Note 7  Goodwill:

The changes in
the carrying amount of goodwill for the year ended December 31, 2005 are as
follows:

|                                                      |  |                       |  
|----------------------------------------------------- |  | --------------------- | -
|                                                      |  | U.S. $ in
  thousands |  
|                                                      |  |                       |  
|                                                      |  |                       |  
|Balance as
  of January 1, 2005                       |  | 196,921               |  
|                                                     
|Acquisition
  of additional interest in subsidiaries  |  | 6,989                 |  
|                                                     
|Capital fund                                          |  | (1,398                | )
|                                                     
|Realization
  and decrease in shareholding percentage |  | (3,396                | )
|                                                     
|Acquisition
  of newly-consolidated subsidiaries      |  | 7,981                 |  
|                                                     
|Realization
  of previously consolidated subsidiaries |  | (866                  | )
|                                                     
|Foreign
  currency translation adjustments            |  | (6,193                | )
|                                                      |  |                       |  
|Balance as of December 31,
2005                       |  | 200,038               |  
|                                                      |  |                       |  

F-34

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

Note 8  Other Assets, Net:

Comprised as follows:

|   |                                        |  |                       |  |         | 
|-- | -------------------------------------- |  | --------------------- |  | ------- | 
|   |                                        |  | December 31,          | 
|   |                                        |  |                       | 
|   |                                        |  | 2005                  |  | 2004    | 
|   |                                        |  |                       |  |         | 
|   |                                        |  | (U.S. $ in thousands) | 
|   |                                        |  |                       | 
|A. | Original amounts:                      |  |                       |  |         | 
|   | Capitalized software
development costs |  | 124,233               |  | 113,135 | 
|  
|   | Deferred expenses and
others           |  | 18,423                |  | 13,369  | 
|  
|   | Deferred tax asset                     |  | 6,282                 |  | 5,467   | 
|   |                                        |  |                       |  |         | 
|   |                                        |  | 148,938               |  | 131,971 | 
|   |                                        |  |                       |  |         | 
|   | Accumulated
  amortization:            |  |                       |  |         | 
|   | Capitalized software
development costs |  | 71,846                |  | 62,045  | 
|  
|   | Deferred expenses and
others           |  | 7,425                 |  | 5,488   | 
|   |                                        |  |                       |  |         | 
|   |                                        |  | 79,271                |  | 67,533  | 
|   |                                        |  |                       |  |         | 
|   | Total                                  |  | 69,667                |  | 64,438  | 
|   |                                        |  |                       |  |         | 

|   |                                                                                                                                                           
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|B. | Amortized expenses totaled
  $15,657 thousand, $11,496 thousand and $10,573 thousand for the years ended
  December 31, 2005, 2004 and 2003, respectively.
|   |                                                                                                                                                           
|   | As for impairments of
  software development cost, see Note 1J.                                                                                           
|   |                                                                                                                                                           
|C. | Estimated deferred
  expenses and other intangible assets amortization expenses for the years
  ended:                                                    

| |                     |  |                         |  | 
| | ------------------- |  | ----------------------- |  | 
| |                     |  | (U.S. $ in
  thousands) |  | 
| |                     |  |                         |  | 
| | December
  31,      |  |                         |  | 
|
| | 2006                |  | 3,264                   |  | 
|
| | 2007                |  | 2,261                   |  | 
|
| | 2008                |  | 1,976                   |  | 
|
| | 2009                |  | 952                     |  | 
|
| | 2010 and thereafter |  | 1,843                   |  | 

Note 9  Debentures:

|                                      |  |         |  |                 |                       |  |              |  |        | 
|------------------------------------- |  | ------- |  | --------------- | --------------------- |  | ------------ |  | ------ | 
|                                      |  |         |  |                 |                       |  | December 31, | 
|                                      |  |         |  |                 |                       |  |             
|                                      |  |         |  |                 | 2005                  |  | 2004         | 
|                                      |  |         |  | Interest
  rate |                       |  |              |  |       
|                                      |  | Linkage |  |                 | (U.S. $ in thousands) | 
|                                      |  |         |  |                 |                       |  |              |  |       
|Debenture
  (see note 2C)             |  | CPI     |  | 5.77            |                       |  | -            |  | 15,875 | 
|                                     
|Convertible
  debenture (see note 2D) |  | CPI     |  | 4.95            |                       |  | 4,464        |  | 14,139 | 
|                                     
|Convertible
  debenture               |  | Dollar  |  | 6               |                       |  | 3,540        |  | 2,360  | 
|                                      |  |         |  |                 |                       |  |              |  |        | 
|Total                                 |  |         |  |                 |                       |  | 8,004        |  | 32,374 | 
|                                      |  |         |  |                 |                       |  |              |  |        | 

F-35

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 10  Liabilities to Banks and Others:

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

|      |                      |  |               |        |                       |                       |                    |                       |                                                       |        |                                                       |        |  |  |  |  | 
|----- | -------------------- |  | ------------- | ------ | --------------------- | --------------------- | ------------------ | --------------------- | ----------------------------------------------------- | ------ | ----------------------------------------------------- | ------ |  |  |  |  | 
|      | Interestrate         |  | 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, 2005 |  |               |        | December 31, 2005     |                       | December 31, 2004  |                      
|      |                      |  |               |        |                       |                       |                    |                      
|      | %                    |  |               |        |                       | (U.S. $ in thousands) |                    | (U.S. $ in thousands) |                                                      
|      |                      |  |               |        |                       |                       |                    |                       |                                                      
|      | 3.88-5               |  |               | Dollar |                       | 13,680                |                    | 3,501                 |                                                       | 10,179 |                                                       | 13,037 | 
|     
|      | 4.32-7.66            |  |               | CPI    |                       | 3,329                 |                    | 1,551                 |                                                       | 1,778  |                                                       | 2,209  | 
|     
|      | 0-9.35               |  |               | Other  |                       | 45,151                |                    | 4,450                 |                                                       | 40,701 |                                                       | 4,223  | 
|      |                      |  |               |        |                       |                       |                    |                       |                                                       |        |                                                       |        |  |  |  |  | 
|      |                      |  |               |        |                       | 62,160                |                    | 9,502                 |                                                       | 52,658 |                                                       | 19,469 | 
|      |                      |  |               |        |                       |                       |                    |                       |                                                       |        |                                                       |        |  |  |  |  | 
|      | Warrants             |  |               |        |                       | 74                    |                    | -                     |                                                       | 74     |                                                       | 320    | 
|      |                      |  |               |        |                       |                       |                    |                       |                                                       |        |                                                       |        |  |  |  |  | 
|Total |                      |  |               |        |                       | 62,234                |                    | 9,502                 |                                                       | 52,732 |                                                       | 19,789 | 
|      |                      |  |               |        |                       |                       |                    |                       |                                                       |        |                                                       |        |  |  |  |  | 

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

| |                                   |  |                       |        |      |  |        | 
| | --------------------------------- |  | --------------------- | ------ | ---- |  | ------ | 
| |                                   |  | December 31,          |       
| |                                   |  |                       |       
| |                                   |  | 2005                  |        | 2004 | 
| |                                   |  |                       |        |      | 
| |                                   |  | (U.S. $ in thousands) |       
| |                                   |  |                       |       
| | First
  year (current maturities) |  |                       | 9,502  |      |  | 17,349 | 
| |                                   |  |                       |        |      |  |        | 
| | Second
  year                     |  |                       | 16,561 |      |  | 17,909 | 
| |                                   |  |                       |        |      |  |        | 
| | Third
  year                      |  |                       | 17,145 |      |  | 1,404  | 
| |                                   |  |                       |        |      |  |        | 
| | Fourth
  year                     |  |                       | 18,113 |      |  | 102    | 
| |                                   |  |                       |        |      |  |        | 
| | Fifth
  year                      |  |                       | 913    |      |  | 27     | 
| |                                   |  |                       |        |      |  |        | 
| | Sixth
  year and thereafter       |  |                       | -      |      |  | 347    | 
| |                                   |  |                       |        |      |  |        | 
| | Total                             |  |                       | 62,234 |      |  | 37,138 | 
| |                                   |  |                       |        |      |  |        | 

|   |                                                    
|-- | ---------------------------------------------------
|C. | For details of liens and
  guarantees, see Note 13.

Note 11  Debentures:

Comprised as follows:

|                                       |  |         |        |               |  |                       |  |              |        |      |  |        | 
|-------------------------------------- |  | ------- | ------ | ------------- |  | --------------------- |  | ------------ | ------ | ---- |  | ------ | 
|                                       |  |         |        |               |  |                       |  | December 31, |       
|                                       |  |         |        |               |  |                       |  |              |       
|                                       |  |         |        |               |  |                       |  | 2005         |        | 2004 | 
|                                       |  |         |        |               |  |                       |  |              |        |      | 
|                                       |  | Linkage |        | Interest rate |  | (U.S. $ in thousands) | 
|                                       |  |         |        |               |  |                       | 
|                                       |  |         |        |               |  | Six-month             |  |              |        |      |  |        | 
|                                       |  |         |        |               |  | Libor                 |  |              |        |      |  |        | 
|Convertible
  debenture (see Note 2G)  |  |         | Dollar |               |  | 4.95%                 |  |              | 4,342  |      |  | 5,149  | 
|Convertible
  debenture (see Note 2D)  |  |         | CPI    |               |  | 5%                    |  |              | -      |      |  | 17,363 | 
|Convertible
  debenture                |  |         | Dollar |               |  | 6%                    |  |              | 3,540  |      |  | 4,720  | 
|Convertible
  debentuere (see Note 2E) |  |         | Dollar |               |  | 5%                    |  |              | 18,483 |      |  | 18,246 | 
|                                       |  |         |        |               |  |                       |  |              |        |      |  |        | 
|                                       |  |         |        |               |  |                       |  |              | 26,365 |      |  | 45,478 | 
|Deferred
  issuance expenses, net      |  |         |        |               |  |                       |  |              | 1,552  |      |  | 1,893  | 
|                                       |  |         |        |               |  |                       |  |              |        |      |  |        | 
|                                       |  |         |        |               |  |                       |  |              | 24,813 |      |  | 43,585 | 
|Current
  maturities                   |  |         |        |               |  |                       |  |              | 8,004  |      |  | 2,360  | 
|Current
  maturities (see note 2D)     |  |         |        |               |  |                       |  |              | -      |      |  | 14,139 | 
|                                       |  |         |        |               |  |                       |  |              |        |      |  |        | 
|                                       |  |         |        |               |  |                       |  |              | 16,809 |      |  | 27,086 | 
|                                       |  |         |        |               |  |                       |  |              |        |      |  |        | 

F-36

---

---



FORMULA SYSTEMS (1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 11  Debentures
(cont.):

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).

In accordance with EITF 00-27, the commitment date of the Debentures is
the date the offering was completed and the measurement date of
the Options was the exercise date of the Options.

