FORM 20 - F/A
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


[_]   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, 2003

                                       OR

[_]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

For the transition period from ________ to ________

Commission file number: 005-52583


                           BLUEPHOENIX SOLUTIONS LTD.
             ------------------------------------------------------
             (Exact Name of Registrant as Specified in Its Charter)


                                     ISRAEL
                 -----------------------------------------------
                 (Jurisdiction of Incorporation or Organization)


                     8 MASKIT STREET, HERZLIA 46120, 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:
                       Ordinary shares, NIS 0.01 par value
                                (Title of Class)

          Securities for which there is a reporting obligation pursuant
                          to Section 15(d) of the Act:
                       Ordinary shares, NIS 0.01 par value
                                (Title of Class)

Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of December 31, 2003:

                 13,484,276 Ordinary shares, NIS 0.01 per share

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

                                  Yes X No __

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

                              Item 17 ___ Item 18 X

<PAGE>


      This Amendment No. 2 on Form 20-F/A (the "Amended 20-F") speaks as of the
filing date of our Form 20-F for the fiscal year ended December 31, 2003, filed
on June 1, 2004 (the "Original 20-F"), as amended by Amendment No. 1 on Form
20-F/A, filed on November 9, 2004, except for the certifications which speak
as of their respective dates and the filing date of the Amended 20-F. Except as
specifically indicated, the Amended 20-F has not been updated to reflect events
occurring subsequent to the filing of the Original 20-F. The filing of this
Amended 20-F shall not be deemed an admission that the Original 20-F, when
filed, included any untrue statement of a material fact or omitted to state a
material fact necessary to make a statement not misleading.



                                    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.

      As used in this annual report, references to "we", "our", "ours" and "us"
refer to BluePhoenix Solutions Ltd. and its subsidiaries, unless otherwise
indicated. References to "BluePhoenix" refer to BluePhoenix Solutions Ltd.

      The name BluePhoenix(TM) and the names BluePhoenix(TM) IT Discovery,
BluePhoenix(TM) LogicMiner, BluePhoenix(TM) PowerText, BluePhoenix(TM)
DBMSMigrator, BluePhoenix(TM) PlatformMigrator, BluePhoenix(TM)
LanguageMigrator, BluePhoenix(TM) DataMigrator, BluePhoenix(TM) eXperanto,
BluePhoenix(TM) Remediator, BluePhoenix(TM) GTIN/UPCEnabler, BluePhoenix(TM)
EuroEnabler, BluePhoenix(TM) LiraEnabler and BluePhoenix(TM) AppBuilder
appearing in this annual report are trademarks of our company. Other trademarks
in this annual report are owned by their respective holders.


                                       3
<PAGE>

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 derived the
statement of operations data for each of the years ended December 31, 2001, 2002
and 2003 and the balance sheet data as of December 31, 2002 and 2003 from our
consolidated financial statements included in Item 18 of this annual report,
which have been prepared in accordance with generally accepted accounting
principles as applied in the United States, or U.S. GAAP. Our consolidated
financial statements have been audited by Ziv Haft certified public accountants
(Isr.) BDO member firm. The selected consolidated financial data as of December
31, 1999, 2000 and 2001 and for the years ended December 31, 1999 and 2000 is
derived from our audited financial statements not included in this annual
report, which have been prepared in accordance with U.S. GAAP. You should read
the selected consolidated financial data set forth below together with our
consolidated financial statements included elsewhere in this annual report. See
"Item 5. Operating and Financial Review and Prospects."


                                       4
<PAGE>

<TABLE>
<CAPTION>
                                                                                   YEAR ENDED DECEMBER 31,
                                                             ----------------------------------------------------------------
                                                               2003          2002          2001          2000          1999
                                                             --------      --------      --------      --------      --------
                                                                                            $
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:                                  (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                          <C>           <C>           <C>           <C>           <C>
Revenues                                                     $ 54,340      $ 36,668      $ 38,438      $ 49,245      $ 45,907
Cost of revenues                                               24,115        15,220        17,722        20,065        20,924
                                                             --------      --------      --------      --------      --------
Gross profit                                                   30,225        21,448        20,716        29,180        24,983
Software development costs                                      8,138         7,387         8,868         9,487         6,037
Selling, general, and administrative expenses                  20,140        13,245        19,794        17,461         9,567
                                                             --------      --------      --------      --------      --------
                                                                1,947           816        (7,946)        2,232         9,379
Goodwill impairment, restructuring costs, and
    non-recurring expenses                                         --           472         4,467            --            --
                                                             --------      --------      --------      --------      --------
Operating income (loss)                                         1,947           344       (12,413)        2,232         9,379
Financial income (expenses), net                                  165          (195)          (62)        1,370         1,020
Gain on realization of shareholdings                              376            --           693         2,444            --
                                                             --------      --------      --------      --------      --------
Other income (expenses), net                                      567        (1,581)       (2,649)           66           (69)
                                                             --------      --------      --------      --------      --------
Income (loss) before taxes on income                            3,055        (1,432)      (14,431)        6,112        10,330
Income tax expense                                                152           160           115           184           646
                                                             --------      --------      --------      --------      --------
                                                                2,903        (1,592)      (14,546)        5,928         9,684
Equity in losses of affiliated companies, net                    (898)       (1,336)       (1,304)       (1,114)         (843)
Minority interest                                                (154)         (702)          863        (1,700)         (876)
                                                             --------      --------      --------      --------      --------
Net income (loss)                                            $  1,851      $ (3,630)     $(14,987)     $  3,114      $  7,965
                                                             ========      ========      ========      ========      ========

Basic earning (loss) per share                               $   0.14      $  (0.35)     $  (1.52)     $   0.31      $   0.81
Diluted earnings (loss) per share                            $   0.14      $  (0.35)     $  (1.52)     $   0.30      $   0.79

Weighted average of Shares outstanding                         13,451        10,517         9,872        10,149         9,802
Weighted average of Shares outstanding assuming dilution       13,644        10,517         9,872        10,363        10,106
</TABLE>

<TABLE>
<CAPTION>
                                                                                      DECEMBER 31,
                                                             ----------------------------------------------------------------
                                                               2003          2002          2001          2000          1999
                                                             --------      --------      --------      --------      --------
                                                                                            $
CONSOLIDATED BALANCE SHEET DATA:                                                      (in thousands)
<S>                                                          <C>           <C>           <C>           <C>           <C>
Working capital                                              $    246      $  1,310      $  9,901      $ 29,961      $ 35,266
Total assets                                                   80,820        87,481        54,667        69,137        68,099
Total liabilities                                              35,422        40,760        19,410        17,728        20,355
Shareholders' equity                                           45,398        46,721        35,257        51,409        47,744
</TABLE>

B.    CAPITALIZATION AND INDEBTEDNESS

Not applicable.

C.    REASONS FOR THE OFFER AND USE OF PROCEEDS

Not applicable.


                                       5
<PAGE>

D.    RISK FACTORS

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

CAPITAL SPENDING ON INFORMATION TECHNOLOGY, OR IT, SOLUTIONS HAS DECLINED
SIGNIFICANTLY. THIS GLOBAL TREND AFFECTED OUR OPERATING RESULTS. IF IT SPENDING
CONTINUES TO SLOW DOWN, OUR BUSINESS MIGHT BE SERIOUSLY HARMED.

      We have been affected by global economic changes, in particular the sharp
decline in capital spending in the information technology sector and the overall
business slow-down in North America and Europe, as well as in Israel.
Uncertainties in the North American and European 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
affect our operating results. Our revenues decreased from $49.2 million in 2000
to $38.4 million in 2001 and to $36.7 million in 2002. In 2003, as a result of a
slight recovery of the market, and the impact of a strategic acquisition we
completed, this trend was changed, and our revenues increased to $54.3 million.
However, due to the overall business slow-down and in particular, the IT
business slow-down, we cannot assure you that we will be able to continue
increasing our revenues or keep our revenues at the same level as in 2003. We
cannot know whether the global market will recover in the future, and how the
economic conditions will continue to affect our business.

IF WE FAIL TO SUCCESSFULLY CONTINUE INTEGRATING LIRAZ'S BUSINESS WITH OUR OWN,
OUR OPERATING RESULTS MAY BE ADVERSELY AFFECTED.

      In March 2003, we completed the acquisition of the entire outstanding
share capital of Liraz Systems Ltd., an Israeli company then publicly-traded on
the Tel Aviv Stock Exchange, or the TASE. While we have already concluded the
integration of Liraz's infrastructure, management, personnel and sales and
marketing activities within our business, we are still in the process of
integrating Liraz's technology, products, service offerings, and research and
development activities. We expect that as a result of the integration of our
business with that of Liraz, the combined companies will be able to realize
greater operating efficiencies and will benefit from a broader product line with
a larger and more diversified marketing and support network. In addition, we
anticipate that the combination of our respective technical personnel will
enhance our product development capabilities. The achievement of these benefits
depends, however, on our ability to successfully complete the integration of
Liraz's business into our business. Difficulties in assimilating Liraz's
business could disrupt our ongoing business, distract our management and
employees, increase our expenses, and adversely affect our results of
operations. We may also encounter difficulties in penetrating markets in which
we have no or limited experience. We cannot assure you that we will be able to
successfully complete the integration of Liraz's business with our own. In
addition, we cannot assure you that the benefits we anticipate will occur as a
result of assimilating Liraz's business will contribute to our business to the
extent anticipated. This in turn may materially adversely affect our business,
financial condition and our quarterly and annual results of operations.


                                       6
<PAGE>

ANY FUTURE ACQUISITIONS OF COMPANIES OR TECHNOLOGIES MAY DISTRACT OUR MANAGEMENT
AND DISRUPT OUR BUSINESS.

      As part of our growth strategy, we have been investing in and acquiring
control of various companies to expand our solution portfolio. We intend to
continue seeking investment opportunities. In addition, as part of our expansion
strategy, we increased our controlling interest in some of our subsidiaries and
fully integrated them within our business. 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, invest
in, or increase our control interest in another company, we could have
difficulty assimilating that company's personnel, operations, technology, or
products and service offerings into our own. In addition, the key personnel of
the acquired company may decide not to work for us. These difficulties could
disrupt our ongoing business, distract our management and employees, increase
our expenses, and adversely affect our results of operations. Acquisitions of
new companies also involve the risk of penetrating markets in which we have no
or limited experience. 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 HAVE A LIMITED OPERATING HISTORY IN OUR CURRENT PRINCIPAL MARKETS, WHICH WILL
MAKE IT DIFFICULT OR IMPOSSIBLE FOR YOU TO PREDICT OUR FUTURE RESULTS OF
OPERATIONS.

      We have experienced major fluctuations in our net results. In 2003, we had
net income of $1.9 million, while in 2002 and 2001 we had a net loss of $3.6
million and $15.0 million, respectively. The net loss in 2002 and 2001 was a
reversal from prior years in which we had net income. In 2000, our net income
was $3.1 million, in 1999, $8.0 million and in 1998, $9.3 million. The
fluctuations in our net results are mainly attributable to the changes in the
suite of modernization tools we have been offering to our customers, the limited
experience we have had in the markets for these tools, and the difficulties we
have encountered in introducing our tools to their respective markets. Most of
the solutions we offer to our customers are based on tools that share a common
generic technology and methodology. However, the introduction of new tools to
new markets involves increased selling and marketing expenses, which in turn
increases our operating expenses and directly affects our results of operations.
Until 1999, we derived substantially all of our revenues from the provision of
year 2000 conversion projects. In 1999, we began focusing on the development and
marketing of new automated software renovation tools. Our future profitability
depends on our ability to continue to successfully develop and market new
software modernization tools and solutions. We cannot assure you that the
markets for our new modernization solutions will develop or reach the size we
estimate or that our products and services will gain market acceptance. In
addition, we devote significant financial resources to the development of new
products. Our prospects must be considered in light of the risks and
difficulties frequently encountered by companies dependent upon operating
revenues from new product lines in emerging and rapidly evolving markets.
Because of our limited experience in our principal markets and with our new
products, we cannot assure you that our strategy for operating in these markets
or selling these products will be successful. You should not rely on our
historical results of operations as indications of future performance.


                                       7
<PAGE>

WE MAY EXPERIENCE SIGNIFICANT FLUCTUATIONS IN OUR ANNUAL AND QUARTERLY RESULTS,
WHICH MAKES IT DIFFICULT FOR OUR SHAREHOLDERS TO MAKE RELIABLE PERIOD-TO-PERIOD
COMPARISONS AND MAY CONTRIBUTE TO VOLATILITY IN THE MARKET PRICE FOR OUR
ORDINARY SHARES.

      Our quarterly and annual revenues, gross profits, and results of
operations have fluctuated significantly in the past and we expect them to
continue to fluctuate significantly in the future. These fluctuations are the
result of risks related to the introduction of new products as described above
and any of the following events:

      o     adverse economic conditions in various geographic areas where our
            customers and potential customers operate;

      o     acquisitions and dispositions of companies;

      o     timing of completion of specified milestones and delays in
            implementation;

      o     timing of product releases;

      o     timing of contracts;

      o     increases in selling and marketing expenses, as well as other
            operating expenses; and

      o     currency fluctuations.

      In addition, unexpected events that do not occur on a regular basis and
that are difficult to predict may cause fluctuations in our operating results.
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.

A DELAY IN COLLECTION OF OUR FEES COULD RESULT IN CASH FLOW SHORTAGES, WHICH IN
TURN MAY SIGNIFICANTLY IMPACT OUR FINANCIAL RESULTS.


      Typical modernization projects, which deploy our solutions, are long-term
projects, and therefore, payment for these projects or a substantial portion of
our fees may be delayed until the successful completion of specified milestones.
In addition, the payment of our fees is dependent upon customer acceptance of
the completed work, and our ability to collect the fees. Further, although the
timing of receipt of our fees varies, we incur the majority of our expenses on a
current basis. As a result, a delay in the collection of our fees could result
in cash flow shortages. To date, we have not experienced any significant payment
delays that resulted in cash flow shortages. Any significant variation in
estimated and actual revenues obtained may significantly impact our financial
results in any given period.



                                       8
<PAGE>


THE ABILITY OF OUR SUBSIDIARY, MAINSOFT, TO CONTINUE TO MARKET THE
CROSS-PLATFORM PRODUCTS FOR THE UNIX ENVIRONMENT (VISUAL MAINWIN FOR UNIX) IS
DEPENDENT UPON MAINSOFT OBTAINING FROM MICROSOFT ACCESS TO UPDATED AND
ADDITIONAL SOURCE CODE.

      In August 1998, our subsidiary, Mainsoft Corporation, entered into a
Windows source-code licensing agreement. Pursuant to this agreement and the
amendments thereto, Microsoft granted Mainsoft access to specified Microsoft
source code, including new versions, service packs, and upgrade releases for
Windows. Microsoft also granted Mainsoft distribution rights to the Windows
object code licensed as a component in Mainsoft's products. Mainsoft's ability
to continue to market the Visual MainWin for Unix depends upon Microsoft
providing access to updated and additional source code. We anticipate that in
the future, we will pursue a source code license from Microsoft for any
subsequent code we may benefit from. However, we cannot assure you that we will
be able to negotiate successfully any additional license rights on a timely
basis or at all, or that these license rights would be on terms acceptable to
us. If we are unable to develop future products under a source code license
agreement with Microsoft, we may encounter difficulties in selling updated
versions of our cross-platform products and as a result, our business, results
of operations, and financial condition could be materially adversely affected.

      The rights that Microsoft granted to Mainsoft are non-exclusive. We cannot
assure you that Microsoft has not granted, or will not grant, similar or more
extensive rights to use its technology on similar or more favorable terms to our
existing or new competitors, which could have a material adverse effect on our
ability to market our cross-platform products. Furthermore, we cannot assure you
that Microsoft will not internally develop or otherwise acquire its own
cross-platform development solution, thereby becoming a direct competitor of
ours. The emergence of Microsoft as a direct or indirect competitor of ours
would intensify competition in the environment in which we operate.

      Under the license agreement between Mainsoft and Microsoft, Mainsoft may
request that Microsoft waive certain Microsoft royalties for particular
customers. In the past, Microsoft generally has granted these customers specific
royalty waivers. However, we cannot assure you that Microsoft will continue to
grant such waivers. An increase in royalties would require us to raise the
prices of specific products or reduce our gross margins, either of which could
harm our business.

      On February 13, 2004, there were public reports that a leak of Microsoft
source code had occurred on the Internet. These reports indicated that the
source code contained trace references to the Mainsoft servers and personnel.
Mainsoft's management team immediately adopted an open door policy of full
cooperation with local authorities, the FBI, and Microsoft in their respective
investigations. Mainsoft, through an internal investigation into the leak,
confirmed that the code had come from one of their servers but was most likely
extracted some time in 2001. All parties conducting investigations have found no
trace of a security breach after that date. According to the FBI, the
investigation is still active and they are proceeding with the investigation to
date.



                                       9
<PAGE>

      While Mainsoft believes its relationship with Microsoft will continue on
terms acceptable to us, a change in the relationship could materially adversely
affect our business, results of operations, and financial condition.

IF WE ARE UNABLE TO ACCURATELY PREDICT AND RESPOND TO MARKET DEVELOPMENTS OR
DEMANDS, OUR BUSINESS WILL BE ADVERSELY AFFECTED.

      The IT modernization business is characterized by rapidly evolving
technology and methodologies. This makes it difficult to predict demand and
market acceptance for our modernization tools and services. In order to succeed,
we need to adapt the tools and services we offer to keep up with technological
developments and changes in customer needs. We cannot guarantee that we will
succeed in enhancing our tools and services or developing or acquiring new
modernization tools and services that adequately address changing technologies
and customer requirements. We also cannot assure you that the tools and services
we offer will be accepted by customers. If our tools 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 solutions obsolete and
unmarketable, or require us to enhance our current tools or develop new tools.
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 FAIL TO ADDRESS THE STRAIN ON OUR RESOURCES CAUSED BY CHANGES IN OUR
COMPANY, WE WILL BE UNABLE TO EFFECTIVELY MANAGE OUR BUSINESS.

      We have recently undergone significant changes in our product offerings.
This has placed and will continue to place substantial demands upon our
management, systems, and resources, including our sales, project management,
consulting personnel, and software development operations. These changes include
developing and marketing new modernization tools and expanding the sales of our
products further into the North American market. 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 MANAGE THE EFFECTS OF THE VARIATIONS IN OUR OFFERING
PORTFOLIO, OUR RESULTS WILL BE ADVERSELY AFFECTED.

      We specialize in the development and implementation of sophisticated
software modernization tools and products. We leverage our know-how, experience
and generic technologies, to develop and introduce new software tools that
enable the modernization of legacy systems. The need for our modernization
solutions changes over time, and recent regulations or newly introduced
technologies may create new needs for modernization solutions. As part of our
growth strategy, as a new need evolves, we typically conduct a market analysis
to qualify and quantify the market opportunity. If the results justify the
investment required for the development of new products or tools , then we begin
the development process of the new product. In order to maintain our position in
the market, and maintain our ability to address the constantly changing needs of
the marketplace, we continually invest in the development of new products. The
net annual expense related to research and development has varied between $7
million and $9 million in the last three years.



                                       10
<PAGE>


      Our solution portfolio is changing, as is the geographical distribution of
our sales. In recent years we have experienced a decline in our sales in North
America, and an increase in the amount of our sales in Europe. This change is
mainly attributable to the integration of Liraz's European sales force.

      In order to properly introduce a new product to the marketplace or to
introduce our current products into new markets, we continuously update our
marketing materials, educate our sales force and make changes to our operations.
If these processes are not completed in a timely manner, our new product
introduction may be delayed.


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 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.

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 past years, we have successfully used our software modernization
tools in numerous software renovation projects. In the course of providing our
modernization solutions, the project team conducts 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 in modernization and transformation
projects to date, and the cost of correcting them, have not been significant.
However, if our modernization 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
<PAGE>

IF WE FAIL TO SATISFY OUR CUSTOMERS' EXPECTATIONS REGARDING OUR SOLUTIONS, OUR
CONTRACTS MAY BE CANCELLED AND WE MAY BE THE SUBJECT OF DAMAGES CLAIMS.

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

WE ARE EXPOSED TO SIGNIFICANT CLAIMS FOR DAMAGE CAUSED TO OUR CUSTOMERS'
INFORMATION SYSTEMS.

      Some of the products, tools, and services we provide involve key aspects
of our 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 modernization solutions or modernization services. However, if a customer's
system fails during or following the provision of modernization solutions or
services by us, or if we fail to provide customers with proper support for our
modernization solutions, we are exposed to the risk of a claim for substantial
damages against us, regardless of our responsibility for the failure. When
possible, we limit our liability under our product and service contracts.
However, we cannot guarantee that these limitations of liability, if any, would
be sufficient to protect us against legal claims. We maintain professional
errors and omissions and general 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, it may have a material adverse effect on our
business, operating results, and financial condition. 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 claim, with or
without merit, could:


                                       12
<PAGE>

      o     be expensive and time-consuming to defend;

      o     divert management's attention and resources; or

      o     require us to enter into royalty or licensing agreements to obtain
            the right to use a necessary product or component.

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

WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS, WHICH MAY LIMIT
OUR ABILITY TO COMPETE EFFECTIVELY.

      Our success and ability to compete are substantially dependent upon our
internally developed technology. Most of our intellectual property consists of
proprietary or confidential information that is not subject to patent or similar
protection. Our employees and contractors have direct access to our technology.
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 also provided our software directly to customers. This may increase the
likelihood of misappropriation or other misuse of our software.

WE ARE EXPOSED TO LITIGATION THAT COULD RESULT IN CONSIDERABLE FINANCIAL
LIABILITIES.


      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 us, as a
class action. The claim relates to the acquisition of Liraz shares, which we
completed in March 2003. The shareholder alleges that the share price we 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. Under Israeli law, the court's
approval is required for the plaintiff to represent all of the shareholders of
Liraz who sold their shareholdings to us pursuant to the tender offer and the
mandatory acquisition. The plaintiff has applied for such approval in the
lawsuit. No preliminary hearing has been scheduled. Based on our analysis of the
statement of claim, our management believes that the claim is without merit.
However, if we are not successful in defending this claim, we could be exposed
to considerable financial liabilities and as a result, our financial condition
could be materially adversely harmed.



                                       13
<PAGE>

OUR LARGEST SHAREHOLDER, FORMULA, CONTROLS A MAJORITY OF OUR ORDINARY SHARES AND
INFLUENCES THE OUTCOME OF MATTERS THAT REQUIRE SHAREHOLDER APPROVAL.

      Formula Systems (1985) Ltd. owns, as of May 21, 2004, 58.6% of our
outstanding ordinary shares. Therefore, Formula has the power to control the
outcome of most matters requiring shareholder approval, including the election
of directors and approval of significant corporate transactions. In addition,
Dan Goldstein, a member of our board of directors and chairman of the board of
Formula, and Gad Goldstein, the chairman of our board and a director, president,
and chief executive officer of Formula, own, in the aggregate, 755,138 ordinary
shares, representing 5.5% of our outstanding ordinary shares. These individuals
have entered into agreements that require them to vote their shares as
instructed by Formula. Accordingly, Formula is deemed to beneficially own
approximately 64.2% of our outstanding ordinary shares.

      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 these persons. Although
Israeli law imposes certain procedures (including shareholder approval) for
approval of certain related party transactions, including certain of those
between us and Formula, we cannot assure you that these procedures will
eliminate the possible detrimental effects of conflicts of interest. Our two
independent directors constitute a majority of the members of our audit
committee. The audit committee reviews potential conflict of interest situations
where appropriate. If certain transactions are not approved in accordance with
required procedures under applicable Israeli law, these transactions may be void
or voidable.

THE MARKET PRICE OF OUR ORDINARY SHARES MAY BE VOLATILE AND OUR INVESTORS MAY
NOT BE ABLE TO RESELL THEIR SHARES AT OR ABOVE THE PRICE THEY PAID, OR AT ALL.

      The stock market in general has recently experienced 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. During 2002, for example, the market price of our
ordinary shares traded on the NASDAQ fluctuated between $4.15 and $2.00, and
during 2003, the market price of our ordinary shares fluctuated between $7.04
and $2.10. The market price of our ordinary shares may fluctuate substantially
due to a variety of factors, including:

      o     any actual or anticipated fluctuations in our or our competitors'
            quarterly revenues and operating results;

      o     shortfalls in our operating results from levels forecast by
            securities analysts;

      o     public announcements concerning us or our competitors;

      o     the introduction or market acceptance of new products or service
            offerings by us or by our competitors;

      o     changes in product pricing policies by us or our competitors;


                                       14
<PAGE>

      o     changes in security analysts' financial estimates;

      o     changes in accounting principles;

      o     sales of our shares by existing shareholders; and

      o     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.

FUTURE SALES OF OUR SHARES IN THE PUBLIC MARKET OR ISSUANCES OF ADDITIONAL
SECURITIES COULD CAUSE THE MARKET PRICE FOR OUR ORDINARY SHARES TO FALL.