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

F-37

---

---



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, 2005, 2004 and 2003 and changes
  during the years then ended:

|                                                                  |  |                     |  |                                   |   |                     |  |                                   |      |                     |  |                                   |   |  |  |      |  |      |  |           |   |  |  |      |  |  |      |  |  |  | 
|----------------------------------------------------------------- |  | ------------------- |  | --------------------------------- | - | ------------------- |  | --------------------------------- | ---- | ------------------- |  | --------------------------------- | - |  |  | ---- |  | ---- |  | --------- | - |  |  | ---- |  |  | ---- |  |  |  | 
|                                                                  |  | Year ended          |  | Year ended                        |   | Year ended          | 
|                                                                  |  | December
  31, 2005 |  | December
  31, 2004               |   | December
  31, 2003 | 
|                                                                  |  |                     |  |                                   |   |                     | 
|                                                                  |  | 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                |  |                     |  | 2,132,587                         |   |                     |  | 5.00                              |      |                     |  | 2,159,993                         |   |  |  | 4.99 |  |      |  | 1,347,260 |   |  |  | 6.56 | 
|                                                                 
|Changes during the year:                                          |  |                     |  |                                   |   |                     |  |                                   |      |                     |  |                                   |   |  |  |      |  |      |  |           |   |  |  |      |  |  |      |  |  |  | 
|                                                                 
|Granted                                                           |  |                     |  | 834,712                           |   |                     |  | 4.96                              |      |                     |  | 163,721                           |   |  |  | 6.00 |  |      |  | 923,000   |   |  |  | 3.03 | 
|                                                                 
|Exercised                                                         |  |                     |  | (10,299                           | ) |                     |  | 3.05                              |      |                     |  | (33,767                           | ) |  |  | 3.56 |  |      |  | (35,267   | ) |  |  | 2.33 | 
|                                                                 
|Forfeited                                                         |  |                     |  | (191,183                          | ) |                     |  | 8.04                              |      |                     |  | (157,360                          | ) |  |  | 6.29 |  |      |  | (75,000   | ) |  |  | 9.46 | 
|                                                                  |  |                     |  |                                   |   |                     |  |                                   |      |                     |  |                                   |   |  |  |      |  |      |  |           |   |  |  |      |  |  |      |  |  |  | 
|                                                                 
|Options outstanding at the end of the
year                        |  |                     |  | 2,765,817                         |   |                     |  | 4.78                              |      |                     |  | 2,132,587                         |   |  |  | 5.00 |  |      |  | 2,159,993 |   |  |  | 4.99 | 
|                                                                  |  |                     |  |                                   |   |                     |  |                                   |      |                     |  |                                   |   |  |  |      |  |      |  |           |   |  |  |      |  |  |      |  |  |  | 
|Options exercisable at year-end                                   |  |                     |  | 2,399,484                         |   |                     |  | 4.78                              |      |                     |  | 877,049                           |   |  |  | 6.08 |  |      |  | 1,233,575 |   |  |  | 6.04 | 
|                                                                  |  |                     |  |                                   |   |                     |  |                                   |      |                     |  |                                   |   |  |  |      |  |      |  |           |   |  |  |      |  |  |      |  |  |  | 
|Weighted-average fair value of options
  granted during the year* |  |                     |  |                                   |   |                     |  |                                   | 1.47 |                     |  |                                   |   |  |  |      |  | 1.71 |  |           |   |  |  |      |  |  | 0.54 | 
|                                                                  |  |                     |  |                                   |   |                     |  |                                   |      |                     |  |                                   |   |  |  |      |  |      |  |           |   |  |  |      |  |  |      |  |  |  | 

| |   |                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | * | 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:
  2005 - 41%, 2004 - 26%, 2003 - 28%, risk-free interest rate 2005 - 3.93%,
  2004  2.78%, 2003 - 2.1% and expected life: 2005, 2004 and 2003 -3 years.

F-38

---

---



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, 2005.

|                               |  |                                              |  |                                               |           |                                   |       |                                           |   |                                   |  |  |  |   |       |  |  |  |  |           |  |  |  |  |       |  | 
|------------------------------ |  | -------------------------------------------- |  | --------------------------------------------- | --------- | --------------------------------- | ----- | ----------------------------------------- | - | --------------------------------- |  |  |  | - | ----- |  |  |  |  | --------- |  |  |  |  | ----- |  | 
|                               |  | Options
  Outstanding                        |  | Options
  Exercisable                         |          
|                               |  |                                              |  |                                               |          
|Range of 
  Exercise 
  Prices |  | Number
  Outstanding 
  at December 31, 2005 |  | Weighted
  Average Remaining Contractual Life |           | Weighted
  Average Exercise Price |       | Number
  Exercisable at December 31, 2005 |   | Weighted
  Average Exercise Price | 
|                               |  |                                              |  |                                               |           |                                   |       |                                           |   |                                   | 
|$                              |  |                                              |  |                                               |           |                                   | Years |                                           | $ |                                   |  |  |  | $ |      
|                               |  |                                              |  |                                               |           |                                   |       |                                           |   |                                   |  |  |  |   |      
|                               |  |                                              |  |                                               |           |                                   |       |                                           |   |                                   |  |  |  |   |       |  |  |  |  |           |  |  |  |  |       | 
|2.25                           |  |                                              |  |                                               | 416,000   |                                   |       |                                           |   | 7.25                              |  |  |  |   | 2.25  |  |  |  |  | 166,000   |  |  |  |  | 2.25  |  | 
|                              
|3.00                           |  |                                              |  |                                               | 106,701   |                                   |       |                                           |   | 7.50                              |  |  |  |   | 3.00  |  |  |  |  | 106,701   |  |  |  |  | 3.00  |  | 
|                              
|3.00                           |  |                                              |  |                                               | 150,000   |                                   |       |                                           |   | 6.50                              |  |  |  |   | 3.00  |  |  |  |  | 150,000   |  |  |  |  | 3.00  |  | 
|                              
|3.00                           |  |                                              |  |                                               | 80,000    |                                   |       |                                           |   | 6.09                              |  |  |  |   | 3.00  |  |  |  |  | 26,667    |  |  |  |  | 3.00  |  | 
|                              
|3.50                           |  |                                              |  |                                               | 70,000    |                                   |       |                                           |   | 7.50                              |  |  |  |   | 3.50  |  |  |  |  | 70,000    |  |  |  |  | 3.50  |  | 
|                              
|3.50                           |  |                                              |  |                                               | 19,500    |                                   |       |                                           |   | 7.75                              |  |  |  |   | 3.50  |  |  |  |  | 6,500     |  |  |  |  | 3.50  |  | 
|                              
|4.00                           |  |                                              |  |                                               | 200,000   |                                   |       |                                           |   | 7.83                              |  |  |  |   | 4.00  |  |  |  |  | 150,000   |  |  |  |  | 4.00  |  | 
|                              
|4.00                           |  |                                              |  |                                               | 150,000   |                                   |       |                                           |   | 10.00                             |  |  |  |   | 4.00  |  |  |  |  | 150,000   |  |  |  |  |       |  | 
|                              
|4.50                           |  |                                              |  |                                               | 39,183    |                                   |       |                                           |   | 5.50                              |  |  |  |   | 4.50  |  |  |  |  | 39,183    |  |  |  |  | 4.50  |  | 
|                              
|4.50                           |  |                                              |  |                                               | 63,000    |                                   |       |                                           |   | 9.67                              |  |  |  |   | 4.50  |  |  |  |  | 63,000    |  |  |  |  | 4.50  |  | 
|                              
|5.00                           |  |                                              |  |                                               | 37,400    |                                   |       |                                           |   | 9.83                              |  |  |  |   | 5.00  |  |  |  |  | 37,400    |  |  |  |  |       |  | 
|                              
|5.00                           |  |                                              |  |                                               | 434,312   |                                   |       |                                           |   | 10.00                             |  |  |  |   | 5.00  |  |  |  |  | 434,312   |  |  |  |  |       |  | 
|                              
|5.20                           |  |                                              |  |                                               | 139,500   |                                   |       |                                           |   | 0.75                              |  |  |  |   | 5.20  |  |  |  |  | 139,500   |  |  |  |  | 5.20  |  | 
|                              
|5.50                           |  |                                              |  |                                               | 13,000    |                                   |       |                                           |   | 4.83                              |  |  |  |   | 5.50  |  |  |  |  | 13,000    |  |  |  |  | 5.50  |  | 
|                              
|6.00                           |  |                                              |  |                                               | 28,000    |                                   |       |                                           |   | 8.00                              |  |  |  |   | 6.00  |  |  |  |  | 28,000    |  |  |  |  | 6.00  |  | 
|                              
|6.00                           |  |                                              |  |                                               | 143,721   |                                   |       |                                           |   | 8.42                              |  |  |  |   | 6.00  |  |  |  |  | 143,721   |  |  |  |  | 6.00  |  | 
|                              
|6.00                           |  |                                              |  |                                               | 150,000   |                                   |       |                                           |   | 9.67                              |  |  |  |   | 6.00  |  |  |  |  | 150,000   |  |  |  |  |       |  | 
|                              
|6.50                           |  |                                              |  |                                               | 311,900   |                                   |       |                                           |   | 0.21                              |  |  |  |   | 6.50  |  |  |  |  | 311,900   |  |  |  |  | 6.50  |  | 
|                              
|6.50                           |  |                                              |  |                                               | 2,000     |                                   |       |                                           |   | 8.00                              |  |  |  |   | 6.50  |  |  |  |  | 2,000     |  |  |  |  | 6.50  |  | 
|                              
|8.00                           |  |                                              |  |                                               | 80,000    |                                   |       |                                           |   | 3.50                              |  |  |  |   | 8.00  |  |  |  |  | 80,000    |  |  |  |  | 8.00  |  | 
|                              
|9.63                           |  |                                              |  |                                               | 43,000    |                                   |       |                                           |   | 4.25                              |  |  |  |   | 9.63  |  |  |  |  | 43,000    |  |  |  |  | 9.63  |  | 
|                              
|10.50                          |  |                                              |  |                                               | 88,600    |                                   |       |                                           |   | 5.25                              |  |  |  |   | 10.50 |  |  |  |  | 88,600    |  |  |  |  | 10.50 |  | 
|                               |  |                                              |  |                                               |           |                                   |       |                                           |   |                                   |  |  |  |   |       |  |  |  |  |           |  |  |  |  |       |  | 
|                               |  |                                              |  |                                               | 2,765,817 |                                   |       |                                           |   |                                   |  |  |  |   |       |  |  |  |  | 2,399,484 |  |  |  |  |       |  | 
|                               |  |                                              |  |                                               |           |                                   |       |                                           |   |                                   |  |  |  |   |       |  |  |  |  |           |  |  |  |  |       |  | 

F-39

---

---



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, 2005, 2004 and 2003:

| |                                                                  |  |                                |           |                                  |   |                                |  |                                  |           |                     |  |                                  |  |  |           |   |  |      | 
| | ---------------------------------------------------------------- |  | ------------------------------ | --------- | -------------------------------- | - | ------------------------------ |  | -------------------------------- | --------- | ------------------- |  | -------------------------------- |  |  | --------- | - |  | ---- | 
| |                                                                  |  | Year ended
  December 31, 2005 |           | Year ended
  December 31, 2004   |   | Year ended
  December 31, 2003 | 
| |                                                                  |  |                                |           |                                  |   |                                | 
| |                                                                  |  | Number of
  Options            |           | Weighted
  Average ExercisePrice |   | Number of
  Options            |  | Weighted
  Average ExercisePrice |           | Number of
  Options |  | Weighted
  Average ExercisePrice | 
| |                                                                  |  |                                |           |                                  |   |                                |  |                                  |           |                     |  |                                  | 
| |                                                                  |  |                                |           |                                  | $ |                                |  |                                  |           | $                   |  |                                  |  |  | $         |  
| |                                                                  |  |                                |           |                                  |   |                                |  |                                  |           |                     |  |                                  |  |  |           |  
| | Options outstanding at the beginning of the year                 |  |                                | 2,513,237 |                                  |   | 2.95                           |  |                                  | 3,346,406 |                     |  | 2.26                             |  |  | 2,751,937 |   |  | 2.31 | 
| |                                                                  |  |                                |           |                                  |   |                                |  |                                  |           |                     |  |                                  |  |  |           |   |  |      | 
| | Granted                                                          |  |                                | 820,028   |                                  |   | 1.70                           |  |                                  | 406,601   |                     |  | 4.84                             |  |  | 1,924,283 |   |  | 2.57 | 
| |                                                                  |  |                                |           |                                  |   |                                |  |                                  |           |                     |  |                                  |  |  |           |   |  |      | 
| | Exercised                                                        |  |                                | (80,604   | )                                |   | 1.04                           |  |                                  | (973,551  | )                   |  | 1.28                             |  |  | (775,284  | ) |  | 1.17 | 
| |                                                                  |  |                                |           |                                  |   |                                |  |                                  |           |                     |  |                                  |  |  |           |   |  |      | 
| | Cancelled                                                        |  |                                | -         |                                  |   | -                              |  |                                  | -         |                     |  | -                                |  |  | -         |   |  | -    | 
| |                                                                  |  |                                |           |                                  |   |                                |  |                                  |           |                     |  |                                  |  |  |           |   |  |      | 
| | Forfeited                                                        |  |                                | (191,445  | )                                |   | 3.54                           |  |                                  | (266,219  | )                   |  | 3.6                              |  |  | (554,530  | ) |  | 3.35 | 
| |                                                                  |  |                                |           |                                  |   |                                |  |                                  |           |                     |  |                                  |  |  |           |   |  |      | 
| | Outstanding at the end of the year                               |  |                                | 3,061,216 |                                  |   | 2.62                           |  |                                  | 2,513,237 |                     |  | 2.95                             |  |  | 3,346,406 |   |  | 2.26 | 
| |                                                                  |  |                                |           |                                  |   |                                |  |                                  |           |                     |  |                                  |  |  |           |   |  |      | 
| |                                                                  |  |                                |           |                                  |   |                                |  |                                  |           |                     |  |                                  |  |  |           |   |  |      | 
| | Exercisable at the end of the year                               |  |                                | 3,061,216 |                                  |   | 2.62                           |  |                                  | 1,423,970 |                     |  | 2.28                             |  |  | 1,304,338 |   |  | 1.92 | 
| |                                                                  |  |                                |           |                                  |   |                                |  |                                  |           |                     |  |                                  |  |  |           |   |  |      | 
| | Weighted average fair value of options granted during the year
* |  |                                |           |                                  |   | 1.1                            |  |                                  |           |                     |  | 2.2                              |  |  |           |   |  | 1.28 | 
| |                                                                  |  |                                |           |                                  |   |                                |  |                                  |           |                     |  |                                  |  |  |           |   |  |      | 

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | * | 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, 2005,2004 and 2003: expected volatility of 80%, 67.3% and 66.6%,
  respectively, risk-free interest rates of 3.9%, 2.8% and 1.5% respectively,
  dividend yields of 0% for each year, and a weighted average expected life of
  the option of 5 years, 3 years and 3 years, respectively.

F-40

---

---



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

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

|   |         
|-- | --------
|B. | (cont.):

| | The following table summarizes information regarding options
  outstanding as of December 31, 2005:
| | ---------------------------------------------------------------------------------------------------

| |                             |       |                                                 |  |                                                   |  |   |                                     |  |       |                                             |  |                                     |           |  |       | 
| | --------------------------- | ----- | ----------------------------------------------- |  | ------------------------------------------------- |  | - | ----------------------------------- |  | ----- | ------------------------------------------- |  | ----------------------------------- | --------- |  | ----- | 
| |                             |       | Options
  Outstanding                           |  | Options
  Exercisable                             | 
| |                             |       |                                                 |  |                                                   | 
| | Range of
  Exercise
  Price |       | Number
  Outstanding
  at
  December 31,
  2005 |  | Weighted
  Average
  Remaining Contractual
  Life |  |   | Weighted
  Average
  Exercise Price |  |       | Number
  Exercisable at December 31,
  2005 |  | Weighted
  Average
  Exercise Price |          
| |                             |       |                                                 |  |                                                   |  |   |                                     |  |       |                                             |  |                                     |          
| | $                           |       |                                                 |  | Years                                             |  |   | $                                   |  |       |                                             |  | $                                   |          
| |                             |       |                                                 |  |                                                   |  |   |                                     |  |       |                                             |  |                                     |           | 
| |                             | 0-1   |                                                 |  | 289,006                                           |  | 6 |                                     |  | 0.85  |                                             |  |                                     | 289,006   |  | 0.85  | 
|
| |                             | 1-2   |                                                 |  | 1,464,024                                         |  | 8 |                                     |  | 1.33  |                                             |  |                                     | 1,464,024 |  | 1.33  | 
|
| |                             | 2-3   |                                                 |  | 15,900                                            |  | 4 |                                     |  | 2.45  |                                             |  |                                     | 15,900    |  | 2.45  | 
|
| |                             | 3-4   |                                                 |  | 616,234                                           |  | 8 |                                     |  | 3.84  |                                             |  |                                     | 616,234   |  | 3.84  | 
|
| |                             | 4-5   |                                                 |  | 479,391                                           |  | 8 |                                     |  | 4.11  |                                             |  |                                     | 479,391   |  | 4.11  | 
|
| |                             | 5-6   |                                                 |  | 145,500                                           |  | 8 |                                     |  | 5.95  |                                             |  |                                     | 145,500   |  | 5.95  | 
|
| |                             | 6-7   |                                                 |  | 1,011                                             |  | 4 |                                     |  | 6.14  |                                             |  |                                     | 1,011     |  | 6.14  | 
|
| |                             | 10-11 |                                                 |  | 41,150                                            |  | 4 |                                     |  | 10.16 |                                             |  |                                     | 41,150    |  | 10.16 | 
|
| |                             | 18-19 |                                                 |  | 9,000                                             |  | 4 |                                     |  | 18.79 |                                             |  |                                     | 9,000     |  | 18.79 | 
| |                             |       |                                                 |  |                                                   |  |   |                                     |  |       |                                             |  |                                     |           |  |       | 
| |                             |       |                                                 |  | 3,061,216                                         |  | 8 |                                     |  | 2.62  |                                             |  |                                     | 3,061,216 |  | 2.62  | 
| |                             |       |                                                 |  |                                                   |  |   |                                     |  |       |                                             |  |                                     |           |  |       | 
| |                             |       |                                                 |  |                                                   |  |   |                                     |  |       |                                             |  |                                     |           |  |       | 

|   |                                                                                                                                                
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------
|C. | The following is a  summary of
  the status of option plans in Matrix as of December 31, 2005 and 2004 and changes during 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 | 
| |                                                                     |  |                                |   |   |                                       |  |  |                      |   |  |                                       | 
| |                                                                     |  |                                |   | $ |                                       |  |  |                      | $ | 
| |                                                                     |  |                                |   |   |                                       |  |  |                      |   | 
| | Options
  outstanding at the beginning of the year                  |  | 6,031,380                      |   |   | 1.8                                   |  |  | 5,665,002            |   |  | 1.62                                  | 
| |                                                                     |  |                                |   |   |                                       |  |  |                      |   |  |                                       | 
| | Changes during
  the year:                                          |  |                                |   |   |                                       |  |  |                      |   |  |                                       | 
| |                                                                     |  |                                |   |   |                                       |  |  |                      |   |  |                                       | 
| | Granted                                                             |  | 530,800                        |   |   | 1.710                                 |  |  | 1,359,000            |   |  | 2.26                                  | 
| |                                                                     |  |                                |   |   |                                       |  |  |                      |   |  |                                       | 
| | Exercised                                                           |  | (1,329,302                     | ) |   | 1.434                                 |  |  | (890,831             | ) |  | 1.6                                   | 
| |                                                                     |  |                                |   |   |                                       |  |  |                      |   |  |                                       | 
| | Forfeited                                                           |  | (29,219                        | ) |   | 1.410                                 |  |  | (101,791             | ) |  | 1.64                                  | 
| |                                                                     |  |                                |   |   |                                       |  |  |                      |   |  |                                       | 
| | Options
  outstanding at the end of the year                        |  | 5,203,659                      |   |   | 1.588                                 |  |  | 6,031,380            |   |  | 1.8                                   | 
| |                                                                     |  |                                |   |   |                                       |  |  |                      |   |  |                                       | 
| | Options
  exercisable at end of year                                |  | 5,180,707                      |   |   | 1.588                                 |  |  | 3,689,752            |   |  | 1.65                                  | 
| |                                                                     |  |                                |   |   |                                       |  |  |                      |   |  |                                       | 
| | Weighted
  average fair value of options granted during the year(*) |  |                                |   |   | -                                     |  |  |                      |   |  | 1.15                                  | 
| |                                                                     |  |                                |   |   |                                       |  |  |                      |   |  |                                       | 

F-41

---

---



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

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

|   |         
|-- | --------
|C. | (cont.):

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | * | The fair value of each option granted is estimated on the date of grant
  using the Black-Scholes option-pricing model, with the following weighted
  average assumptions used for grants: dividend yield of 0% for all the years;
  expected volatility: 2004 -
  31.3%, 2003 - 47.31%, 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, 2005:

| |                              |       |                                               |           |                       |                                                 |      |                                     |  |                                                 |   |                                     |  |           |  |       | 
| | ---------------------------- | ----- | --------------------------------------------- | --------- | --------------------- | ----------------------------------------------- | ---- | ----------------------------------- |  | ----------------------------------------------- | - | ----------------------------------- |  | --------- |  | ----- | 
| |                              |       | Options
  Outstanding                         |           | Options
  Exercisable |                                                
| |                              |       |                                               |           |                       |                                                
| | Range of
  Exercise
  Prices |       | Number
  Outstanding
  at December
  31, 2005 |           |                       | Weighted
  Average
  Remaining Contractual Life |      | Weighted
  Average
  Exercise Price |  | Number
  Exercisable
  at
  December
  31, 2005 |   | Weighted
  Average
  Exercise Price | 
| |                              |       |                                               |           |                       |                                                 |      |                                     |  |                                                 |   |                                     | 
| | $                            |       |                                               |           | Years                 |                                                 | $    |                                     |  |                                                 | $ |                                    
| |                              |       |                                               |           |                       |                                                 |      |                                     |  |                                                 |   |                                    
| |                              | 1.199 |                                               | 459,054   |                       |                                                 | 2.68 |                                     |  | 1.199                                           |   |                                     |  | 463,654   |  | 1.199 | 
|
| |                              | 1.399 |                                               | 2,389,772 |                       |                                                 | 3.39 |                                     |  | 1.399                                           |   |                                     |  | 2,362,220 |  | 1.399 | 
|
| |                              | 1.599 |                                               | 839,833   |                       |                                                 | 3.55 |                                     |  | 1.599                                           |   |                                     |  | 839,833   |  | 1.599 | 
|
| |                              | 1.999 |                                               | 1,515,000 |                       |                                                 | 4.34 |                                     |  | 1.999                                           |   |                                     |  | 1,515,000 |  | 1.999 | 
| |                              |       |                                               |           |                       |                                                 |      |                                     |  |                                                 |   |                                     |  |           |  |       | 
| |                              |       |                                               | 5,203,659 |                       |                                                 |      |                                     |  |                                                 |   |                                     |  | 5,180,707 |  |       | 
| |                              |       |                                               |           |                       |                                                 |      |                                     |  |                                                 |   |                                     |  |           |  |       | 

F-42

---

---



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, 2005, 2004 and 2003 and changes during the years then ended:

| |                                                                 |  |                                |   |                                |                                       |                                |  |                     |   |   |                                       |  |  |                     |   |  |                                    | 
| | --------------------------------------------------------------- |  | ------------------------------ | - | ------------------------------ | ------------------------------------- | ------------------------------ |  | ------------------- | - | - | ------------------------------------- |  |  | ------------------- | - |  | ---------------------------------- | 
| |                                                                 |  | Year ended
  December 31, 2005 |   | Year ended
  December 31, 2004 |                                       | Year ended
  December 31, 2003 | 
| |                                                                 |  |                                |   |                                |                                       |                                | 
| |                                                                 |  | Number of
  options            |   |                                | Weighted
  Average
  Exercise
  Price |                                |  | Number of
  options |   |   | Weighted
  Average
  Exercise
  Price |  |  | Number of
  options |   |  | WeightedAverage
  Exercise
  Price | 
| |                                                                 |  |                                |   |                                |                                       |                                |  |                     |   |   |                                       |  |  |                     |   |  |                                    | 
| |                                                                 |  |                                |   |                                | $                                     |                                |  |                     |   | $ |                                       |  |  |                     | $ | 
| |                                                                 |  |                                |   |                                |                                       |                                |  |                     |   |   |                                       |  |  |                     |   |  |                                   
| | Options outstanding at the beginning of the
year                |  | 1,640,871                      |   |                                | 9.05                                  |                                |  | 1,558,495           |   |   | 10.25                                 |  |  | **1,580,713         |   |  | 11.25                              | 
| | Changes during the year:                                        |  |                                |   |                                |                                       |                                |  |                     |   |   |                                       |  |  |                     |   |  |                                    | 
| |                                                                 |  |                                |   |                                |                                       |                                |  |                     |   |   |                                       |  |  |                     |   |  |                                    | 
| | Granted                                                         |  | 1,608,200                      |   |                                | 2.61                                  |                                |  | 321,539             |   |   | 4.05                                  |  |  | 157,600             |   |  | 4.06                               | 
| |                                                                 |  |                                |   |                                |                                       |                                |  |                     |   |   |                                       |  |  |                     |   |  |                                    | 
| | Exercised                                                       |  | (19,500                        | ) |                                | -                                     |                                |  | (5,000              | ) |   | 4.07                                  |  |  | (6,820              | ) |  | 3.91                               | 
| |                                                                 |  |                                |   |                                |                                       |                                |  |                     |   |   |                                       |  |  |                     |   |  |                                    | 
| | Forfeited                                                       |  | (417,359                       | ) |                                | 8.31                                  |                                |  | (234,163            | ) |   | 10.23                                 |  |  | (172,998            | ) |  | 14.05                              | 
| |                                                                 |  |                                |   |                                |                                       |                                |  |                     |   |   |                                       |  |  |                     |   |  |                                    | 
| | Options outstanding at the end of the
year                      |  | **2,812,212                    |   |                                | 5.54                                  |                                |  | **1,640,871         |   |   | 9.05                                  |  |  | **1,558,495         |   |  | 10.25                              | 
| |                                                                 |  |                                |   |                                |                                       |                                |  |                     |   |   |                                       |  |  |                     |   |  |                                    | 
| | Options exercisable at year-end                                 |  | 2,812,212                      |   |                                | 5.54                                  |                                |  | 1,143,432           |   |   | 11.24                                 |  |  | 1,095,779           |   |  | 11.86                              | 
| |                                                                 |  |                                |   |                                |                                       |                                |  |                     |   |   |                                       |  |  |                     |   |  |                                    | 
| | Weighted-average fair value of options granted during the
year* |  |                                |   |                                | 1.32                                  |                                |  |                     |   |   | 1.46                                  |  |  |                     |   |  | 2.30                               | 
| |                                                                 |  |                                |   |                                |                                       |                                |  |                     |   |   |                                       |  |  |                     |   |  |                                    | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | *  | 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.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                       
| | ** | Including 102,100, 102,100, and 62,300 options repriced to zero, as
  of December 31, 2003, 2004 and 2005.                                                                                                                                                                                                                                                                                                            