      As of May 21, 2004, we had 13,522,139 ordinary shares outstanding
(excluding 1,870,565 held by two of our wholly owned subsidiaries). In addition,
we have reserved 2,467,500 ordinary shares for issuance under our option plans.
We also have certain commitments described below to issue BluePhoenix ordinary
shares and register them for resale.

      We have made a commitment to purchase from First Israel Mezzanine
Investors Ltd., known as FIMI, promissory notes issued by Intercomp Ltd., one of
our affiliates, in an aggregate principal amount of $3.5 million plus interest
accrued since January 2001 at an annual rate of 5%. Of the principal amount of
such promissory notes, $2.33 million plus the interest accrued may be paid,
subject to FIMI's approval, in BluePhoenix's ordinary shares. We also undertook
to issue FIMI warrants to purchase up to 336,000 BluePhoenix's ordinary shares.
We also agreed to register the shares underlying FIMI's option for resale. Under
certain circumstances, we are obliged to register for resale the shares
underlying FIMI's warrants.

      For more information about the option and warrants granted to FIMI, see
"Item 5.B. Liquidity and Capital Resources--Contractual Commitments and
Guarantees."


      In addition, as part of a $5 million private placement we completed on
March 30, 2004, we issued to each of the participating four institutional
investors, convertible debentures and warrants exercisable into BluePhoenix's
ordinary shares. If all such debentures, including interest, are converted into
BluePhoenix's ordinary shares and the warrants are fully exercised, we would be
required to issue to the investors up to 1,708,411 ordinary shares, subject to
adjustments. Under certain circumstances, the investors are entitled to purchase
additional convertible debentures and warrants, which if converted and exercised
in full, would increase the number of issued shares by an additional 1,025,047
ordinary shares. In connection with the private placement, we agreed to file a
registration statement for the resale of the ordinary shares underlying the
convertible debentures and warrants.


      For more information about the $5 million private placement, see "Item
6.E. Share Ownership--Arrangements Involving the Issue of Blue Phoenix' Shares
or Grant of Options to Purchase Shares--Convertible Debentures and Warrants
Purchased by Institutional Investors."


                                       15
<PAGE>

      In addition, certain of our shareholders, holding in the aggregate
10,468,972 ordinary shares, have registration rights with respect to the shares
they hold, including piggyback rights.

      If a large number of our ordinary shares are sold in a short period, the
price of our ordinary shares would likely decrease.

RISKS RELATING TO INTERNATIONAL OPERATIONS

MARKETING OUR TOOLS AND SOLUTIONS IN INTERNATIONAL MARKETS MAY CAUSE INCREASED
EXPENSES AND GREATER EXPOSURE TO RISKS THAT WE MAY NOT BE ABLE TO SUCCESSFULLY
ADDRESS.

      We intend to continue to expand our international operations, which will
require significant management attention and financial resources. In order to
continue to expand worldwide sales, we need to establish additional marketing
and sales operations, hire additional personnel and recruit additional resellers
internationally. To the extent that we are unable to do so effectively, our
growth is likely to be limited and our business, operating results and financial
condition will be materially adversely affected.


      We have generated approximately 53% of our international revenues in 2003
from sales to European customers. Additional risks inherent in our European and
other worldwide business activities generally include unexpected changes in
regulatory requirements, tariffs and other trade barriers, costs of localizing
products for foreign countries, lack of acceptance of localized products in
European and other foreign countries, longer accounts receivable payment cycles,
difficulties in operations of management, potentially adverse tax consequences,
including restrictions on the repatriation of earnings, and the burdens of
complying with a wide variety of European and other foreign laws. We cannot
assure you that these factors will not have a material adverse effect on our
future European and other international sales and, consequently, on our
business, operating results and financial condition.

WE MAY BE ADVERSELY AFFECTED IF THE RATE OF INFLATION IN ISRAEL EXCEEDS THE RATE
OF DEVALUATION OF THE NEW ISRAELI SHEKEL AGAINST THE DOLLAR OR THE EURO.

      Our reporting currency is the United States dollar, which is our
functional currency. Most of our revenues are in dollars and euros, 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:

      o     that the inflation rate in Israel will exceed the NIS devaluation
            rate against the dollar or the euro;

      o     that the devaluation process will lag behind the NIS inflation
            timing; or

      o     that the euro will devaluate against the dollar.



                                       16
<PAGE>


      If any of these occur, the dollar or euro cost of our operations would
increase, as well as our financial expenses. 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
please see "Item 5 - Overview - Our Reporting Currency".


FLUCTUATIONS IN FOREIGN CURRENCY VALUES AFFECT THE PRICES OF OUR PRODUCTS, WHICH
IN TURN MAY AFFECT OUR BUSINESS AND RESULTS OF OPERATIONS.

      Most of our worldwide sales are currently denominated in dollars. A
decrease in the value of the dollar relative to foreign currencies, in
particular the euro, Danish kroner (DKK) 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.

WE ARE SUBJECT TO MULTIPLE TAXING JURISDICTIONS. IF WE FAIL TO ESTIMATE
ACCURATELY THE AMOUNT OF INCOME TAX DUE IN ANY OF THESE JURISDICTIONS, OUR NET
INCOME MIGHT BE AFFECTED.

      We operate within multiple taxing jurisdictions and are subject to
taxation by these jurisdictions at rates higher than those to which we are
subject in Israel. In addition, we may be subject to audits in these
jurisdictions. These audits can involve complex issues, which may require an
extended period of time to resolve. In our management's opinion, we have made
adequate provisions for income taxes for all past years. Although our management
believes that its estimates are reasonable, we cannot assure you that the final
tax outcome of these issues will not be different than those, which are
reflected in our historical income tax provisions. Such differences could have a
material effect on our income tax provision and net income in the period in
which such outcome occurs.

RISKS RELATING TO OPERATIONS IN ISRAEL

POLITICAL, ECONOMIC, AND MILITARY CONDITIONS IN ISRAEL COULD NEGATIVELY IMPACT
OUR BUSINESS.


      We are incorporated under the laws of the State of Israel, and certain of
our key management personnel as well as certain of our research and development
facilities are located in Israel. Although we generate most of our revenues from
international markets, we nonetheless are influenced by the political, economic
and military conditions affecting Israel. 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
<PAGE>

THE TAX BENEFITS AVAILABLE TO US FROM GOVERNMENT PROGRAMS MAY BE DISCONTINUED OR
REDUCED AT ANY TIME, WHICH WOULD LIKELY INCREASE OUR TAXES.


      We receive tax benefits under Israeli government programs, particularly as
a result of the "Approved Enterprise" status of certain of our operations in
Israel. "Approved Enterprise" status is granted by the Israeli Investment Center
of the Ministry of Industry and Trade and entitles the company to a variety of
tax incentives. The incentives awarded to certain of our subsidiaries include
reduced tax rates and a tax holiday. We were granted a two year tax exemption,
followed by a five year tax reduced tax rate of 25% instead of 36% on income
derived from our "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 May 31, 2004, we
have met those criteria and received tax benefits from our "Approved Enterprise"
programs, as presented in Note 14I to our financial statements. To maintain our
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. Most 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:


o     effect service of process within the United States on us or any of our
      executive officers or directors who are nonresidents of the United States;

o     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 which are nonresidents of the United States, in the
      United States or Israel; and

o     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 in 1987 under the name A. Crystal Solutions
Ltd. In 1996, we changed our name to Crystal Systems Solutions Ltd. In 2003,
following the acquisition of Liraz Systems Ltd., we changed our name to
BluePhoenix Solutions Ltd. Our registered office is located at 8 Maskit Street,
Herzlia, 46120 Israel and our telephone number is 972-9-9526110. Our agent in
the United States is Blue Phoenix Solutions USA Inc., 8000 Regency Parkway,
Cary, NC 27511 United States and its telephone number is (919) 380-5100.


                                       18
<PAGE>

      Prior to the acquisition of Liraz, we conducted our international
operations through our wholly owned subsidiaries, Crystal America Inc., in the
United States, and Crystal Europe (1999) B.V., in Europe.

      In 2002, we acquired control of Liraz Systems Ltd. In 2003, we completed
the acquisition of the remaining outstanding share capital of Liraz. Since 2002,
we have run our worldwide operations through several additional wholly owned
subsidiaries, named below:

         NAME OF SUBSIDIARY                          COUNTRY OF INCORPORATION
         ------------------                          ------------------------

         BluePhoenix Solutions USA Inc.              United States

         IntraComp Group Inc.                        Unites States

         BluePhoenix Solutions Nordic ApS            Denmark

         BluePhoenix Solutions U.K. Ltd.             United Kingdom

         BluePhoenix Solutions SRL                   Italy

         BluePhoenix Solutions GmbH                  Germany

         BluePhoenix Solutions B.V.                  The Netherlands

         BluePhoenix Solutions Ltd.                  Cyprus

         Alphatech (2000) Srl.                       Romania

         BluePhoenix Solutions Pty Ltd.              Australia

      For a discussion of our capital expenditures and divestitures, see "Item
4.B. Business Overview--Investments and Acquisitions" and "Item 5.B. Liquidity
and Capital Resources."

B.    BUSINESS OVERVIEW

OUR BUSINESS

      We develop and market unique enterprise IT modernization, or EIM,
solutions that enable companies to automate the process of modernizing and
upgrading their mainframe and distributed IT infrastructure and to effectively
compete in today's environment. The combination of our comprehensive set of
products and tools with our expert services methodology provides an efficient
and cost-effective process for extending the return on investment of existing
enterprise IT assets. Our solutions, which include technology for Understanding,
Presentment, Migration, Remediation, and Redevelopment, allow companies to fully
leverage their current systems and applications, speed up and reduce the cost of
the renewal process, and effectively update their systems in order to adapt to
new business demands.

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


                                       19
<PAGE>

      Our solutions enable companies to:

      o     better understand and manage their IT systems and resources;

      o     easily integrate packaged applications and build customized
            applications;

      o     significantly decrease maintenance, human resource, and technology
            costs;

      o     quickly migrate to modern databases, platforms, applications, and
            programming languages;

      o     substantially transform applications and databases in order to
            address regulatory and business changes; and

      o     directly gain access to cutting edge technology and new business
            channels.

      Our comprehensive enterprise technologies span mainframe, midrange, and
client/server computing platforms. We have enhanced our expertise through the
successful completion of projects for many large organizations over the past 17
years, establishing our credibility and achieving international recognition and
presence. Based on our technology and that of our affiliates, we develop and
market software products, tools, and related methodologies. We deliver our 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, we introduced our C-MILL conversion tool, which was developed
based on our generic modernization technology, and we were awarded significant
contracts from leading international system integrators. Our strategic
partnerships with these system integrators, as well as strong performance of our
conversion tool, provided us with international recognition and global presence
in the market. We delivered C-MILL together with consulting services, training,
and support as a comprehensive conversion solution to solve the millennium
problem. In 1997 and 1998, we derived substantially all of our revenues from
millennium conversion projects. In 1999, we derived less than half of our
revenues from millennium conversions, and since 2000, we have derived all of our
revenues from providing legacy modernization and porting solutions.

      As part of our growth strategy, we sought opportunities to increase our
revenue base through the acquisition of complementary products and services.
This culminated in the acquisition of a controlling interest in Liraz in
November 2002, and the purchase of the remaining outstanding interest in Liraz
in 2003. Liraz's business includes the operations of BluePhoenix Solutions B.V.
and its international subsidiaries. Through its subsidiaries, Liraz develops and
markets the AppBuilder, a software product used for the development of
sophisticated and robust applications needed by large enterprises. Liraz's large
install base includes leading international banks and financial institutions,
whose information systems operate in various legacy environments.


      We believe that following the Liraz acquisition, utilizing our combined
broad technology offering and our worldwide marketing capabilities, we became a
leading global player in the enterprise IT modernization market. With 12 offices
in 10 countries, 5 full service delivery centers, and representatives, we
provide our products and services worldwide.




                                       20
<PAGE>

MARKET BACKGROUND

      Companies initiate IT modernization projects for a wide range of reasons,
such as:

      o     maintaining a competitive edge in the market;

      o     addressing changing business needs;

      o     complying with new regulations

      o     reducing maintenance, human resource, and technology costs; or

      o     gaining access to cutting edge technology and new business channels.

      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. We provide 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--Application portfolio management solutions
that 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. These tools
facilitate global assessments and impact analyses of application assets, thus
helping reduce costs, streamline working processes, and increase efficiency.