F-43

---

---



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

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

|   |         
|-- | --------
|D. | (cont.):

| |                                                                                                        
| | -------------------------------------------------------------------------------------------------------
| | The following table summarizes information in respect of options
  outstanding as of December 31, 2005:

| |                           |  |                                                 |  |                       |                                                   |  |   |                                     |  |  |  |                                               |  |                                     |  | 
| | ------------------------- |  | ----------------------------------------------- |  | --------------------- | ------------------------------------------------- |  | - | ----------------------------------- |  |  |  | --------------------------------------------- |  | ----------------------------------- |  | 
| |                           |  | Options
  Outstanding                           |  | Options
  Exercisable |                                                  
| |                           |  |                                                 |  |                       |                                                  
| | Range of
  Exercise Price |  | Number
  Outstanding
  at
  December 31,
  2005 |  |                       | Weighted
  Average
  Remaining Contractual
  Life |  |   | Weighted
  Average
  Exercise Price |  |  |  | Number
  Exercisable at
  December 31,
  2005 |  | Weighted
  Average
  Exercise Price | 
| |                           |  |                                                 |  |                       |                                                   |  |   |                                     |  |  |  |                                               |  |                                     | 
| | $                         |  |                                                 |  | Years                 |                                                   |  | $ |                                     |  |  |  | $                                             | 
| |                           |  |                                                 |  |                       |                                                   |  |   |                                     |  |  |  |                                               |  |                                    
| | -                         |  | 62,300                                          |  |                       | 1.37                                              |  |   | -                                   |  |  |  | 62,300                                        |  | -                                   | 
|
| | 1.61-1.74                 |  | 309,000                                         |  |                       | 8.72                                              |  |   | 1.73                                |  |  |  | 309,000                                       |  | 1.73                                | 
|
| | 1.86-2.63                 |  | 386,400                                         |  |                       | 8.74                                              |  |   | 2.32                                |  |  |  | 386,400                                       |  | 2.32                                | 
|
| | 3                         |  | 1,000,000                                       |  |                       | 9.86                                              |  |   | 3.00                                |  |  |  | 1,000,000                                     |  | 3.00                                | 
|
| | 3.28-3.75                 |  | 169,800                                         |  |                       | 3.63                                              |  |   | 3.55                                |  |  |  | 169,800                                       |  | 3.55                                | 
|
| | 4.06-5.70                 |  | 653,600                                         |  |                       | 4.37                                              |  |   | 4.56                                |  |  |  | 653,600                                       |  | 4.56                                | 
|
| | 11.25-16.875              |  | 75,050                                          |  |                       | 0.88                                              |  |   | 12.07                               |  |  |  | 75,050                                        |  | 12.07                               | 
|
| | 19.375-29.375             |  | 30,650                                          |  |                       | 3.74                                              |  |   | 28.67                               |  |  |  | 30,650                                        |  | 28.67                               | 
|
| | 32.5-47.5                 |  | 90,112                                          |  |                       | 2.94                                              |  |   | 37.58                               |  |  |  | 90,112                                        |  | 37.58                               | 
|
| | 61.25-69.375              |  | 35,300                                          |  |                       | 3.98                                              |  |   | 67.67                               |  |  |  | 35,300                                        |  | 67.67                               | 
| |                           |  |                                                 |  |                       |                                                   |  |   |                                     |  |  |  |                                               |  |                                     | 
| |                           |  | 2,812,212                                       |  |                       |                                                   |  |   | 5.54                                |  |  |  | 2,812,212                                     |  | 5.54                                | 
| |                           |  |                                                 |  |                       |                                                   |  |   |                                     |  |  |  |                                               |  |                                     | 

|   |                                                                                                                                     
|-- | ------------------------------------------------------------------------------------------------------------------------------------
|E. | The following is a summary of the status of options plans in F.V.T as
  of December 31, 2005 and changes during the year then ended:

| |                                                                   |  |                                |           |                                     |  |     | 
| | ----------------------------------------------------------------- |  | ------------------------------ | --------- | ----------------------------------- |  | --- | 
| |                                                                   |  | Year ended
  December 31, 2005 |          
| |                                                                   |  |                                |          
| |                                                                   |  | Number of
  options            |           | Weighted
  Average
  Exercise price | 
| |                                                                   |  |                                |           |                                     | 
| |                                                                   |  |                                |           | $                                   | 
| |                                                                   |  |                                |           |                                     | 
| |                                                                   |  |                                |           |                                     |  |     | 
| | Options outstanding at
  beginning of the year                    |  |                                | 1,779,500 |                                     |  | 0.3 | 
| |                                                                   |  |                                |           |                                     |  |     | 
| | Changes during the year:                                          |  |                                | -         |                                     |  |     | 
| |                                                                   |  |                                |           |                                     |  |     | 
| | Exercised                                                         |  |                                | (69,500   | )                                   |  | 0.3 | 
| |                                                                   |  |                                |           |                                     |  |     | 
| | Forfeited                                                         |  |                                | -         |                                     |  | 0.3 | 
| |                                                                   |  |                                |           |                                     |  |     | 
| | Options outstanding at the
  end of the year                      |  |                                | 1,710,000 |                                     |  | 0.3 | 
| |                                                                   |  |                                |           |                                     |  |     | 
| |                                                                   |  |                                |           |                                     |  |     | 
| | Options exercisable at
  year-end                                 |  |                                |           |                                     |  |     | 
| |                                                                   |  |                                |           |                                     |  |     | 
| | Weighted-average fair
  value of options granted during the year* |  |                                | -         |                                     |  |     | 
| |                                                                   |  |                                |           |                                     |  |     | 

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

F-44

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|   |                                                                                                          
|-- | ---------------------------------------------------------------------------------------------------------
|F. | The
  following table summarizes information in respect of options outstanding as
  of December 31, 2005:

| |                           |  |                                               |           |                                                   |  |                                     |  |                                               |     |                                     |  |           |  |  |     | 
| | ------------------------- |  | --------------------------------------------- | --------- | ------------------------------------------------- |  | ----------------------------------- |  | --------------------------------------------- | --- | ----------------------------------- |  | --------- |  |  | --- | 
| |                           |  | Options
  outstanding                         |           | Options
  exercisable                             | 
| |                           |  |                                               |           |                                                   | 
| | Range of
  exercise price |  | Number
  Outstanding at
  December 31,
  2005 |           | Weighted
  Average
  Remaining
  Contractual Life |  | Weighted
  Average
  Exercise Price |  | Number
  Exercisable at
  December 31,
  2005 |     | Weighted
  Average
  Exercise Price | 
| |                           |  |                                               |           |                                                   |  |                                     |  |                                               |     |                                     | 
| | $                         |  |                                               |           | Years                                             |  | $                                   |  |                                               |     | $                                   | 
| |                           |  |                                               |           |                                                   |  |                                     |  |                                               |     |                                     | 
| |                           |  |                                               |           |                                                   |  |                                     |  |                                               |     |                                     |  |           |  |  |     | 
| | 0.3                       |  |                                               | 1,710,000 |                                                   |  | 3                                   |  |                                               | 0.3 |                                     |  | 1,710,000 |  |  | 0.3 | 
| |                           |  |                                               |           |                                                   |  |                                     |  |                                               |     |                                     |  |           |  |  |     | 

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 $9.8 million as at
December 31, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                     
|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 $41 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                                                                                                               

F-45

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 13  Commitments and
Contingencies (cont.):

|   |             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                        
|-- | ----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ---------------------------------------------------------------------------------------
|C. | Guarantees:
|   |             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | 1.          | Subsidiaries have provided bank guarantees in the amount of approximately $8.4 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.          | Sapiens and F.V.T (the guarantors) have provided guarantees to banks in support of the
  credit facilities given to their subsidiaries. In the case of Sapiens the
  guarantees are for $273,000
  and in the case of Formula Vision the guarantees are for $20.85 million. Each such guarantee is provided for the
  term of the credit facility, such term being generally one year. If a
  subsidiary whose credit line has been guaranteed by the guarantors were to
  breach certain terms of its credit agreement, the lending bank could demand
  that the guarantor pay amounts claimed to be due.
|   |             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |             | 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, 2005 and December 31, 2004, 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 $1,593 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.                                                                                                                                                                                                                                                                                                         
|   |             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|D. | Others:    
|   |             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | 1.          | In connection with credit facilities the
  Company has 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.

F-46

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 13  Commitments and
Contingencies (cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|D. | Others (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | Under Israels Stamp Tax on Documents Law, certain documents are
  subject to stamp tax. Recently promulgated regulations provide for a gradual
  phase-out of the stamp tax by 2008. In 2004, however, the tax authorities
  began an enforcement campaign involving extensive audits of companies
  compliance with the stamp tax obligation with respect to all agreements which
  had been signed since June 2003.                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | Formula and certain subsidiaries have received legal advice that
  there are a variety of defenses relating to its obligation to pay stamp tax
  or the amount to be paid. The Groups management believes that the applicable
  provision in its financial statements as of December 31, 2005 is adequate to
  cover probable costs arising from this law.                                                                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | 3.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | On February
  13, 2004 there were public reports that Microsoft source code had leaked on
  the Internet. These reports indicated that the source code contained trace
  references to the Mainsoft servers and personnel. Mainsofts management team
  fully cooperated with local authorities, the FBI, and Microsoft in their
  respective investigations. All parties conducting investigations have found
  no trace of a security breach after that date. Although Mainsoft has been
  notified in 2004 that the investigation has not yet been completed, it has not received any update from
  the FBI since then.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|E. | Legal Proceedings:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | In July 2003, a former Liraz Systems Ltd. Or Liraz shareholders filed
  an application with the Tel Aviv Jaffa District Court to approve a claim
  filed by him against BluePhoenix, as a class action. The claim relates to the
  acquisition of Liraz shares, which BluePhoenix completed in March 2003. The
  shareholder alleges that the share price BluePhoenix paid to Lirazs
  shareholders in the tender offer and in a subsequent mandatory purchase was
  lower than the fair price of Liraz shares. The maximum amount of the claim is
  approximately $5.8 million in the aggregate. In the lawsuit, the plaintiff
  has applied for the courts approval to represent all of the shareholders of
  Liraz who sold their shareholdings pursuant to the tender offer and the
  mandatory acquisition. A preliminary hearing is scheduled for June 7, 2006.
  Based on BluePhoenixs analysis of the statement of claim, including and
  evaluation of the fair value of the Liraz shares, and the price paid for
  Liraz in a previous transaction immediately prior to the tender offer, the
  Company believes that the allegations against BluePhoenix in this proceeding
  are without merit and intend to vigorously defend the claim and contest the
  allegations made therein.

F-47

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 13  Commitments and
Contingencies (cont.):

|   |                                                                                                                                     
|-- | ------------------------------------------------------------------------------------------------------------------------------------
|F. | Lease Commitments:                                                                                                                  
|   |                                                                                                                                     
|   | The
  following are details of the future minimum lease commitments under
  non-cancelable operating leases as of December 31, 2005:

| |                       |  |                       |  | 
| | --------------------- |  | --------------------- |  | 
| |                       |  | U.S. $ in
  thousands | 
| |                       |  |                       | 
| |                       |  |                       |  | 
| | 2006                  |  | 13,507                | 
|
| | 2007                  |  | 10,490                | 
|
| | 2008                  |  | 7,896                 | 
|
| | 2009                  |  | 5,570                 | 
|
| | 2010
  and thereafter |  | 1,394                 | 
| |                       |  |                       | 
| |                       |  | 38,857                | 
| |                       |  |                       | 

| |                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Rent expenses for the years ended December 31, 2005, 2004 and 2003, were approximately $15,741thousand, $10,215
thousand and $10,293 thousand, respectively.
| |                                                                                                                                                             
| | Most of the building leases will expire between 2007-2010.                                                                                                  

Note 14  Shareholders Equity:

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

| |                                         |  |                   |            |                   |  |             |  |            |            |        |  |             |  |  |            |  |  |            | 
| | --------------------------------------- |  | ----------------- | ---------- | ----------------- |  | ----------- |  | ---------- | ---------- | ------ |  | ----------- |  |  | ---------- |  |  | ---------- | 
| |                                         |  | December 31, 2005 |            | December 31, 2004 | 
| |                                         |  |                   |            |                   | 
| |                                         |  | 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  |  |  | 10,824,780 |  |  | 10,800,000 | 
| |                                         |  |                   |            |                   |  |             |  |            |            |        |  |             |  |  |            |  |  |            | 

| |    |                                                                                                                                                                                                                    
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 December 2003, Formula issued 500,000 ordinary shares consequent
  to the exercise of options to acquire 500,000 ordinary shares.
  The options were granted by
  Formula to Shandol on August 2000.            
| |    |                                                                                                                                                                                                                    
| | 4. | In March
  2005, Formula completed a private placement of 2,400,000 Formula shares for
  an aggregate consideration of $33 million.                                                                                

F-48

---

---



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:                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | 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.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | The
  following is a summary of the status of Formulas option plans as of December 31, 2005, 2004 and 2003 and for the years then
ended:                                                                                                                                                                                                                                                                                                                                                               

|                                                 |  |                                |   |                                       |  |                                |  |                                       |   |                     |  |                                       |  |  |  |  |  |  | 
|------------------------------------------------ |  | ------------------------------ | - | ------------------------------------- |  | ------------------------------ |  | ------------------------------------- | - | ------------------- |  | ------------------------------------- |  |  |  |  |  |  | 
|                                                 |  | Year ended
  December 31, 2005 |   | Year ended
  December 31, 2004        |  | Year ended
  December 31, 2003 | 
|                                                 |  |                                |   |                                       |  |                                | 
|                                                 |  | Number of
  Options            |   | Weighted
  Average
  Exercise
  Price |  | 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                                  |   | 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                                  |   | 64,500              |  | 30.8                                  | 
|                                                 |  |                                |   |                                       |  |                                |  |                                       |   |                     |  |                                       |  |  |  |  |  |  | 
|Exercisable options at the end of the
year       |  | -                              |   | 30.8                                  |  | 64,500                         |  | 30.8                                  |   | 64,500              |  | 30.8                                  | 
|                                                 |  |                                |   |                                       |  |                                |  |                                       |   |                     |  |                                       |  |  |  |  |  |  | 

|   |                                                                                                   
|-- | --------------------------------------------------------------------------------------------------
|C. | Dividends:                                                                                        
|   |                                                                                                   
|   | On June 1,
  2005 Formula declared and distributed a cash dividend in the amount of $50
  million.

F-49

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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.                                                                                                                                                                                                                                                                                             
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | 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.                                                                                                                                                                                                                                                                                           

F-50

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 15 Taxes on Income
(cont.):

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | Tax Laws in
  Israel (cont.):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Measurement of results for tax purposes under the Income Tax
  (Inflationary Adjustments) Law, 1985 (hereafter - the Inflationary
  Adjustments Law):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | Results for
  tax purposes in Israel are measured and reflected in real terms in accordance
  with the change in the CPI. The consolidated financial statements are
  presented in dollars. The differences between the change in the Israeli CPI
  and in the NIS/dollar exchange rate causes a difference between taxable
  income or loss and the income or loss before taxes reflected in the
  consolidated financial statements. In accordance with paragraph 9(f) of SFAS
  No. 109, Accounting for Income Taxes (SFAS No. 109), the Company has not
  provided deferred income taxes on this difference between the reporting
  currency and the tax bases of assets and liabilities.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   | 3.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Tax benefits under the Law for the Encouragement of Industry
  (Taxation), 1969:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | Some
  subsidiaries currently qualify as an Industrial Company as defined by this
  law, and as such are entitled to certain tax benefits including, inter alia,
  depreciation at increased rates as stipulated by regulations published under
  the Inflationary Adjustments Law and the right to deduct, for tax purposes,
  over a period of 3 years, expenses relating to public issue of shares. If
  realized, any tax benefit relating to issuance expenses is credited to
  capital surplus.                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   | 4.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Tax Rates Applicable to Income in Israel:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | 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, 2005 totaling approximately $300,158 thousand, of which
  $204,818 thousand is in respect of Companies in
  Israel (December 31, 2004 -
  $229,091 thousand), and approximately $95,340 thousand in respect of Companies abroad
  (December 31, 2004 - $94,904 thousand). The likelihood of the utilization of
  most of these losses in the future is low. Therefore, no deferred tax asset
  has been recorded in respect of such losses.

F-51

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 15 Taxes on Income (cont.):

|   |                                                                                                                                                                          |             
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------
|D. | Income Tax
  Assessments:                                                                                                                                               
|   |                                                                                                                                                                          |             
|   | Formula received final tax assessments through the tax year 2000. Formulas tax assessments for the years
  2001-2004 are currently been reviewed by the tax authorities
|   |                                                                                                                                                                         
|E. | Deferred Taxes:                                                                                                                                                         
|   |                                                                                                                                                                         
|   | 1.                                                                                                                                                                       | Composition:

| |                                      |  |                         |         |      |  |         |   |  |         |  
| | ------------------------------------ |  | ----------------------- | ------- | ---- |  | ------- | - |  | ------- | -
| |                                      |  | December
  31,          |        
| |                                      |  |                         |        
| |                                      |  | 2005                    |         | 2004 |  | 2003    |  
| |                                      |  |                         |         |      |  |         |  
| |                                      |  | (U.S. $ in
  thousands) |        
| |                                      |  |                         |        
| |                                      |  |                         |         |      |  |         |   |  |         |  
| | Net operating losses carried forward |  |                         | 94,737  |      |  | 98,756  |   |  | 85,560  |  
| |                                      |  |                         |         |      |  |         |   |  |         |  
| | Software development costs           |  |                         | 3,496   |      |  | 2,329   |   |  | 1,080   |  
| |                                      |  |                         |         |      |  |         |   |  |         |  
| | Allowances and reserves              |  |                         | 4,773   |      |  | 4,865   |   |  | 5,465   |  
| |                                      |  |                         |         |      |  |         |   |  |         |  
| |                                      |  |                         | 103,006 |      |  | 105,950 |   |  | 92,105  |  
| |                                      |  |                         |         |      |  |         |   |  |         |  
| | Valuation allowance                  |  |                         | (95,130 | )    |  | (97,690 | ) |  | (85,335 | )
| |                                      |  |                         |         |      |  |         |   |  |         |  
| |                                      |  |                         |         |      |  |         |   |  |         |  
| | Total                                |  |                         | 7,876   |      |  | 8,260   |   |  | 6,770   |  
| |                                      |  |                         |         |      |  |         |   |  |         |  

| |    |                                                                                                                                                                                                                                                              
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | 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.                           
| |    |                                                                                                                                                                                                                                                              
| |    | As a result of Formla Vision acquisition in 2004, the Companys valuation allowance
  increased by $22 million which was offset by a decrease in Matrix valuation
  allowance in the amount of $9 million.due to the use of net oparating loss
  caryforward.
| |    |                                                                                                                                                                                                                                                              
| | 2. | Presentation in
  balance sheets:                                                                                                                                                                                                                            

| |                                  |  |                         |        |      |  |       |  
| | -------------------------------- |  | ----------------------- | ------ | ---- |  | ----- | -
| |                                  |  | December 31,            |       
| |                                  |  |                         |       
| |                                  |  | 2005                    |        | 2004 | 
| |                                  |  |                         |        |      | 
| |                                  |  | (U.S. $ in
  thousands) |       
| |                                  |  |                         |       
| |                                  |  |                         |        |      |  |       |  
| | Stated in current assets         |  |                         | 2,876  |      |  | 3,751 |  
| |                                  |  |                         |        |      |  |       |  
| | Stated in other assets           |  |                         | 6,282  |      |  | 5,467 |  
| |                                  |  |                         |        |      |  |       |  
| | Stated in long term liabilities  |  |                         | (1,282 | )    |  | (958  | )
| |                                  |  |                         |        |      |  |       |  
| | Total included in balance sheets |  |                         | 7,876  |      |  | 8,260 |  
| |                                  |  |                         |        |      |  |       |  

F-52

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 15 Taxes on Income (cont.):

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

| |          |  |                         |       |      |  |        |   |  |        | 
| | -------- |  | ----------------------- | ----- | ---- |  | ------ | - |  | ------ | 
| |          |  | Year ended December 31, |      
| |          |  |                         |      
| |          |  | 2005                    |       | 2004 |  | 2003   |  
| |          |  |                         |       |      |  |        |  
| |          |  | (U.S. $ in
  thousands) |      
| |          |  |                         |      
| |          |  |                         |       |      |  |        |   |  |        | 
| | Domestic |  |                         | 7,458 |      |  | 25,205 |   |  | 2,498  | 
| |          |  |                         |       |      |  |        |   |  |        | 
| | Foreign  |  |                         | 2,525 |      |  | (7,472 | ) |  | 8,351  | 
| |          |  |                         |       |      |  |        |   |  |        | 
| |          |  |                         |       |      |  |        |   |  |        | 
| | Total    |  |                         | 9,983 |      |  | 17,733 |   |  | 10,849 | 
| |          |  |                         |       |      |  |        |   |  |        | 

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

| |                                             |  |                         |       |      |  |       |   |  |       |  
| | ------------------------------------------- |  | ----------------------- | ----- | ---- |  | ----- | - |  | ----- | -
| |                                             |  | Year ended December 31, |      
| |                                             |  |                         |      
| |                                             |  | 2005                    |       | 2004 |  | 2003  |  
| |                                             |  |                         |       |      |  |       |  
| |                                             |  | (U.S. $ in
  thousands) |      
| |                                             |  |                         |      
| | Current taxes:                              |  |                         |       |      |  |       |   |  |       |  
| |                                             |  |                         |       |      |  |       |   |  |       |  
| | In Israel                                   |  |                         | 3,670 |      |  | 4,445 |   |  | 1,584 |  
| |                                             |  |                         |       |      |  |       |   |  |       |  
| | Abroad                                      |  |                         | 1,165 |      |  | 798   |   |  | 924   |  
| |                                             |  |                         |       |      |  |       |   |  |       |  
| |                                             |  |                         | 4,835 |      |  | 5,243 |   |  | 2,508 |  
| |                                             |  |                         |       |      |  |       |   |  |       |  
| | Taxes in Israel
  in respect of prior years |  |                         | (6    | )    |  | 184   |   |  | (795  | )
| |                                             |  |                         |       |      |  |       |   |  |       |  
| | Deferred taxes,
  net                       |  |                         | 371   |      |  | (796  | ) |  | 827   |  
| |                                             |  |                         |       |      |  |       |   |  |       |  
| | Total                                       |  |                         | 5,200 |      |  | 4,631 |   |  | 2,540 |  
| |                                             |  |                         |       |      |  |       |   |  |       |  