      Enterprise IT Presentment--Noninvasive solutions that enable companies to
intelligently mine text and convert documents from any legacy system into
Web-enabled formats. These tools help medium-large sized organizations offer
their customers and employees immediate Web-based viewing and delivery of all
their documents, including invoices, statements, bills, reports, and policies.

      Enterprise IT Migration--Solutions that enable companies to consolidate
and eliminate a wide range of legacy technologies through automated migrations
of applications, databases, platforms, programming languages, and data. These
tools help reduce costs and resources, and minimize reliance on proprietary
technology, sunset products, and dwindling skill sets.

      Enterprise IT Remediation--Solutions that 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.


                                       21
<PAGE>

      Enterprise IT Redevelopment--Solutions that 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. These tools help reduce maintenance costs and resources and
application development time-to-market.

ENTERPRISE IT UNDERSTANDING

      In the current lean budgetary environment, companies that want to extend
the return on investment of their existing systems need to modernize their
legacy systems. Since modernization projects are intricate and complex, the
essential first step is a thorough review of existing IT assets.

      Our understanding solutions provide automated, detailed mapping of
system-wide IT activity and the interconnections between all software
components. This detailed road map serves as the basis for optimizing the reuse
of existing IT systems, tailoring the modernization plan for the company's
unique IT environment and corporate requirements, and reducing future ongoing
maintenance costs.

      Modernization initiatives that need to be based on an in-depth examination
of actual system elements include:

      o     building and rewriting enterprise-scale application components;

      o     implementing new technologies such as Web-enablement;

      o     integrating purchased and newly written applications;

      o     consolidating servers and applications;

      o     migrating to more modern platforms, databases, applications, and
            languages;

      o     transforming current applications to adapt to changing business
            standards; and

      o     protecting against the loss of critical personnel and corporate
            knowledge base.

      Our integrated set of enterprise IT understanding solutions are designed
to assist companies in achieving these goals by accurately mapping raw IT
operational and development data, down to the program code level, into a
consolidated enterprise-wide warehouse. The gathered information enables
companies to keep track of system inventories, resources, and interrelationships
and intelligently mine systems and application metadata.

      This enterprise-wide view can then be used for a variety of strategic
purposes, including:

      o     performing impact, cost, and trend analyses as well as ongoing
            tracking of IT resources, inventories, components, their usage and
            their interrelationships;

      o     running business-logic analyses for business process identification,
            evaluation, extraction, transition, and enhancement;

      o     achieving significant cost reductions through the elimination of
            unused products, unnecessary software upgrades, inefficient storage
            allocations, and wasteful CPU usage; and

      o     providing more efficient application development by reusing systems
            and leveraging existing business rules.


                                       22
<PAGE>

      BluePhoenix(TM) IT Discovery--An application portfolio management system
that 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. IT Discovery provides
the ability to analyze on a refreshable basis numerous technology environments,
and from them extract and report on the interrelationships among the components
that make up these environments. In this manner, it provides an organization the
ability to discover information about its current systems, thereby insuring that
ongoing decisions are made based on an accurate audit of the current
environment.

ENTERPRISE IT PRESENTMENT

      Our enterprise IT presentment solutions enable companies to more
effectively use the large amount of information produced by batch reports
generated from legacy systems. The presentment process extracts and manages
report and document content and then selectively redisplays it in graphical form
over the Web. The results are easy to access, read, and distribute, fully
secure, and do not require huge amounts of storage space.

      BluePhoenix(TM) PowerText--This product provides companies with the
ability to define XML (Extensible Markup Language)-based data views from their
existing reports. Each data view can be associated with an XSL (Extensible
Stylesheet Language) definition used to create a graphical presentation of the
data. This process enables data such as invoice numbers to be extracted from a
character-based batch report and redisplayed as data on an actual invoice form.
Original reports are fed though the listener-based PowerText that uses the
created definitions to extract the XML views. Once extracted, they are stored in
the view database requiring much less storage capacity than either scanned
reports or the original character reports. Using PowerText's browser-based view
selector, the XML views in the database can be displayed graphically using the
associated XSL. They can also be downloaded directly as XML into any tool that
supports XML input, such as Microsoft Excel.

ENTERPRISE IT MIGRATION

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

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


                                       23
<PAGE>

      Our migration solutions provide numerous advantages, including:

      o     significantly decreasing project costs, risk of errors, and time;

      o     preserving corporate business knowledge;

      o     substantially reducing dependency on scarce skill sets;

      o     solving problematic maintenance issues;

      o     enabling end-to-end project control and management;

      o     directly supplying a full audit trail and documentation of all
            changes;

      o     minimizing system freeze time with a unique "refresh" feature; and

      o     comprehensively working with most mainframe and non-mainframe
            platforms.

      The enterprise IT migration suite includes the following solutions:

      BluePhoenix(TM) DBMSMigrator--An automated migration tool that converts
applications from nonrelational databases, such as IDMS, ADABAS, and VSAM, to
relational databases, such as DB2 and Oracle. 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. DBMSMigrator leaves no residuals, emulation software, or
translation procedures and allows system support to continue uninterrupted
during the migration project. As a result of the conversion process, the
migrated database operates more efficiently, is easier to maintain, and contains
complete documentation of the customer's knowledge base and guidelines.

      BluePhoenix(TM) 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. PlatformMigrator solutions assist companies with maintaining service
levels, setting and upgrading standards, implementing the new IT environment,
training IT users, implementing new facilities like a security system or a batch
scheduler, and testing for functional equivalence.

      BluePhoenix(TM) LanguageMigrator--An automated migration tool for
converting 4GLs (fourth generation languages). Our tool is currently capable of
converting COBOL, ADSO and COOL:Gen. This reliable, time-efficient, and
comprehensive solution enables site-wide installation, simultaneous testing, and
implementation of batch programs. In addition, LanguageMigrator identifies the
compatibility of the code, converts it to the new standards required by
customers, and analyzes converted programs to identify potential problems. For
more information about future developments of this tool, see "Research and
Development."

      BluePhoenix(TM) 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. In
addition, it provides support for partial or incremental migration and for
multiple run-time environments.


                                       24
<PAGE>

      BluePhoenix(TM) eXperanto--A software product that enables mainframe
applications to operate via the Web and other technology channels. eXperanto is
currently being further developed to provide an end-to-end solution by handling
the Web interface while developing attractive applications without the
associated training and management burden of other solutions. For more
information about eXperanto, see "Research and Development."

ENTERPRISE IT REMEDIATION

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

      BluePhoenix(TM) Remediator--The core technology used by all of the
BluePhoenix remediation solutions. BluePhoenix Remediator uses a rule-driven
approach to automate data field adjustment and identify code associated with
various data fields. This unique and flexible technology solution was developed
for complex, large-scale data field length, type, or structure modification.
This tool has so far been used in successful conversions of close to 1 billion
lines of code. Coupled with a well-tested four-step methodology, it provides
support for all major conversion strategies and for a wide range of mainframe,
midrange, and AS/400 platforms, covering a wide range of database management
systems, languages, source and load libraries, databases, and files.

      BluePhoenix(TM) GTIN/UPCEnabler--A comprehensive solution that ensures the
success of GTIN (global trade identification number) and 2005 Sunrise compliance
projects, it is based on a unique, flexible technology developed for complex and
large-scale modifications to data field length, type, and structure. The tool
accelerates the compliance process and provides enhanced control over
large-scale changes. Additionally, modifications are made simultaneously and
tested as a whole, thus minimizing maintenance freeze time. GTIN/UPCEnabler is
available for MVS and Unix systems written in most popular programming
languages, using various databases and file structures.

      BluePhoenix(TM) EuroEnabler--A highly automated, rules-based tool that
enables a step-by-step, comprehensive euro conversion process. The tool fully
preserves system and data integrity and helps maintain the usual level of system
application development and maintenance throughout the process.

      BluePhoenix(TM) LiraEnabler--A rule-based tool that enables a
step-by-step, comprehensive Turkish Lira conversion process. LiraEnabler
provides several distinct benefits that simplify the transition effort and
assure the success of the redenomination project.

      In addition, we market specialized remediation tools that include the
following:

      OS/390 (MVS) standardization--A tool that migrates the applications,
databases, and data that need to be modified when consolidating or rationalizing
multiple OS/390 systems or logical partitions. Integrated facilities may also
require conversion, including security, batch schedulers, tape management, and
disk management systems.


                                       25
<PAGE>

      Naming conventions--An automated tool for standardizing naming conventions
that greatly facilitates the process of system consolidation. Since all
resources being converted must be changed in parallel, changing system component
naming standards is such a large task that a manual solution is not realistic.
This tool provides a single integrated solution for the challenge of handling
the multi-dimensional technical aspects of the consolidation of IT systems.

      Consolidating security systems--Since there is a significant difference in
the approach and internal structure of security facilities in a customer's IT
systems, consolidating logical partitions that use the same product can still be
complex. Our automated tool facilitates this process, minimizes the freeze time
and increasing the reliability of the consolidated system.

ENTERPRISE IT REDEVELOPMENT

      Enterprise IT environments are complex, and can prevent companies from
quickly and easily adapting to new business needs and requirements. The more
companies can organize and understand their applications, the faster they can
adapt to inevitable change. While organizations are mostly satisfied with the
existing business functionality of their applications, they usually want to
improve their business processes and leverage technologies such as Web-enabled
and service-oriented architectures. Additionally, they are eager to find a way
to lower their maintenance costs, which consume 70-80% of total IT spending.

      Our enterprise IT redevelopment suite enables companies to efficiently
mine, reuse, and rewrite their existing applications, thus incrementally
redeveloping their legacy systems, extending them into new technologies, and
saving on development and programmer costs.


      BluePhoenix(TM) AppBuilder--Our 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. AppBuilder acts like a virtual application
warehouse, keeping the underlying structure of the system in an organized
framework such that developers can easily understand it. This allows companies
to reuse critical business components, realizing a long-term return on
investment for both new and existing applications.


      Visual MainWin(R) for the Unix and Linux platforms (formerly
MainWin)--Visual MainWin(R) for the Unix and Linux platforms is an advanced
application-porting platform that enables IT organizations to develop
applications in Visual C++ and deploy them natively on Unix and Linux without
the investment that is usually associated with such an undertaking.

      Customers continue to choose Unix due to its reliability and scalability
in production environments, despite the wide popularity of Windows-based systems
for application development and smaller departmental production applications. As
a result, enterprises confront not only the complexity inherent in these
heterogeneous computing environments, but also the higher costs of developing,
maintaining, and updating applications for multiple systems. Using our Visual
MainWin(R) products, independent software vendors and enterprise IT
professionals can develop software applications using the powerful Windows
development tools and then quickly and efficiently deploy those Windows
applications natively on Unix systems.


                                       26
<PAGE>

      The uniqueness of the Mainsoft solution is its ability to recompile
Windows application source code on Unix, creating natively executable code,
which consequently achieves native Unix performance levels. In addition, our
remote development technology enables Windows developers to build native Unix
applications from within the comfort of the familiar Microsoft Visual Studio
interface. This enables development teams to focus on a single development
environment while leveraging the resulting code onto multiple platforms, saving
valuable time and money. Developers, therefore, focus on adding
revenue-generating functionality rather than on software porting.

      Mainsoft has entered into a licensing agreement with Microsoft, pursuant
to which Microsoft granted Mainsoft access to specified Microsoft source code,
including new versions, service packs, and upgrade releases for Windows.
Microsoft also granted Mainsoft distribution rights to the Windows object code
licensed as a component in Mainsoft's products.


      Visual MainWin(R) for the J2EE platform--In February 2004, Mainsoft
launched its new generation product: Visual MainWin(R) for the J2EE platform
(formerly named Grasshopper). The Visual MainWin(R) for J2EE Platform is a
cross-platform development solution that bridges the .NET/J2EE divide, enabling
Visual Basic .NET and C# developers to develop J2EE Web Applications and Web
services using the Visual Studio .NET development environment. With Visual
MainWin(R) for the J2EE platform, .NET and Java developers can accelerate J2EE
development by co-developing Web applications and Web services. Visual
MainWin(R) also eliminates .NET/J2EE server integration costs by enabling
ASP.NET applications to be deployed on industry-leading J2EE application
servers, such as BEA Weblogic, IBM WebSphere or Tomcat.


INVESTMENTS AND ACQUISITIONS

      In order to enhance our solutions and services portfolio, we have been
pursuing a strategy of adding new technologies to our suite of automated
modernization tools. We implement this strategy via internal development of new
software tools and through acquisitions and investments. Accordingly, we devote
significant resources to the development and marketing of new software
modernization tools, and invest in businesses that develop software tools that
are complementary to our existing portfolio. The broad portfolio that we
established, among others, through these acquisitions, contributes to our
ability to penetrate new markets and to offer a complete set of solutions
addressing the broad array of changing demands of our customers. We integrate
the acquired businesses into our business and assimilate many of their
functions, including, marketing, sales, finance and administration into our
existing infrastructure.

      Following is a description of our investments and acquisitions, which form
a part of our business as described above:



                                       27
<PAGE>


      LIRAZ. In November 2002, we purchased through a share exchange
transaction, approximately 86% of the outstanding share capital of Liraz, an
international software and services company, developing and marketing the
AppBuilder, then publicly traded on the TASE. As part of the share exchange
transaction, we issued to Liraz's selling shareholders, including Formula,
3,478,624 of our ordinary shares, constituting an aggregate of 26% of our
outstanding share capital. In two public tender offers that we published in
December 2002 and March 2003, we purchased additional shares of Liraz
representing 9% of the outstanding share capital of Liraz. In March 2003,
pursuant to the provisions of the Israeli Companies Law, we purchased the
remaining outstanding share capital of Liraz. The total aggregate amount of
those cash purchases was $2.7 million. Following these transactions, we
currently hold the entire outstanding share capital of Liraz. During 2003, we
assimilated and integrated Liraz's infrastructure, management, personnel and
sales and marketing activities within our business by combining our delivery
centers, teaching the respective sales forces about the products of the other
company, combining operations and eliminating duplicative roles in
administration. The acquisition of Liraz has enhanced our ability to market our
solutions in international markets through Liraz's international sales force,
and its experience in the mainframe environment. As a result, we have been able
to expand the services we provide to our customers. For more information about
the AppBuilder, see "Enterprise IT Redevelopment--BluePhoenix AppBuilder."


      MAINSOFT. Since 1999, we purchased, in a series of transactions, 57.5% of
the outstanding share capital of Mainsoft, for aggregate consideration of
approximately $17.2 million. These holdings include the exercise of a warrant in
May 2003, pursuant to which we purchased 630,000 shares of Mainsoft for an
aggregate of $378,000. We believe that our controlling interest in Mainsoft, the
developer and marketer of the Visual MainWin(R) products, including Visual
MainWin(R) for J2EE, enables us to address customer needs across a wide range of
computing platforms, from mainframe through midrange and workstations. We also
believe that holding a controlling interest in Mainsoft positions us as a
specialized cross-platform software solutions provider. For more information
about Mainsoft's products, see "Enterprise IT Redevelopment--Visual MainWin(R)
for the Unix and Linux platforms; Visual MainWin(R) for J2EE Platform."


      INTRACOMP. IntraComp Group Inc. provides migration and conversion services
for large-scale systems and back-end integration services. In the second quarter
of 2000, we acquired a 52% controlling interest in IntraComp for aggregate
consideration of $3.2 million. In the fourth quarter of 2000, we increased our
shareholdings in IntraComp to 53% by investing an additional $240,000. In
addition, as of May 21, 2004, we lent to IntraComp an aggregate amount of $2.3
million. Under the loan agreement, IntraComp is required to repay the loan by
April 2006 or when the current ratio of IntraComp exceeds 1.25, whichever is
earlier. During the second quarter of 2003, we purchased from the other
shareholders of IntraComp the remaining outstanding share capital of IntraComp
for consideration to be calculated based on IntraComp's cumulative earnings
before interest and taxes, referred to as EBIT, during the three-year period
commencing on January 1, 2003, as follows:

      o     If the EBIT exceeds $3,000,000 but is less than or equal to
            $4,000,000, then the consideration shall be equal to the sum of
            $900,000 plus 40% of the difference between the EBIT and $3,000,000;



                                       28
<PAGE>


      o     If the EBIT exceeds $4,000,000 but is less than or equal to
            $5,000,000, then the consideration shall be equal to the sum of
            $1,300,000 plus 50% of the difference between the EBIT and
            $4,000,000;

      o     If the EBIT exceeds $5,000,000 but is less than or equal to
            $6,000,000, then the consideration shall be equal to the sum of
            $2,500,000 plus 60% of the difference between the EBIT and
            $5,000,000; and

      o     If the EBIT exceeds $6,000,000, then the consideration shall be
            equal to the sum of $3,600,000 plus 60% of the difference between
            the EBIT and $6,000,000.

      We undertook to pay to the selling shareholders, on August 30, 2004, an
advance on account of the contingent consideration, based on the interim EBIT at
that time. The balance is due in February 2006, based on a final report of
IntraComp's earning. Following the purchase of the entire interest in IntraComp,
we integrated IntraComp's business completely into ours. For more information
about IntraComp's solutions, see "Enterprise IT Migration--BluePhoenix
PlatformMigrator."


      SCH. We wholly own SCH Software Conversion House Ltd., a developer and
marketer of software conversion tools and services for midrange environments. We
completed the acquisition of the outstanding share capital of SCH in 2001. Since
its formation in 1994, SCH has focused on providing cost-effective technology
enhancement tools and solutions for enterprise IT migrations and conversions for
midrange computer environments.


      MULTICONN. In 1999, we acquired 51% of the outstanding share capital of
M.S.I. MultiConn Solutions International (1995) Ltd., referred to as M.S.I.
MultiConn, and in 2000, we increased our shareholdings in M.S.I. MultiConn to
60%. Effective as of January 2004, the other shareholders of M.S.I. MultiConn
transferred their entire holdings in M.S.I. MultiConn to us. Following this
transaction, we assumed control over the daily management of M.S.I. MultiConn.
We currently wholly own M.S.I. MultiConn and finance its activities.

      In 2000, we established together with the other shareholders of M.S.I.
MultiConn, a new company named MultiConn Technologies Ltd., and initially owned
19% of its share capital. MultiConn Technologies develops and markets eMulticonn
and related solutions, referred to as eXperanto. Under our agreement with
MultiConn Technologies entered into in 2000, we lent to MultiConn Technologies
$2.1 million, of which $1 million was convertible into ordinary shares of
MultiConn Technologies. In December 2002, we converted the $1 million loan into
shares of MultiConn Technologies and as a result our holdings increased to 60%.
Following a transaction entered into between us and the other shareholders of
MultiConn Technologies in 2004, the other shareholders of MultiConn Technologies
increased their holdings in MultiConn Technologies to 58.2% in the aggregate,
through the issuance of shares by MultiConn Technologies. As a result, we
currently hold approximately 40% of the outstanding share capital of MultiConn
Technologies. We have an option to increase our holdings in MultiConn
Technologies to 60% of its outstanding share capital for an exercise price of
$50,000. In May 2004, we provided on behalf of MultiConn Technologies a
guarantee in the amount of $300,000, which expires in May 2005. In 2004, we
included in our equity in affiliated companies 100% of the losses of MultiConn
Technologies up to the guaranteed amount. In 2002 and 2003, we wrote down $1.8
million and $350,000, respectively, of the balance of our investments and loans
to MultiConn Technologies, due to the impairment of the investment and since it
was probable that we would be unable to collect all amounts due. For more
information about eXperanto, see "Enterprise IT Migration--eXperanto."



                                       29
<PAGE>

      INTERCOMP. In 1998, we invested in Intercomp Ltd., which has developed a
set of automated analysis and reengineering tools for legacy COBOL applications.
During 2002 and 2003 Intercomp focused its efforts on the development of
software tools that comprise a part of BluePhoenix LogicMiner. For more
information about LogicMiner, see "Research and Development--Enterprise IT
Understanding--BluePhoenix LogicMiner."


      In the fourth quarter of 2003, we exercised an option to purchase from
Intercomp its tool known as AnalyzeIT for an aggregate of $1.9 million. In
addition, we undertook to pay to Intercomp royalties of 25% of the revenues
generated from the purchased technology. AnalyzeIT provides an analysis of a
legacy application and creates a repository and inventory of the application's
components and the relationships between them. The results of the analysis are
presented graphically and in reports. They include a study of the application's
control flow and data flow which enable the user to examine the code and
structure of the application down to the level of a single variable. In
connection with the purchase of Intercomp's technology, we assumed the rights
and obligations of Intercomp under the distribution agreement described below.
The consideration for the acquired technology was offset against the outstanding
loan balance owed to us by Intercomp, as described in the next paragraph.

      Duing the years 1998-2003, we lent to Intercomp an aggregate of $3.7
million. As of December 31, 2003, after offsetting the $1.9 million described
above for the purchase of technology, an aggregate of approximately $1.8 million
was outstanding. These loans are required to be repaid by Intercomp at the end
of a 5-year period commencing on February 19, 2002 or earlier (i) in the event
of liquidation or acquisition of Intercomp by a third party or (ii) if the
current ratio of Intercomp is equal or greater than 1.25. The loans bear
interest at a rate of LIBOR +1% per annum. The principal of the loans plus
interest accrued are convertible into preferred shares of Intercomp at a
conversion price of $162.70 per share.

      Effective as of January 2004, we entered into an option agreement,
pursuant to which we were granted an option to purchase all of Eran Tirer's
interest in Intercomp, constituting 18.5% of the outstanding share capital of
Intercomp. In the event we exercise our option to purchase Eran Tirer's shares
in Intercomp, we are obligated to issue to him as consideration for his shares,
warrants to purchase 5,000 BluePhoenix ordinary shares at an exercise price of
$20 per share. The warrants are exercisable until October 25, 2005.
Concurrently, the remaining shareholders of Intercomp comprised of several funds
acting through their general partner, Israel Infinity Venture Capital Partners
Ltd., referred to as Infinity, and we, approved the signing of a non-exclusive
distribution agreement between Intercomp and a distributor partially owned by
Mr. Tirer, pursuant to which Intercomp granted non-exclusive rights to the
distributor to further develop and distribute Intercomp's products. In March
2004, we exercised our option to purchase Mr. Tirer's holdings in Intercomp. In
addition, Infinity converted certain outstanding loans owed to it by Intercomp
into 7,236 shares of Intercomp at a price per share of $162.70. Following these
transactions, our holdings in Intercomp increased from 49% to approximately 62%.
Since the end of the first quarter of 2004, we consolidated the results of
operations of Intercomp.



                                       30
<PAGE>


      In April 2004, Infinity granted us a call option to purchase its entire
holdings in Intercomp, exercisable until April 1, 2006. If we do not exercise
such option, Infinity will have a put option to cause us to purchase Infinity's
entire holdings in Intercomp, exercisable during a period of six months
commencing in April 2006. If either of the options is exercised, we shall be
obliged to issue to Infinity, as consideration for Intercomp's shares, 100,000
BluePhoenix ordinary shares and an additional amount of shares to be calculated
based on revenues generated from the sale of licenses to use Intercomp's
products during a 3-year period commencing on April 1, 2003, as follows:

      o     For the first $3 million of revenues, the number of additional
            shares shall be to 10,000 shares for each $1 million of revenues.

      o     If revenues exceed $3,000,000 but are less than or equal to
            $15,000,000, then the number of additional shares shall be 30,000
            plus 20,000 shares for each $1 million of revenues exceeding $3
            million.

      o     If revenues exceed $15,000,000, then the number of additional shares
            shall be 270,000 plus 10,000 shares for each $1 million of revenues
            exceeding $15 million.

      The shares will be subject to a lock-up period until April 1, 2006. We
undertook, upon Infinity's request, to use our best efforts to effect
registration of the shares, within 8 months of the end of the lock-up period or
within 90 days of such date, if we filed our annual report on Form 20-F during
such 90-day period, whichever is earlier. We may, at our option, pay to Infinity
the cash equivalent of such shares which will be calculated according to the
average closing price of BluePhoenix shares during the 20 trading days prior to
the exercise of any of the options.

      We have granted to FIMI, a creditor of Intercomp, a put option to sell to
us convertible promissory notes issued to FIMI by Intercomp in an aggregate
principal amount of $3.5 million. For more information about this transaction,
see "Item 5.B. Liquidity and Capital Resources--Contractual Commitments and
Guarantees."

      ALEXANDRIA. During 1999, we purchased 19% of the outstanding share capital
of Alexandria Migration Technologies Ltd., which develops DBMSMigrator (formerly
known as C-MIDAS). In consideration therefor, we undertook to extend to
Alexandria loans in an aggregate amount of $4.2 million, which were extended to
Alexandria from time to time during 1999, 2000 and 2001. In 2001, we wrote off
$2.5 million of these loans since it was probable that we would be unable to
collect all amount due. The purpose of the loans was for working capital. As of
December 31, 2003, we lent to Alexandria an aggregate amount of approximately
$3.9 million. In September 2002, we entered into an agreement with the other
shareholder of Alexandria to purchase his entire shareholdings in Alexandria,
constituting 81% of Alexandria's outstanding share capital, for an aggregate
amount of $585,000. As a result, we currently wholly own Alexandria and its
entire activity is integrated within our business. For more information about
the DBMSMigrator, see "Enterprise IT Migration--BluePhoenix DBMSMigrator."