F-53

---

---



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, |       
| |                                                                                        |  |                         |       
| |                                                                                        |  | 2005                    |        | 2004 |  | 2003   |  
| |                                                                                        |  |                         |        |      |  |        |  
| |                                                                                        |  | (U.S. $ in
  thousands) |       
| |                                                                                        |  |                         |       
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Income before
  taxes on income, as per the statement of operations                    |  |                         | 9,983  |      |  | 17,733 |   |  | 10,849 |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Statutory tax
  rate in Israel                                                         |  |                         | 34     | %    |  | 35     | % |  | 36     | %
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Theoretical tax
  expense                                                              |  |                         | 3,394  |      |  | 6,207  |   |  | 3,906  |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Additional tax
  (tax savings) in respect of:                                          |  |                         |        |      |  |        |   |  |        |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Non-deductible
  expenses                                                              |  |                         | 2,069  |      |  | 1,727  |   |  | (162   | )
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Tax-exempt
  income (mainly relating to decrease in shareholdings)                     |  |                         | (521   | )    |  | (2,677 | ) |  | (71    | )
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Tax-exempt
  income and reduced tax rates in companies which have approved enterprises |  |                         | (1,458 | )    |  | (461   | ) |  | (74    | )
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Losses and
  temporary differences for which deferred taxes were not recorded          |  |                         | (853   | )    |  | 66     |   |  | (55    | )
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Write off of deferred taxes and tax
  advances                                         |  |                         | 1,797  |      |  | -      |   |  | -      |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Taxes in
  respect of previous years                                                   |  |                         | 132    |      |  | 118    |   |  | (795   | )
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Effect of the
  Inflationary Adjustments Law                                           |  |                         | (65    | )    |  | (140   | ) |  | 41     |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Other                                                                                  |  |                         | 705    |      |  | (209   | ) |  | (250   | )
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Taxes on income as per the statement of
operations                                     |  |                         | 5,200  |      |  | 4,631  |   |  | 2,540  |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  
| | Effective tax
  rate - in%                                                             |  |                         | 52.1   |      |  | 26.1   |   |  | 23.4   |  
| |                                                                                        |  |                         |        |      |  |        |   |  |        |  

F-54

---

---



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,            |       
| |                                            |  |                         |       
| |                                            |  | 2005                    |        | 2004 | 
| |                                            |  |                         |        |      | 
| |                                            |  | (U.S. $ in
  thousands) |       
| |                                            |  |                         |       
|
| | Government departments                     |  |                         | 6,185  |      |  | 6,510  | 
|
| | Employees (1)                              |  |                         | 808    |      |  | 1,064  | 
|
| | Prepaid expenses and advances to suppliers |  |                         | 12,234 |      |  | 12,489 | 
|
| | Deferred taxes                             |  |                         | 2,876  |      |  | 3,751  | 
|
| | Affiliates                                 |  |                         | 953    |      |  | 109    | 
|
| | Other                                      |  |                         | 1,714  |      |  | 2,182  | 
| |                                            |  |                         |        |      |  |        | 
| | Total                                      |  |                         | 24,770 |      |  | 26,105 | 
| |                                            |  |                         |        |      |  |        | 

| |     |                                                                                           
| | --- | ------------------------------------------------------------------------------------------
| | (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         |  |          |  |                         |        
| |                                                  |  |              |  |          |  | December 31,            |        
| |                                                  |  | December 31, |  |          |  |                         |        
| |                                                  |  | 2005         |  |          |  | 2005                    |         | 2004 | 
| |                                                  |  |              |  | Linkage  |  |                         |         |      | 
| |                                                  |  | %            |  | basis    |  | (U.S. $ in
  thousands) |        
| |                                                  |  |              |  |          |  |                         |        
| |                                                  |  |              |  |          |  |                         |         |      |  |         | 
| | Bank overdraft                                   |  | 4.8-17.7     |  | Unlinked |  |                         | 11,265  |      |  | 3,647   | 
|
| | Short-term bank loans                            |  | 5-7.5        |  | Unlinked |  |                         | 41,357  |      |  | 49,633  | 
|
| | Short-term bank loans                            |  | 4-7.5        |  | Dollar   |  |                         | 40,654  |      |  | 32,759  | 
|
| | Short-term bank loans                            |  | 4.71         |  | CPI      |  |                         | 12      |      |  | 905     | 
|
| | Short-term bank loans                            |  | 3.75-5.68    |  | Euro     |  |                         | 2,630   |      |  | 682     | 
|
| | Current maturities of long-term loans from banks |  |              |  |          |  |                         | 9,502   |      |  | 17,349  | 
| |                                                  |  |              |  |          |  |                         |         |      |  |         | 
| | Total                                            |  |              |  |          |  |                         | 105,420 |      |  | 104,975 | 
| |                                                  |  |              |  |          |  |                         |         |      |  |         | 

F-55

---

---



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,            |       
| |                                                           |  |                         |       
| |                                                           |  | 2005                    |        | 2004 | 
| |                                                           |  |                         |        |      | 
| |                                                           |  | (U.S. $ in
  thousands) |       
| |                                                           |  |                         |       
| |                                                           |  |                         |       
|
| | Employees and
  other wage and salary related liabilities |  |                         | 27,309 |      |  | 25,933 | 
|
| | Government
  departments                                  |  |                         | 8,228  |      |  | 11,156 | 
|
| | Prepaid income
  and customer advances                    |  |                         | 24,532 |      |  | 32,676 | 
|
| | Accrued
  expenses and other current liabilities          |  |                         | 14,696 |      |  | 11,340 | 
| |                                                           |  |                         |        |      |  |        | 
| | Total                                                     |  |                         | 74,765 |      |  | 81,105 | 
| |                                                           |  |                         |        |      |  |        | 

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

| |                            |  |                         |       |      |  |      |  |  |   | 
| | -------------------------- |  | ----------------------- | ----- | ---- |  | ---- |  |  | - | 
| |                            |  | Year ended December 31, |      
| |                            |  |                         |      
| |                            |  | 2005                    |       | 2004 |  | 2003 | 
| |                            |  |                         |       |      |  |      | 
| |                            |  | (U.S. $ in
  thousands) |      
| |                            |  |                         |      
| |                            |  |                         |      
| | Wages and related expenses |  |                         | 1,455 |      |  | -    |  |  | - | 
| |                            |  |                         |       |      |  |      |  |  |   | 
| | Total                      |  |                         | 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, |        
| |                                                           |  |                         |        
| |                                                           |  | 2005                    |         | 2004 |  | 2003   |  
| |                                                           |  |                         |         |      |  |        |  
| |                                                           |  | (U.S. $ in
  thousands) |        
| |                                                           |  |                         |        
| |                                                           |  |                         |         |      |  |        |   |  |        |  
|
| | Financing
  income                                        |  |                         | 12,942  |      |  | 4,047  |   |  | 4,726  |  
|
| | Financing costs
  related to long-term credit             |  |                         | (7,205  | )    |  | (5,355 | ) |  | (3,347 | )
|
| | Financing costs
  related to short-term credit and others |  |                         | (15,918 | )    |  | (8,686 | ) |  | (6,046 | )
|
| | Gain from
  marketable securities                         |  |                         | 975     |      |  | 1,090  |   |  | 991    |  
| |                                                           |  |                         |         |      |  |        |   |  |        |  
| | Total                                                     |  |                         | (9,206  | )    |  | (8,904 | ) |  | (3,676 | )
| |                                                           |  |                         |         |      |  |        |   |  |        |  

F-56

---

---



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, |  
|   |                                                             |  |                         |  
|   |                                                             |  | 2005                    |   | 2004 |   | 2003 |  
|   |                                                             |  |                         |   |      |   |      |  
|   |                                                             |  | (U.S. $ in
  thousands) |  
|   |                                                             |  |                         |  
|   |                                                             |  |                         |   |      |   |      |   |  |  | 
|   | Gain on sale of fixed assets,
  net                         |  | 20                      |   | 60   |   | 26   |  
|  
|   | Dividend received from
  another company                    |  | -                       |   | 770  |   | -    |  
|  
|   | Impairment in value of
  investment in affiliates companies |  | (1,667                  | ) | (471 | ) | (915 | )
|  
|   | Other                                                       |  | 827                     |   | (691 | ) | 799  |  
|   |                                                             |  |                         |   |      |   |      |   |  |  | 
|   | Total                                                       |  | (820                    | ) | (332 | ) | (90  | )
|   |                                                             |  |                         |   |      |   |      |   |  |  | 
|   |                                                             |  |                         |   |      |   |      |   |  |  | 

|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 
|-- | --------------------------------------------------------------------------------- |  | ----------------------- | - | ----- |  | ----- | - |  |  | 
|G. | Gain on Realization of Shareholdings, Net:                                       
|   |                                                                                  
|   | Composition:                                                                     
|   |                                                                                   |  | Year ended December 31, |  
|   |                                                                                   |  |                         |  
|   |                                                                                   |  | 2005                    |   | 2004  |  | 2003  |  
|   |                                                                                   |  |                         |   |       |  |       |  
|   |                                                                                   |  | (U.S. $ in
  thousands) |  
|   |                                                                                   |  |                         |  
|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 
|   | Gain from realization of
  investment in Level 8                                  |  | -                       |   | 171   |  | 376   |  
|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 
|   | Gain (loss) from sale and
  decrease in shareholding percentage in Magic          |  | (48                     | ) | 1,151 |  | 294   |  
|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 
|   | Gain from realization of
  investment in the News Company                         |  | -                       |   | 142   |  | 409   |  
|  
|   | Gain (loss) from sale and
  decrease in shareholding percentage in Formula Vision |  | (15                     | ) | 383   |  | -     |  
|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 
|   | Gain from sale and decrease
  in shareholding percentage in Matrix                |  | 3,357                   |   | 3,557 |  | 1,131 |  
|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 
|   | Gain from decrease in shareholding percentage in
Babylon                          |  | -                       |   | 651   |  | -     |  
|  
|   | Loss from sale and decrease in shareholding
percentage
  in New Applicom          |  | -                       |   | -     |  | (93   | )
|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 
|   | Realization of investment in
  warrants in Matrix                                 |  | (102                    | ) | -     |  | 300   |  
|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 
|   | Gain from decrease in shareholding percentage
  in F.T.S                          |  | 988                     |   | -     |  | -     |  
|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 
|   | Realization of unrealized
  gain in Matrix (see Note 2A)                          |  | -                       |   | 2,820 |  | 342   |  
|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 
|   | Gain (loss) on realization of
  other investments                                 |  | (73                     | ) | 18    |  | (3    | )
|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 
|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 
|   | Total                                                                             |  | 4,107                   |   | 8,893 |  | 2,756 |  
|   |                                                                                   |  |                         |   |       |  |       |   |  |  | 

F-57

---

---



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.                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                              
|   | Formula
  Vision Technologies (F.V.T.) Ltd.                                                                                                                                                                                                                                                                                                                                                                                  

F-58

---

---



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:                |  |                       |         |                                     |  |         |   |  |         |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2005                     |  |                       | 278,807 |                                     |  | 233,223 |   |  | 512,030 |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2004                     |  |                       | 230,880 |                                     |  | 231,435 |   |  | 462,315 |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2003                     |  |                       | 196,782 |                                     |  | 170,048 |   |  | 366,830 |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|Inter-segment sales:     |  |                       |         |                                     |  |         |   |  |         |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2005                     |  |                       | 3,907   |                                     |  | 1,752   |   |  | 5,659   |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2004                     |  |                       | 3,618   |                                     |  | 2,087   |   |  | 5,705   |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2003                     |  |                       | -       |                                     |  | -       |   |  | -       |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|Operating income (loss): |  |                       |         |                                     |  |         |   |  |         |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2005                     |  |                       | 17,529  |                                     |  | (1,627  | ) |  | 15,902  |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2004                     |  |                       | 15,017  |                                     |  | 3,059   |   |  | 18,076  |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2003                     |  |                       | 8,289   |                                     |  | 3,570   |   |  | 11,859  |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|Financial expenses:      |  |                       |         |                                     |  |         |   |  |         |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2005                     |  |                       | (746    | )                                   |  | (8,460  | ) |  | (9,206  | )
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2004                     |  |                       | (3,504  | )                                   |  | (5,400  | ) |  | (8,904  | )
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2003                     |  |                       | (3,205  | )                                   |  | (471    | ) |  | (3,676  | )
|                         |  |                       |         |                                     |  |         |   |  |         |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|Net income (loss)        |  |                       |         |                                     |  |         |   |  |         |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2005                     |  |                       | 11,263  |                                     |  | (11,080 | ) |  | 183     |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2004                     |  |                       | 12,178  |                                     |  | (4,079  | ) |  | 8,099   |  
|                         |  |                       |         |                                     |  |         |   |  |         |  
|2003                     |  |                       | 2,106   |                                     |  | 1,014   |   |  | 3,120   |  