                                       31
<PAGE>

      CEPOST. In January 2004, we purchased the entire outstanding share capital
of CePost Ltd., an Israeli company that develops and markets software solutions
for electronic document mining, management and presentment. Pursuant to the
purchase agreement, we paid to the shareholders of CePost $172,500 and issued to
them 31,500 BluePhoenix ordinary shares. In addition, we undertook to pay to the
sellers royalties from CePost's revenues in an amount ranging between $120,000
and $1.5 million. At our option, we may pay the royalties in BluePhoenix
ordinary shares. At the transfer date, we recorded for the contingent purchase
consideration at the minimum level of $120,000 based upon our estimated future
royalties. For more information about CePost's software solutions, see
"Enterprise IT Presentment--BluePhoenix PowerText."

      OUTLOOK. Effective as of January 2004, we acquired from an Israeli
company, Outlook Systems Ltd., through our new wholly owned subsidiary, Outlook
& BluePhoenix Ltd., Outlook Systems' entire business activities in Israel in the
field of software development services. Pursuant to the purchase agreement, we
hired 31 employees previously employed by Outlook Systems and assumed all the
obligations in respect of the purchased activity. These obligations include the
extension of a guarantee to banks with respect to loans in an aggregate amount
of $720,000 plus interest accrued, to be repaid by us by February 15, 2007. In
addition, under the purchase agreement, we undertook to pay to the shareholders
of Outlook Systems in the first quarter of 2007, an amount equal to between 5
and 7 times the average operating profit of Outlook & BluePhoenix Ltd. in the
years 2004, 2005 and 2006, less an amount of $720,000.

      TESNET. Effective as of January 1999, we acquired 32% of the outstanding
share capital of Tesnet--Software Testing Ltd., a provider of testing and
software quality assurance services, for an aggregate amount of $2.0 million
that we paid during 1999 and 2002. In February 2000, Tesnet consummated a public
offering of its shares on the Tel Aviv Stock Exchange. Net proceeds from the
offering were $9.5 million. As a result, we recorded a capital gain of
approximately $1.0 million. During 2000, we sold a portion of our holdings which
constitutes 3% of the outstanding share capital of Tesnet, and in the first
quarter of 2004, we sold our entire remaining holdings in Tesnet. As a result,
we currently do not hold any interest in Tesnet.

      ALPHATECH. In December 2002, we purchased from Intercomp, our affiliate, a
65% controlling interest in Alphatech (2000) Srl. for aggregate consideration of
$100,000. Alphatech, a company incorporated in Romania, provides us software
development services.

      PURCHASE OF SDC'S ACTIVITY. In October 2002, Liraz, through a wholly owned
subsidiary, acquired from SDC FinansSystems A/S, referred to as SDC, a company
incorporated in Denmark, its IT development services activities relating to
customers in the banking sector in Denmark. Pursuant to the purchase agreement,
we assumed all the obligations in respect of the purchased activity and hired
100 employees, of which 30 employees were dismissed during the first quarter of
2003. The seller agreed to reimburse us for any costs associated with such
dismissals. The aggregate consideration paid for the purchased activity and
goodwill was $800,000. In addition, we entered into an agreement with two of the
seller's shareholders, pursuant to which the shareholders have purchased from us
IT development services.



                                       32
<PAGE>


      LEVEL 8. As of May 21, 2004, we hold shares and several capital
instruments, including warrants and rights to receive warrants exercisable into
shares of Level 8 Systems Inc. If we exercise these capital instruments in full,
our shareholdings in Level 8 would reach 4%. During 2003 and in the first
quarter of 2004, we sold substantially all of the preferred stock of Level 8
then held by us for $624,000. In 2003, we purchased 444,444 ordinary shares of
Level 8 for $200,000. In addition, as of May 21, 2004, we extended to Level 8
guarantees of approximately $2 million in the aggregate. In November 2003, we
agreed to extend the term of our guarantee to November 2004. As consideration
for the extension of such guarantee through November 2004, we were issued an
aggregate of 300,000 Level 8 ordinary shares in November 2003 and March 2004.

CUSTOMERS

      We provide our modernization solutions directly or through our strategic
partners, such as IBM, Capgemini, EDS, Cook Systems, Temenos, Millennium and
TACT. Additionally, from time to time, other IT services companies license our
technologies for use in modernization projects in various markets. Our partners
are usually system integrators who assist us in increasing our penetration and
exposure in the market. We provide solutions to our partners' customers in
collaboration with the system integrator's team. In most cases, the partners
provide related services to the customers. Our arrangements with our partners
vary. We may enter into distribution agreements with the partners under which we
grant license rights to the partners and/or the partners' customers, provide
related services or a combination of both. Alternatively, we may enter into
subcontractor relationships with our strategic partners.

      Approximately 10% of our agreements are based on fixed price contracts.
Although we have significant experience in pricing fixed price projects, these
projects may bear some risks and uncertainties as we price these contracts based
on estimates of future costs, duration of the project and the impact potential
changes in the scope of the work. We also enter into other types of contracts,
including annual maintenance contracts, license agreements and arrangements on a
time and material basis. To date, shifts in revenues generated from different
types of agreements have not materially affected our results of operations.

      Our customers include, among others:


<TABLE>
<CAPTION>
FINANCIAL SERVICES            INSURANCE                    OTHER INDUSTRIES
------------------            ---------                    ----------------
<S>                           <C>                          <C>
o   Rabobank Netherland BV    o   AXA Sunlife Services,    o   Altera Corporation
    PCL(UK)
                              o   NV Interpolis BTLLACERA  o   Cadence Design Systems,
o   CGD Bank - Caixa              (USA)                        Inc.
    General de Depositos
    (Portugal)                o   LBS (Germany)            o   * Computer Associates
                                                               Islandia
o   Credit Suisse             o   Mivtachim (Israel)
                                                           o   Crystal Decisions
o   Fidelity International    o   Legal and general
    Resource Management o         Resources)               o   ESRI
    Argus Health Systems
                              o   Phoenix (Israel)         o   Mentor Graphics
o   Temenos Group                 Barmenia                     Corporation
                                  Krankenversicherung
o   Rural Servicios               A.G.                     o   Microsoft Corporation
    Informaticos (Spain)
                                                           o   Cognos
o   SDC Udvikling (Denmark)
                                                           o   Synopsys MT VIEW

                                                           o   Electronic Data Systems
                                                               Corp

                                                           o   IBM Japan Ltd.

                                                           o   Commonwealth of
                                                               Australia

                                                           o   MCI WorldCom Network
                                                               Services, Inc.

                                                           o   Net Quation

                                                           o   IBM (Rational Software)
</TABLE>

---------
Each of the customers mentioned above contributed at least $600,000 to our
annual revenues for a project performed within the previous two fiscal years.


                                       33
<PAGE>



      SDC Udvikling A/S, referred to as SDC Udvikling, an affiliated company of
SDC, accounted for 14% of our revenues in 2003.


      The following table summarizes the revenues from our tools and services by
geographic regions for the periods indicated:

                                                  YEAR ENDED DECEMBER 31,
                                           -------------------------------------
                                             2003           2002           2001
                                           -------        -------        -------
                                                      (IN THOUSANDS)
United States                              $18,520        $20,847        $21,428
Europe (other then Denmark)                 19,799          7,785          8,518
Denmark                                      8,997          2,530             --
Israel                                       3,986          4,636          7,482
Other                                        3,038          1,010            870
                                           -------        -------        -------
Total                                      $54,340        $36,668        $38,438

RESEARCH AND DEVELOPMENT

      In order to maintain our position as a market leader in the IT
modernization market, we are focusing our development efforts on further
enhancements to current solutions, as well as addressing newly emerging aspects
of the modernization market. We are planning additional software development
activities to extend our modernization solutions by leveraging our technological
skills to create added value for our customers and to generate additional
business opportunities.

      The next generation of our solutions will be extended to address the
entire modernization process from legacy systems to modern platforms. We have
started to develop our next generation of products and tools, which will allow
the fluent transformation of legacy code to state-of-the-art platforms, such as
J2EE and .NET. The new generation of solutions is composed of products and tools
in several EIM categories.


                                       34
<PAGE>

Enterprise IT Understanding

      Application Portfolio Management--By further productizing our existing
scanning technology and combining it with the additional technology licensed
from Merrill Lynch, our IT Discovery product will provide the basis for legacy
understanding needed by the rest of our modernization solutions, and in addition
it will also directly address the newly emerging application portfolio
management (APM) challenge. This market addresses organizations' needs to
understand their current systems and to manage them on an ongoing basis.

      BluePhoenix(TM) LogicMiner--A comprehensive solution that mines IT
development data and extracts business rules from the legacy code, thus
providing IT departments with a better understanding of their IT environments.
This tool retains past investments in software assets by producing reusable code
objects or descriptive data that can later be used for improving the quality of
the legacy code, rewriting the legacy application, or building a full
modernization plan. LogicMiner decreases maintenance costs and efforts and
increases a system's manageability, while eliminating rules that no longer apply
to current business procedures.

Enterprise IT Presentment

      Report-IT --In the area of noninvasive modernization or legacy wrapping
for customers looking for a "quick and easy" modernization payback, we are
continuing to enhance our PowerText report-to-Web technology acquired through
our wholly owned subsidiary CePost. In addition, CePost has recently reached a
joint development agreement with Elixir Technology, a company headquartered in
Singapore. Elixir develops and markets e-Reporting solutions. Elixir has
recently introduced an innovative mobile reporting solution that provides an
auto-matched ease of publishing of corporate information to any Java or
XHTML-enabled mobile devices. CePost and Elixir are developing together the
Report-IT an XML-based reporting and output management solution for legacy
systems, based on text files source.

Enterprise IT Migration

      Fourth generation language Migration--4GL migrations are also consistent
with our approach of using automated migration techniques when the legacy system
is relatively clean and no architectural changes are required. We intend to
further provide a unique approach to language migration that maximizes the
organization's capabilities to recover the investment already made in legacy
systems. Our next target languages are Mantis and PowerBuilder.

      EXperanto--Technology owned by MultiConn Technologies is currently being
further developed to enable mainframe applications to access web services, in a
standard and simplified path.


                                       35
<PAGE>

Enterprise IT Redevelopment

      Re-Builder (code name)--We are addressing application redevelopment as an
alternative to automated migration, when legacy code quality is poor or
architectural changes are required as part of the application migration. In
particular, application redevelopment provides a second generation approach to
the very large and rapidly growing market for migrating COBOL to J2EE or .NET, a
migration that involves extensive architectural changes to the application. This
market requires tools that can mine core business rules from legacy applications
and then recombine these rules into applications in the new J2EE and .NET
architectures. To address this we are integrating IT Discovery, the logic mining
capabilities of the technology acquired from Intercomp and the AppBuilder
repository and regeneration capabilities into a complete products suite
addressing application redevelopment.

      Visual MainWin(R) for J2EE Platform--Mainsoft's Visual MainWin(R) for the
J2EE platform, launched in February 2004, is a cross-platform development
solution that bridges the .NET/J2EE divide, enabling Visual Basic .NET and C#
developers to develop J2EE Web applications and Web services using the Visual
Studio .NET development environment.

      With Visual MainWin(R) for the J2EE platform, .NET and Java, developers
can accelerate J2EE development by co-developing Web applications and Web
services. Visual MainWin(R) also eliminates .NET/J2EE server integration costs
by enabling ASP.NET applications to be deployed on industry-leading J2EE
application servers, such as BEA Weblogic, IBM WebSphere or Tomcat.

      In 2003, the Microsoft Intermediate Language to Java Byte code compiler
and all required initial steps of integration with Visual Studio .NET have been
completed. In 2004, Mainsoft plans to achieve enterprise quality and to add new
functionalities. These additional developments are planned to include: support
of new c# features, support portals standards and support new release of Visual
studio .NET and new Java standards.

Costs and Grants

      We employ 120 employees in our software development departments. Our
development expenditures were $8.1 million in 2003, $7.4 million in 2002 and
$8.9 million in 2001. Certain of our new product development projects have been
awarded research grants that are repayable as royalties.

      Mainsoft--Through December 31, 2003, our subsidiary, Mainsoft, accrued an
aggregate of approximately $570,000 in grants from the OCS for the development
of Visual MainWin(R) for J2EE. Royalties of 3% are payable to the OCS on sales
of Visual MainWin(R) for J2EE, up to 100% of the dollar-linked grant received in
respect of the funded product. As of May 21, 2004, Mainsoft has paid to the OCS
the royalties that were required to be repaid. Mainsoft has submitted to the OCS
an application for obtaining research and development grants for 2004, which is
pending approval.