F-59

---

---



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:           |  |                       |         |                                     |  |         |  |  |         | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|2005                           |  |                       | 196,321 |                                     |  | 350,708 |  |  | 547,029 | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|2004                           |  |                       | 181,200 |                                     |  | 380,107 |  |  | 561,307 | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|Identifiable liabilities:      |  |                       |         |                                     |  |         |  |  |         | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|2005                           |  |                       | 84,025  |                                     |  | 122,335 |  |  | 206,360 | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|2004                           |  |                       | 133,458 |                                     |  | 230,203 |  |  | 363,661 | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|Depreciation and amortization: |  |                       |         |                                     |  |         |  |  |         | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|2005                           |  |                       | 5,326   |                                     |  | 19,804  |  |  | 25,130  | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|2004                           |  |                       | 4,714   |                                     |  | 15,883  |  |  | 20,597  | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|2003                           |  |                       | 5,602   |                                     |  | 12,945  |  |  | 18,547  | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|Investments in segment assets: |  |                       |         |                                     |  |         |  |  |         | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|2005                           |  |                       | 2,574   |                                     |  | 8,941   |  |  | 11,515  | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|2004                           |  |                       | 1,877   |                                     |  | 3,841   |  |  | 5,718   | 
|                               |  |                       |         |                                     |  |         |  |  |         | 
|2003                           |  |                       | 1,924   |                                     |  | 2,963   |  |  | 4,887   | 

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

|                                          |  |                       |         |      |  |         |   |  |         | 
|----------------------------------------- |  | --------------------- | ------- | ---- |  | ------- | - |  | ------- | 
|                                          |  | 2005                  |         | 2004 |  | 2003    |  
|                                          |  |                       |         |      |  |         |  
|                                          |  | (U.S. $ in thousands) |        
|                                          |  |                       |        
|Revenues:                                 |  |                       |         |      |  |         |   |  |         | 
|                                          |  |                       |         |      |  |         |   |  |         | 
|Revenues as
  above                       |  |                       | 512,030 |      |  | 462,315 |   |  | 366,830 | 
|                                          |  |                       |         |      |  |         |   |  |         | 
|Less
  inter-segment transactions         |  |                       | (5,659  | )    |  | (5,705  | ) |  | -       | 
|                                          |  |                       |         |      |  |         |   |  |         | 
|Revenues
  as per statement of operations |  |                       | 506,371 |      |  | 456,610 |   |  | 366,830 | 
|                                          |  |                       |         |      |  |         |   |  |         | 

F-60

---

---



FORMULA SYSTEMS
(1985) LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 16  Supplementary
Financial Statement Information (cont.):

|   |                                                        |                                                            |                         |                         |         |      |         |         |  |  |         | 
|-- | ------------------------------------------------------ | ---------------------------------------------------------- | ----------------------- | ----------------------- | ------- | ---- | ------- | ------- |  |  | ------- | 
|H. | Operating
  Segments (cont.):                          |                                                           
|   |                                                        |                                                            |                         |                         |         |      |         |         |  |  |         | 
|   |                                                        |                                                            | 2005                    |                         | 2004    |     
|   |                                                        |                                                            |                         |                         |         |     
|   |                                                        |                                                            | (U.S. $ in
  thousands) |                        
|   |                                                        |                                                            |                         |                        
|   |                                                        |                                                            |                         |                        
|   | Identifiable
  assets:                                 |                                                            |                         |                         |         |      |         |        
|   |                                                        |                                                            |                         |                         |         |      |         |        
|   | Total assets of
  operating segments                   |                                                            |                         | 547,029                 |         |      | 561,307 |        
|   |                                                        |                                                            |                         |                         |         |      |         |        
|   | Assets not
  identifiable to a particular segment      |                                                            |                         | 139,599                 |         |      | 127,766 |        
|   |                                                        |                                                            |                         |                         |         |      |         |        
|   | Elimination of
  inter-segment assets and other        |                                                            |                         | (56,543                 | )       |      | (48,053 | )      
|   |                                                        |                                                            |                         |                         |         |      |         |        
|   | Total assets as per consolidated balance
  sheet       |                                                            |                         | 630,085                 |         |      | 641,020 |        
|   |                                                        |                                                            |                         |                         |         |      |         |        
|   |                                                        |                                                            |                         |                         |         |      |         |        
|   |                                                        |                                                            |                         |                         |         |      |         |        
|   | Identifiable
  liabilities:                            |                                                            |                         |                         |         |      |         |        
|   |                                                        |                                                            |                         |                         |         |      |         |        
|   | Total
  liabilities of operating segments              |                                                            |                         | 206,360                 |         |      | 363,661 |        
|   |                                                        |                                                            |                         |                         |         |      |         |        
|   | liabilities not
  identifiable to a particular segment |                                                            |                         | 206,555                 |         |      | 42,030  |        
|   |                                                        |                                                            |                         |                         |         |      |         |        
|   | Elimination of
  inter-segment liabilities and other   |                                                            |                         | (54,956                 | )       |      | (48,028 | )      
|   |                                                        |                                                            |                         |                         |         |      |         |        
|   | Total liabilities as per consolidated
  balance sheet  |                                                            |                         | 357,959                 |         |      | 357,663 |        
|   |                                                        |                                                            |                         |                         |         |      |         |        
|I. | Geographical Information:                              |                                                            |                         |                         |         |      |         |        
|   |                                                        |                                                            |                         |                         |         |      |         |         | 
|   | 1.                                                     | The Companys Long-Lived Assets are as follows:            |                         |                         |         |      |         |         | 
|   |                                                        |                                                            |                         |                         |         |      |         |         | 
|   |                                                        |                                                            |                         | December 31,            |        
|   |                                                        |                                                            |                         |                         |        
|   |                                                        |                                                            |                         | 2005                    |         | 2004 |        
|   |                                                        |                                                            |                         |                         |         |      |        
|   |                                                        |                                                            |                         | (U.S. $ in thousands)   |        
|   |                                                        |                                                            |                         |                         |        
|   |                                                        |                                                            |                         |                         |         |      |         |         | 
|   |                                                        | Israel                                                     |                         |                         | 54,610  |      |         | 64,032  | 
|   |                                                        |                                                            |                         |                         |         |      |         |         | 
|   |                                                        | U.S.A.                                                     |                         |                         | 7,398   |      |         | 7,355   | 
|   |                                                        |                                                            |                         |                         |         |      |         |         | 
|   |                                                        | Others                                                     |                         |                         | 3,524   |      |         | 6,231   | 
|   |                                                        |                                                            |                         |                         |         |      |         |         | 
|   |                                                        | Total                                                      |                         |                         | 65,532  |      |         | 77,618  | 
|   |                                                        |                                                            |                         |                         |         |      |         |         | 
|   |                                                        |                                                            |                         |                         |         |      |         |         | 
|   | 2.                                                     | Revenues:                                                  |                         |                         |         |      |         |         | 
|   |                                                        |                                                            |                         |                         |         |      |         |         | 
|   |                                                        | Revenues
  classified by geographic area:                  |                         |                         |         |      |         |         | 
|   |                                                        |                                                            |                         |                         |         |      |         |         | 
|   |                                                        |                                                            |                         | Year ended December 31, |        
|   |                                                        |                                                            |                         |                         |        
|   |                                                        |                                                            |                         | 2005                    |         | 2004 |         | 2003    | 
|   |                                                        |                                                            |                         |                         |         |      |         |         | 
|   |                                                        |                                                            |                         | (U.S. $ in
  thousands) |        
|   |                                                        |                                                            |                         |                         |        
|   |                                                        |                                                            |                         |                         |        
|   |                                                        | Israel                                                     |                         |                         | 245,109 |      |         | 213,020 |  |  | 171,108 | 
|   |                                                        |                                                            |                         |                         |         |      |         |         |  |  |         | 
|   |                                                        | International:                                             |                         |                         |         |      |         |         |  |  |         | 
|   |                                                        |                                                            |                         |                         |         |      |         |         |  |  |         | 
|   |                                                        | United States                                              |                         |                         | 105,340 |      |         | 106,849 |  |  | 93,695  | 
|   |                                                        |                                                            |                         |                         |         |      |         |         |  |  |         | 
|   |                                                        | Other                                                      |                         |                         | 155,922 |      |         | 136,741 |  |  | 102,027 | 
|   |                                                        |                                                            |                         |                         |         |      |         |         |  |  |         | 
|   |                                                        |                                                            |                         |                         | 261,262 |      |         | 243,590 |  |  | 195,722 | 
|   |                                                        |                                                            |                         |                         |         |      |         |         |  |  |         | 
|   |                                                        | Total                                                      |                         |                         | 506,371 |      |         | 456,610 |  |  | 366,830 | 
|   |                                                        |                                                            |                         |                         |         |      |         |         |  |  |         | 
|   |                                                        |                                                            |                         |                         |        
|   |                                                        | Classification was based on the location of the customers. |                        



F-61

---

---



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 (loss) per share:

| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| | --------------------------------------------------------------------------------- |  | ----------------------- | ------ | ---- |  | ------ | - |  | ------ | -
| |                                                                                   |  | Year ended December 31, |       
| |                                                                                   |  |                         |       
| |                                                                                   |  | 2005                    |        | 2004 |  | 2003   |  
| |                                                                                   |  |                         |        |      |  |        |  
| |                                                                                   |  | (U.S. $ in
  thousands) |       
| |                                                                                   |  |                         |       
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| | Amount for
  basic earnings (loss) per share - income available to shareholders   |  |                         | 183    |      |  | 7,884  |   |  | 2,909  |  
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| | Effect of
  dilutive securities of subsidiaries                                   |  |                         | -      |      |  | (885   | ) |  | (466   | )
| | Amount for
  diluted earnings (loss) per share - income available to shareholders |  |                         | 183    |      |  | 6,999  |   |  | 2,443  |  
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| | Weighted average
  shares outstanding                                             |  |                         |        |      |  |        |   |  |        |  
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| | Denominator for
  basic net earnings (loss) per share                             |  |                         | 12,800 |      |  | 10,800 |   |  | 10,037 |  
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| | Effect of
  dilutive securities                                                   |  |                         | -      | *)   |  | *)-    |   |  | 248    |  
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| | Denominator for
  diluted net earnings (loss) per share                           |  |                         | 12,800 |      |  | 10,800 |   |  | 10,285 |  
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| | Basic net
  earnings per share                                                    |  |                         | 0.01   |      |  | 0.73   |   |  | 0.29   |  
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| | Diluted net
  earnings per share                                                  |  |                         | 0.01   |      |  | 0.65   |   |  | 0.24   |  
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| |                                                                                   |  |                         |        |      |  |        |   |  |        |  
| | *)       Anti dilutive.                                                           |  |                         |        |      |  |        |   |  |        |  

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


F-62

---

---



FORMULA SYSTEMS (1985)
LTD.

(An Israeli Corporation)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17 Transactions with
Related Parties:

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|A. | In July 2001, Formula granted to F.V.T, an option to purchase Formulas interests in certain privately-held
  companies. On November 28, 2001, F.V.T exercised the option. Accordingly, Formula transferred to F.V.T its entire interest,
including related obligations, in certain
  companies for aggregate consideration of $58.9 million. Under the agreement
  with F.V.T. issued to Formula
  in December 2001, a series of
  debentures in the amount of $58.9 million, linked to the CPI and bearing
  interest at an an annual rate of 5%.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   | On March 31, 2002, Formula lent an additional amount of $19.4 million to Formula Vision in
  consideration for a series of debentures with similar terms to the debentures
  issued in December 2001. This series of transactions is considered a related
  party transaction since Dan and Gad Goldstein serve as directors of Formula
  and Formula Vision.                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   | For more information about the transaction between Formula and F.V.T, see Note 2A.                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|B. | 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 (Formula chief executive
  officer and chairman of the board) and FIMI Opportunity Fund (see note 2.G)                                                                                                                                                                                                                

Note
18 - Subsequent Events:

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

F-63

---

---

| |   |                                                                  |   |            |                           
| | - | ---------------------------------------------------------------- | - | ---------- | --------------------------
| | n | Kost Forer
Gabbay & Kasierer3 Aminadav St.Tel-Aviv 67067, Israel | n | Phone:Fax: | 972-3-6232525972-3-5622555

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

# To the Shareholders of

# Sapiens International
Corporation N.V.

We
have audited the accompanying consolidated balance sheets of Sapiens International
Corporation N.V. and its subsidiaries (the Company) as of December 31, 2004
and 2005 and the related consolidated statements of operations, shareholders equity
and cash flows for each of the three years in the period ended December 31, 2005. 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, 2004 and 2005 and the
consolidated results of their operations and their cash flows for each of the three years
in the period ended December 31, 2005, in conformity with U.S. generally accepted
accounting principles.

|                               |                                                                                                 
|------------------------------ | ------------------------------------------------------------------------------------------------
|
|
|
|
|Tel-Aviv, Israel
June 29, 2006 | /s/ Kost Forer Gabbay & Kasierer
  KOST FORER GABBAY & KASIERER
A Member of Ernst & Young Global



---

---



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, 2004
and 2005, 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, 2005. 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 19% and 10% as
of December 31, 2004 and 2005, respectively, and total revenues of 34%, 39% and
18% for each of the three years in the period ended December 31, 2005. 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, 2004 and 2005, and the related consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2005, in conformity with U.S. generally accepted
accounting principles.

|                 |  |                                   
|---------------- |  | ----------------------------------
|                 |  | -s- Kost Forer Gabbay & Kasierer  
|Tel-Aviv, Israel |  | KOST
  FORER GABBAY & KASIERER    
|April 5, 2006    |  | A
  Member of Ernst & Young Global



---

---





DOTTORI COMMERCIALISTI


Damiano Nassini, Giovanni Nulli, Federico Pozzi, Alessandro Masetti
Zannini





6th February 2006


REPORT
OF INDEPENDENT AUDITORS
To the Shareholders of

MAGIC
SOFTWARE ENTERPRISES ITALY SRL.

We
have audited the accompanying balance sheets of Magic Software Enterprises
Italy SRL (the Company) as of December 31, 2005, and the related consolidated
statements of operations for the years then ended. 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
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States) in compatibility with the Italian
Principles.

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 audits provide a reasonable basis
for our opinion.

In our opinion, based on our audits, the financial
statements referred to above present fairly, in all material respects, the
financial position of the Company as of December 31, 2005, and the related consolidated
results of operations for the years then ended, in conformity with accounting
principles generally accepted in the United States and in Italy.

| |                   
| | ------------------
| | Yours truly,      
| | Federico Pozzi    
| | -s- Federico Pozzi

25125 Brescia, Italy Via
Brozzoni, 9 Tel. +39.30.223262 r.a. Fax +39.30.224054 E-mail: info@studionassini.it
web site: http://www.studionassini.it




ARGENTINA,
AUSTRALIA, AUSTRIA, BELGIUM, CANADA (BRITHIS COLUMBIA, ONTARIO, QUEBEC), CHINA,
CYPRUS, EGYPT, ENGLAND, FRANCE, GERMANY, GUATEMALA, HONG KONG, INDIA, IRELAND, JAPAN,
KENYA, LEBANON, LUXEMBOURG, MALAYSIA, MALTA, MAURITIUS, MEXICO, NETHERLANDS,
PAKISTAN, POLAND, SCOTLAND, SINGAPORE, SPAIN, SWITZERLAND, TURKEY, USA
(ALABAMA, ARIZONA, CALIFORNIA, ILLINOIS, NEW JERSEY, NEW YORK, NORTH CAROLINA,
OKLAHOMA, PENNSYLVANIA, TEXAS, UTAH, WASHINGTON,)





C.F.e P.IVA 01957960170


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---



REPORT OF INDEPENDENT AUDITORS
To the Shareholder of

Magic (Onyx) Magyarország Korlatolt
Felelossegu Tarsasag

We
have audited the accompanying balance sheets of Magic (Onyx) Magyarország
Korlatolt Felelossegu Tarsasag (the Company) as of December 31, 2004 and 2005,
and the related statements of operations for the then ended. 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
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting
principles used and significant estimates made by management as well as
evaluating the overall financial statement presentation. We believe that our
audits and the reports of other auditors provide a reasonable basis for our
opinion.

In our
opinion, based on our audits, the financial statements referred to above
present fairly, in all material respects, the financial position of the Company
as of December 31, 2004 and 2005, and the related results of  operations for the years
then ended, in conformity with accounting principles generally accepted in the
United States.

Budapest,
March 30, 2006

| |                    | 
| | ------------------ | 
| | -s- Maria Negyessy
| | Mária Négyessy     | 
| | Reg. auditor       | 
| | 003784             | 

---

---



MOCK & PARTNERS INTERNATIONAL
registeraccountants

AUDITORS REPORT

Introduction

We have
audited the financial statements of Magic Beheer B.V., for the period until
December 31st, 2005. 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, 2005 and of the result
for the year then ended in accordance with accounting principles generally
accepted in the United States of America.

Amsterdam,
Februar 2nd 2006

Mock &
Partners International

-s- H.J.S. Mock

Drs. H.J.S. Mock RA

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

---

---



(LEVY COHEN & CO. LOGO)

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

REPORT
OF INDEPENDENT AUDITORS
To The Shareholders Of

HERMES
LOGISTICS TECHNOLOGIES LIMITED

We have
audited the accompanying balance sheet of Hermes Logistics Technologies Limited,
(the Company) as of 31 December 2005 and the related statements of
operations, changes in shareholders equity for the period ended 31 December 2005. These
financial statements are the responsibility of Companys management. Our
responsibility is to express an opinion of these financial statements based on our
audits of the this year in the period ended 31 December 2005.

We
conducted our audits in accordance with the standards of Public Company Accounting Oversight
Boards (United States) auditing standards 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 financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.

In our opinion, based on our audits,
the financial statements referred to above present fairly, in all material respects, the
financial position of the Company as of 31 December 2005 and the related results of their
operations and each of year in the period ended 31 December 2005 in conformity with
accounting principles generally accepted in the United States.

|                      |                
|--------------------- | ---------------
|-s- Levy Cohen & Co.  |                
|LEVY COHEN
  & CO.    |                
|Registered
  Auditors |                
|                      | 27
  March 2006

|                      |                                                          
|--------------------- | ---------------------------------------------------------
|                      |                                                          
|J. Cohen C.P.A. (ISR) | Registered by The Institute
  of Chartered Accountants in
|R. Shahmoon ACA       | England and Wales to carry out Company Audit work        

---

---



(LEVY COHEN & CO. LOGO)

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

REPORT OF INDEPENDENT AUDITORS
To The Shareholders Of

MAGIC SOFTWARE ENTERPRISES (UK) LIMITED

We have
audited the accompanying balance sheet of Magic Software Enterprises (U.K) Ltd. (the
Company) as of 31 December 2005 and 2004 and the related statements of operations, changes in shareholders
equity for each of the two years in the period ended 31 December 2005. These financial statements are the
responsibility of Companys management. Our responsibility is to express an opinion,
of these financial statements based on our audits of the two years in the period ended 31
December 2005.

We
conducted our audits in accordance with the standards of Public Company Accounting Oversight
Boards (United States) auditing standards 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 financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our
opinion, based on our audits, the financial statements referred to above present fairly, in all
material respects, the financial position of the Company as of 31 December 2004 and 2005 and the
related results of their operations and each of the two years in the period ended 31
December 2005 in conformity with accounting principles generally accepted in the United States.

|                                        |              
|--------------------------------------- | -------------
|-s- Levy Cohen & Co.
LEVY
  COHEN & CO. |              
|Registered
  Auditors                   |              
|                                        |              
|                                        | 27 March 2006

|                     |                                                        
|-------------------- | -------------------------------------------------------
|                    
|J. Cohen C.P.A.(ISR) | Registered by The Institute of Chartered Accountants
in
|R. Shahmoon ACA      | England
and Wales to carry out Company Audit work      

---

---

(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, 2005 and 2004, 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, 2005. 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, 2005 and 2004, and the
consolidated statements of income and its cash flows for each of the two years
in the period ended December 31, 2005, in conformity with United States
generally accepted accounting principles.

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



---

---

SIGNATURES

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

FORMULA
SYSTEMS (1985) LTD.

|    |                           |  |      |               | 
|--- | ------------------------- |  | ---- | ------------- | 
|By: | /s/Dan
  Goldstein        |  |      | June 29, 2006 | 
|    |                           |  |      |               | 
|    | Dan
  Goldstein           |  | Date |              
|    | Chairman of the Board and |  |      |              
|    | Chief Executive Officer   |  |      |              

99

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---



Exhibit Index

|            |  |                                                                                                                                                                      
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                      
|            |  |                                                                                                                                                                      
|            |  |                                                                                                                                                                      
|1.1         |  | Memorandum
  of Association*                                                                                                                                         
|            |  |                                                                                                                                                                      
|1.2         |  | Articles of
  Association as amended on December 28, 2005                                                                                                            
|            |  |                                                                                                                                                                      
|2           |  | The
  description of terms of debentures issued by the Registrant in May 2002,
  contained in Section 2.3 of the prospectus of the Registrant dated May 23,
  2002 **
|            |  |                                                                                                                                                                      
|4.1         |  | Share
  Purchase Agreement dated February 16, 2005 between the Registrant and FIMGold
  LP***                                                                        
|            |  |                                                                                                                                                                      
|4.2         |  | Registration
  Rights Agreement dated March 3, 2005 between the Registrant and FIMGold LP***                                                                         
|            |  |                                                                                                                                                                      
|4.3         |  | Form of
  Letter of Indemnification, dated December 28, 2005                                                                                                         
|            |  |                                                                                                                                                                      
|4.4         |  | Agreement
  dated December 30, 2001 between the Registrant and Formula Vision
  Technologies (F.V.T.) Ltd. (English summary accompanied by Hebrew
  original)****    
|            |  |                                                                                                                                                                      
|4.5         |  | Agreement
  dated December 15, 2003 between the Registrant and Formula Vision
  Technologies (F.V.T.) Ltd. *****                                                     
|            |  |                                                                                                                                                                      
|4.6         |  | An agreement
  dated November 17, 2005 between the Registrant and Formula Vision
  Technologies (F.V.T) Ltd. (English translation from Hebrew original)              
|            |  |                                                                                                                                                                      
|8           |  | List of
  Subsidiaries                                                                                                                                               
|            |  |                                                                                                                                                                      
|12.1        |  | Certification
  of the Chief Executive Officer pursuant to §302 of the Sarbanes-Oxley Act                                                                            
|            |  |                                                                                                                                                                      
|12.2        |  | Certification
  of the Principal Financial Officer pursuant to §302 of the Sarbanes-Oxley Act                                                                        
|            |  |                                                                                                                                                                      
|13.1        |  | Certification
  of the Chief Executive Officer pursuant to 18 U.S.C. sec. 1350, as adopted
  pursuant to sec. 906 of the Sarbanes-Oxley Act                          
|            |  |                                                                                                                                                                      
|13.2        |  | Certification
  of the Principal Financial Officer pursuant to 18 U.S.C. sec. 1350, as
  adopted pursuant to sec. 906 of the Sarbanes-Oxley Act                      

100

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---



|                                                                                                                                                                         
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                         
|*
  Incorporated by reference to the Registration Statement on Form F-1 (File No.
  333-8858).                                                                           
|                                                                                                                                                                         
|**
  Incorporated by reference to the Form 6-K filed with the Securities and Exchange
  Commission on June 14, 2002.                                                     
|                                                                                                                                                                         
|***
  Incorporated by reference to the Annual Report on Form 20-F filed with the
  Securities and Exchange Commission on June 30, 2005 as amended on December
  20, 2005.
|                                                                                                                                                                         
|****
  Incorporated by reference to the Annual Report on Form 20-F filed with the
  Securities and Exchange Commission on June 28, 2002.                                 
|                                                                                                                                                                         
|*****
  Incorporated by reference to the Annual Report on Form 20-F filed with the
  Securities and Exchange Commission on June 30, 2004.                                

101

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