                                       36
<PAGE>

      CePost--As of January 1, 2004, our subsidiary CePost, accrued an aggregate
of approximately $250,000 in grants from the OCS for the development of
PowerText. Royalties of 3% are payable to the OCS on all sales of PowerText up
to 100% of the dollar-linked grant received. As of May 21, 2004, CePost has paid
to the OCS the royalties that were required to be repaid.

      In the first quarter of 2004, the Singapore-Israel Industrial Research and
Development Foundation agreed to provide CePost together with a company
incorporated in Singapore, financing for the development of Report-IT.
Accordingly, the foundation agreed to award CePost up to $100,000 payable
according to an agreed upon schedule. CePost is required to repay that amount in
payments based on sales of the Report-IT up to the amount of the grant.

INTELLECTUAL PROPERTY

      We rely on a combination of trade secret, copyright, and trademark laws
and non-disclosure agreements, to protect our proprietary know-how. 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.

COMPETITION

      The modernization market in which we operate is highly competitive. The
principal competitive factors affecting the market for our modernization
solutions include:

      o     product functionality, performance, and reliability;

      o     technical range of the offered solutions;

      o     integration between the offered solutions;

      o     availability of experienced personnel;

      o     prices;

      o     ability to respond in a timely manner to changing customer needs;

      o     ease of use; and

      o     quality of support.

      Competition in the enterprise IT modernization field is, to a large
extent, based upon the functionality of the tools. Vendors in this market
address the evolutionary modernization of legacy systems in different ways, and
therefore do not always compete directly with others in the market. Many small
vendors address only a small part of the market, whereas only a few offer a
comprehensive and integrated solution set which can provide answers for most of
the modernization challenges that companies currently face.


                                       37
<PAGE>

      Our principal competitors consist of system integrators and tool vendors,
including leading software developers, who enable customers to replace or
modernize their legacy systems. Major system integrators in the market include
IBM, Capgemini, and EDS. 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. We cooperate 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. In addition, we face competition from niche companies
operating in each of the five principal areas of the enterprise IT modernization
market:

      o     Enterprise IT Understanding;

      o     Enterprise IT Migration;

      o     Enterprise IT Remediation;

      o     Enterprise IT Redevelopment; and

      o     Enterprise IT Presentment.

      For example, Micro Focus International markets its solutions to the COBOL
market, Software Technologies addresses the Natural/ADABAS arena, and other
competitors focus on collecting sufficient information about application
portfolios to enable improved working processes. Other solution developers
provide legacy and distributed repository solutions that are important for a
variety of modernization processes.

C.    ORGANIZATIONAL STRUCTURE

      We are part of the Formula group, a global IT solutions and services group
headquartered in Israel. The Formula group is principally engaged in providing
software consulting services, developing proprietary software products, and
providing computer-based business solutions. The Formula group delivers its
solutions in over 50 countries worldwide to clients with complex IT services
needs, including a number of "Fortune 1000" companies. We are a subsidiary of
Formula Systems (1985) Ltd., or Formula, which holds directly 58.6% of our
ordinary shares and, through voting agreements with Dan Goldstein, a director of
our company and Formula's chief executive officer and chairman of the board of
directors, and Gad Goldstein, the chairman of our board and Formula's president,
beneficially own 64.2% of our ordinary shares.

      Following is a list of our significant subsidiaries, their country of
incorporation, and proportion of our ownership interest in them, as of May 21,
2004:

<TABLE>
<CAPTION>
NAME OF SUBSIDIARY                             COUNTRY OF                 PROPORTION OF
                                              INCORPORATION             OWNERSHIP INTEREST
                                              -------------             ------------------
<S>                                         <C>                         <C>
BluePhoenix Solutions B.V.                  The Netherlands                     100%

Liraz Systems Ltd.                          Israel                              100%

Mainsoft Corporation                        United States                       58%
</TABLE>


                                       38
<PAGE>

D.    PROPERTY, PLANTS AND EQUIPMENT

      We, together with our subsidiaries and affiliates, currently occupy
approximately 10,000 square meters of office space. The aggregate annual rent we
paid for these facilities in 2003 was $2.2 million. The following table presents
certain information about our facilities and the terms of lease of these
facilities.

<TABLE>
<CAPTION>
------------------------- ------------------------- ---------- --------------------- -----------------------
   COUNTRY AND STATE                CITY            SQ.             EXPIRATION         ANNUAL ANTICIPATED
                                                     METERS                           RENTAL FEES IN 2004
                                                                                        IN THOUSANDS US$
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
<S>                       <C>                       <C>        <C>                   <C>
Israel                    Herzlia                       1,400  December 2006                       300
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
Israel                    Tel Aviv                        400  Monthly renewal                      60
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
Israel                    Holon                           250  February 2005                        50
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
Israel                    Lod                           1,100  June 2006                           140
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
Israel                    Azor                            450  August 2004                          75
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
USA, North Carolina       Cary                          1,300  May 2006                            260
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
USA, California           San Jose                        700  September 2006                      150
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
USA, Indiana              South Band                      700  December 2004                       120
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
Denmark                   Ballerup                      2,600  Monthly renewal                     270
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
Germany                   Frankfurt                       270  November 2004                        70
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
Netherlands               Amsterdam                       130  June 2005                            25
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
Romania                   Bucharest                       400  August 2005                          60
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
United Kingdom            Uxbridge                         40  July 2004                            75
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
Cyprus                    Nicosia                         300  June 2005                            45
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
Italy                     San Felice                      150  November 2005                        30
                          Segrate--Milano
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
TOTAL                                                  10,190                                    1,730
------------------------- ------------------------- ---------- --------------------- ---- ------------- ----
</TABLE>

      If, in the future, we determine that we need 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. We do
not own any real property.


                                       39
<PAGE>

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

BACKGROUND

      We develop and market unique enterprise IT modernization, or EIM,
solutions that enable companies to automate the process of modernizing and
upgrading their mainframe and distributed IT infrastructure and to effectively
compete in today's environment. The combination of our comprehensive set of
products and tools with our expert services methodology provides an efficient
and cost-effective process for extending the return on investment of existing
enterprise IT assets. Our solutions, which include technology for Understanding,
Presentment, Migration, Remediation, and Redevelopment, allow companies to fully
leverage their current systems and applications, speed up and reduce the cost of
the renewal process, and effectively update their systems in order to adapt to
new business demands.

      Our quarterly and annual revenues, gross profit, and results of operations
have fluctuated significantly in the past and we expect them to continue to
fluctuate significantly in the future, as a result of numerous factors,
including the changes in the suite of modernization tools we have been offering
to our customers, the limited experience we have had in the markets for these
newly introduced tools, and the difficulties we have encountered in introducing
our tools to their respective markets. Therefore, we believe that
period-to-period comparisons of our financial results are not necessarily
meaningful and you should not rely on them as an indication for future
performance.

      The following discussion of our critical accounting policies and our
financial condition and operating results should be read in conjunction with our
consolidated financial statements and related notes, prepared in accordance with
U.S. GAAP for the years ended December 31, 2003, 2002 and 2001, and with any
other selected financial data included elsewhere in this report.

OVERVIEW

GENERAL


      In recent years, we have been affected by the global economic changes, in
particular the sharp decline in capital spending in the IT sector and the
overall business slowdown in North America and Europe, as well as in Israel.
Uncertainties in the North American and European markets have influenced the
purchasing patterns of leading software developers who delayed their planned
orders and caused developers to reduce the amount of their planned license
commitments. These changes in purchasing patterns in the IT industry directly
affect our operating results. Our revenues decreased from $49.2 million in 2000
to $38.4 million in 2001 and to $36.7 million in 2002. In 2003, as a result of a
slight recovery of the market, and the impact of a strategic acquisition we
completed, this trend changed, and our revenues increased to $54.3 million. As
part of this change, our average backlog has increased from a range of between
$10 million and $15 million in late 2002 to a range of between $20 million and
$25 million at the end of 2003. This increase improves management's ability to
engage in near-term planning. We typically fill current backlog within one year.



                                       40
<PAGE>


      In providing our solutions, we work closely with our customers or system
integrators, and can therefore be impacted by holiday seasons of the customers
and system integrators. As a result, we may sometimes experience a decline in
our third quarter revenues due to the summer holiday season in Europe and
Israel.

      In order to enhance our solutions and services portfolio, we have been
pursuing a strategy of adding new technologies to our suite of automated
modernization tools. We implement this strategy via internal development of new
software tools and through acquisitions and investments. Accordingly, we devote
significant resources to the development and marketing of new software
modernization tools. In addition, we invest in businesses that develop software
tools that are complementary to our existing portfolio and have a skilled and
specialized workforce.

LIRAZ ACQUISITION

      In November 2002, we completed the acquisition of a majority of the
outstanding share capital of Liraz, an Israeli company then publicly traded on
the TASE. In March 2003, we completed the acquisition of all the remaining
outstanding share capital of Liraz. Liraz's development environment, the
AppBuilder, acts as a virtual application warehouse for large legacy mainframe
installations. Most of BluePhoenix's tools are based on generic technologies
that were initially developed to be used in the mainframe environment. By
combining with Liraz, we intend to increase sales of our solutions by leveraging
Liraz's well-developed marketing infrastructure and expertise in the mainframe
environment. Liraz's customers are all veteran users of the AppBuilder. Our
suite of Enterprise IT Modernization tools is appealing to them, since its main
target market consists of legacy mainframe installations. As a result of our
integration with Liraz, we have generated cross sales of our software
modernization tools and solutions to Liraz's existing customers. During 2003,
$824,000 of our total revenue was attributable to these cross sales. We have
completed the integration of Liraz's management, personnel and sales and
marketing activities within our business. We are still in the integration
process and expect to complete it by the end of 2004. We believe that as a
result of the integration of our business with that of Liraz, the combined
company will be able to realize greater operating efficiencies and will benefit
from a larger and more diversified marketing and support network. In addition,
we anticipate that the combination of our respective technical personnel will
enhance our product development capabilities. We currently offer a broad suite
of enhanced enterprise IT modernization solutions, from legacy reuse to platform
rehosting, which we believe will assist us in achieving our goal of being a
market leader in the IT modernization market.

RESTRUCTURING

      In October 2002, when our board of directors approved the acquisition of
Liraz, and we entered into the agreement with the selling shareholders, we began
implementing our restructuring plan. This plan was aimed at aligning our cost
structure with our then-current revenue stream, as well as building our combined
positioning and recognition as a leader in enterprise IT modernization.



                                       41
<PAGE>


      Prior to the merger, each of the companies maintained a complete range of
infrastructure that enabled it to operate as a public company in the global IT
market. In late 2002, immediately following the acquisition of a majority of the
outstanding share capital Liraz, we began our restructuring plan, which affected
employees in all departments of both companies. During the first stage of this
plan, all duplicative functions were eliminated in sales, finance and
administration. The annual savings generated from the implementation of the
initial stage of our restructuring plan was approximately $1.2 million,
resulting from the dismissal of approximately 25 employees.

      During the second stage, which took place in the second half of 2003, we
established our off-shore delivery centers in Romania and Cyprus. These
off-shore centers allow us to reduce the prices paid by our customers for our
solutions while at the same time improving our operating profit.

      After the off-shore remote delivery centers were ready to operate and our
management learned to function under the revised structure, we dismissed an
additional 20 employees, increasing our annual cost saving by an additional $1
million. In the United States, we converted the South-Bend, Indiana office into
a low cost on-shore delivery center.

      In addition to the dismissals mentioned above, we consolidated office
space, resulting in annual savings of approximately $370,000 of direct lease
payments.

      Following a temporary increase in late 2003 of certain costs due to some
remaining overlapping functions, we streamlined our operations through the
complete integration of the assets, workforce and infrastructure of some of our
other subsidiaries and affiliates. In addition, we disposed of less efficient
product lines. Our restructuring activities have directly contributed to our
operating profit, which grew from $344,000, or 1% of revenues, in 2002 to $1.9
million, or 4% of revenues, in 2003. Since the beginning of the integration
process, the management analyzes the combined business as one business unit.

VISUAL MAINWIN

      Our revenues relating to the Visual MainWin product depend on the
availability of Window's source code, which is provided by Microsoft under its
agreement with Mainsoft. In order to diversify Mainsoft's product offering, we
have begun the development of a new innovative product that converts
applications developed on .NET to J2EE platform, without the need to rely on
Microsoft's source code. The source code leak in February 2004 has caused
customers of our old product, Visual MainWin, to delay or cancel pending
purchase orders due to the uncertainty in regard to the future source code
availability caused by the source code leak. We believe that the source code
leak could cause a temporary decrease of approximately $3 million to $4 million
in our annual sales. For a more detailed description of the source code leak and
the licensing relationship with Microsoft, see "Item 3.D. Risk Factors--The
ability of our subsidiary, Mainsoft, to continue to market the cross-platform
products for the Unix environment (Visual Mainsoft for Unix) is dependent upon
Mainsoft obtaining from Microsoft access to updated and additional source code."



                                       42
<PAGE>


CHALLENGES AND OPPORTUNITIES

      Our principal opportunity is to enhance our revenues by leveraging the
marketing resources and skilled specialized workforce of Liraz to market the
suite of tools and solutions that we offer. We also anticipate expanding our
customer base by entering new markets, such as Australia, which we view as an
introduction of our products into the greater Far East market. Another
opportunity for us is to market newly developed products. The next generation of
tools and solutions we are developing include software to bridge the .NET and
J2EE platforms.

      We believe that we can realize this potential growth while improving our
profitability. We expect to realize the benefits of our integrating the
operation of Liraz and ourselves to reduce the overall cost structure. In
addition, we anticipate increasing profitability by expanding our use of our
off-shore delivery centers.

      The principal challenge we face is to accomplish our growth objectives
while also enhancing profitability. In order to expand our revenue base, we will
continue to invest in our sales and marketing operations. In addition, we will
continue to devote substantial resources to research and development. There is
no assurance that these investments will lead to revenue growth. If they do not
lead to such growth, our profitability will be adversely affected.


CONSOLIDATION OF THE RESULTS OF OPERATIONS OF OUR SUBSIDIARIES

      Following is information regarding the consolidation of the results of
operations of certain of our subsidiaries, for the periods indicated. We began
to consolidate the results of operations of each of these subsidiaries when we
acquired control in them.


                                       43
<PAGE>

<TABLE>
<CAPTION>
                                                                              CESSATION OF CONSOLIDATION
NAME OF SUBSIDIARY                             BEGINNING CONSOLIDATION              (IF APPLICABLE)
------------------                             -----------------------              ---------------
<S>                                        <C>                               <C>
Mainsoft Corporation                         Fourth quarter of 1999

Tesnet--Software Testing Ltd.                First quarter of 1999             Second quarter of 2000

M.S.I. MultiConn Solutions                   Third quarter of 1999
International (1995) Ltd. (1)

IntraComp Group Inc.                         Second quarter of 2000

Liraz Systems Ltd.                           Fourth quarter of 2002

Advanced Systems Europe B.V.                 Fourth quarter of 2002

BluePhoenix Solutions B.V.                   Fourth quarter of 2002

Alexandria Migration Technologies            First quarter of 2003
Ltd.

CePost Ltd.                                  First quarter of 2004

Outlook & BluePhoenix Ltd.                   First quarter of 2004

Intercomp Ltd.                               Second quarter of 2004
</TABLE>

      ----------------------


      (1) We did not consolidate the results of operations of M.S.I. MultiConn
      in 2003, since the other shareholders undertook the daily management and
      control. Following the acquisition of the remaining shareholdings of
      M.S.I. MultiConn Solutions from the other shareholders, effective as of
      the first quarter of 2004, M.S.I. MultiConn's results are consolidated
      with ours.


      In 2003, we recognized a portion of the net losses of our affiliates,
Intercomp, Tesnet, M.S.I. MultiConn Solutions International (1995) Ltd. and
MultiConn Technologies Ltd., in accordance with the equity method of accounting.

CRITICAL ACCOUNTING POLICIES

      We prepare the consolidated financial statements of BluePhoenix in
conformity with accounting principles generally accepted in the United States,
referred to as U.S. GAAP. Accordingly, 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:


                                       44
<PAGE>


o     Revenue recognition. Our revenue recognition policy is significant because
      our revenue is a key component of our results of operations. In addition,
      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
      management to determine that these guidelines are not met for certain
      future transactions, revenue recognized for any reporting period could be
      adversely affected. (See note 1K to our financial statements).


            We recognize revenues from direct software license agreements 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 production, modification or
      customization of software, and with respect to fixed fee contracts,
      revenue is generally recognized according to the percentage of completion
      method in accordance with the provisions of SOP 81-1 "Accounting for
      performance of Construction-Type Contracts." Under this method, estimated
      revenue is generally accrued based on costs incurred to date as a
      percentage of total updated estimated costs. If we do not accurately
      estimate the resources required or the scope of work to be performed, or
      do not manage our projects properly within the planned periods of time or
      satisfy our 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. We
      recognize contract losses, if any, in the period in which they first
      become evident.


            Under some of our 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 contracts. Accordingly, we do not establish a
      provision due to the lack of warranties claims in the past. Some of our
      contracts include client acceptance clauses. In determining whether
      revenue can be recognized, when an acceptance clause exists, we consider
      our history with similar arrangements, the customer's involvement in the
      progress, the existence of other service providers and the payments terms.



                                       45
<PAGE>


            Our 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.

            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 non-refundable.

o     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 when detailed program
      design is completed and verified in accordance with the provisions of SFAS
      No. 86 of the FASB. Software development costs incurred before
      technological feasibility is established are charged to the statement of
      operations as incurred. Our 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. Management is required to use
      professional judgment in determining whether development costs meet the
      criteria for immediate expense or capitalization. Our failure to
      accurately predict the life of capitalized software could cause a one-time
      amortization, which could adversely affect our operating results.


o     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 SFAS No. 142 "Goodwill and Other intangible
      Assets" (SFAS No. 142), effective January 1, 2002, indefinite life
      intangible assets and goodwill are not amortized but rather subject to
      annual impairment testing.


            The annual impairment testing required by SFAS No. 142 also requires
      us to use our judgment as to the value of these intangible assets. If we
      are incorrect in these judgments, we may be required to write down the
      carrying value of our goodwill and other intangible assets in future
      periods. 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. Any resulting
      impairment loss could have a material adverse impact on our financial
      condition and result of operations.

o     Income taxes. Our income tax policy records the estimated future tax
      effects of temporary differences between the tax bases of assets and
      liabilities and amounts reported in the accompanying consolidated balance
      sheets, as well as operating loss and tax credit carry forwards. We follow
      very specific and detailed guidelines regarding the recoverability of any
      tax assets recorded on the balance sheet and provide any necessary
      allowances as required in accordance with the provisions of SFAS No. 109
      of the FASB "Accounting for Income Taxes." If we fail to accurately
      predict our estimated tax and if we are required to pay higher taxes than
      we anticipated, our results of operations could be seriously harmed.


                                       46
<PAGE>

o     Accounts receivable. We maintain a conservative method to assure the
      collection of our accounts receivable. Under this methodology, we
      periodically estimate the outstanding amounts and deduct an allowance for
      receivables with a low collection certainty. When there is a major
      deterioration of a customer's credit worthiness, we make allowances for
      doubtful accounts upon specific review of all outstanding invoices of such
      customer. If we fail to estimate accurately the recoverability of amounts
      due to us, our results of operations could be adversely affected.

OUR REPORTING CURRENCY

      Most of our revenues and a substantial portion of our costs are
denominated in United States dollars, or dollars. The dollar is the primary
currency of the economic environment in which BluePhoenix operates. Thus the
dollar is our functional and reporting currency. Accordingly, monetary accounts
maintained in currencies other than the dollar are remeasured into dollars under
the principles described in Financial Accounting Standards Board Statement No.
52. Assets and liabilities have been translated at period-end exchange rates.
Results of operations have been translated at average exchange rates. The
exchange gains and losses arising from these translations are included in the
statements of income (loss).


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

<TABLE>
<CAPTION>
      FOR THE YEAR ENDED          INFLATION RATE IN ISRAEL       DEVALUATION OF NIS            DEVALUATION OF EURO
         DECEMBER 31,                                             AGAINST THE US$              AGAINST THE US$
                                             %                            %                            %
<S>                               <C>                            <C>                           <C>
             2001                           1.4                          9.3                          5.2
             2002                           6.5                          7.3                        (15.7)
             2003                          (1.9)                        (7.6)                       (17.0)
</TABLE>


A.    OPERATING RESULTS

      The following table presents the percentage relationships of certain items
from our consolidated statement of operations, as a percentage of total revenues
for the periods indicated:


                                       47
<PAGE>

<TABLE>
<CAPTION>
                                                   2003        2002        2001
                                                  ------      ------      ------
                                                     %           %           %
STATEMENT OF OPERATIONS DATA
AS A PERCENTAGE OF REVENUES:
<S>                                               <C>         <C>         <C>
Revenues                                           100.0       100.0       100.0
Cost of revenues                                    44.4        41.5        46.1
                                                  ------      ------      ------
Gross profit                                        55.6        58.5        53.9
Software development costs                          15.0        20.1        23.1
Selling, general, and administrative expenses       37.0        36.1        51.5
                                                  ------      ------      ------
                                                     3.6         2.2       (20.7)
Goodwill impairment, restructuring costs, and
    non-recurring expenses                            --         1.3        11.6
                                                  ------      ------      ------
Operating income (loss)                              3.6         0.9       (32.3)
Financial income (expenses), net                     0.3        (0.5)       (0.1)
Gain on realization of shareholdings                 0.7         0.0         1.8
Other income (expenses), net                         1.0        (4.3)       (6.9)
                                                  ------      ------      ------
Income (loss) before taxes on income                 5.6        (3.9)      (37.5)
Income tax expense                                   0.3         0.4         0.3
                                                  ------      ------      ------
                                                     5.3        (4.3)      (37.8)
Minority interest                                   (0.3)       (1.9)        2.2
Equity in losses of affiliated companies, net       (1.6)       (3.6)       (3.4)
                                                  ------      ------      ------
Net income (loss)                                    3.4        (9.9)      (39.0)
                                                  ======      ======      ======
</TABLE>

YEARS ENDED DECEMBER 31, 2003 AND 2002


      Revenues. Revenues increased 48% from $36.7 million in 2002 to $54.3
million in 2003. This increase is attributable to the inclusion of $30.0 million
representing the integration of Liraz's and SDC's businesses. In addition, our
revenues increased as a result of the initial recovery in the markets in which
we operate, leading to increased IT spending, which in turn increased the volume
of our services and products' sales. The price of our products and services have
not changed significantly during the recent three years, and price fluctuations
had no material impact on our revenues. During the second half of 2003, we had
several cross-sales of our modernization solutions to veteran AppBuilder
customers of Liraz.


      The table below presents the breakdown of our revenues based on the
location of our customers for the periods indicated:

                                                  2003         2002         2001
                                                  ----         ----         ----

                                                    %            %            %
United States                                       34           57           56
Europe (Other then Denmark)                         36           21           22
Denmark                                             17            7           --
Israel                                               7           13           20
Other                                                6            2            2
                                                  ----         ----         ----
Total                                              100          100          100


                                       48
<PAGE>


      Sales by Liraz's European sales force contributed a material portion to
our overall revenues. The increase in sales in Denmark is attributable to the
impact of the SDC acquisition in the fourth quarter of 2002. We believe that the
decline in our sales in the United States is temporary. This decline is mainly
attributable to the slow recovery of the IT industry in North America, as well
as the relatively low resources we initially allocated to this region in 2003.
We have increased our resource allocation to North America for 2004 in
anticipation of a more robust IT industry.

      Cost of revenues. Cost of revenues consists of salaries, travel costs
relating to products and services rendered, amortization of capitalized software
costs and consulting fees paid to independent contractors. Due to the overall
growth in the volume of our activities, cost of revenues increased 58% from
$15.2 million in 2002 to $24.1 million in 2003. Cost of revenues as a percentage
of revenues increased to 44% in 2003 compared to 42% in 2002. The increase in
cost of revenues was attributable to the integration of Liraz's and SDC's
businesses, which contributed $12.9 million to our cost of revenues in 2003 and
to the temporary overlapping functions caused by to the consolidation of Liraz's
business. During 2003, we further implemented our restructuring plan that was
aimed at aligning our cost structure with our revenue stream, while realizing
the benefits of the local and offshore delivery centers. This restructuring plan
partially offset the overall increase in cost of sales.


      Software development costs. Software development costs, gross, consist of
salaries and consulting fees that are paid to professionals engaged in the
development of new software tools and related methodologies. Software
development costs, net, consist of software development costs, gross, less
development grants and capitalized software costs. During 2003, our subsidiary,
Mainsoft, accrued an aggregate of $570,000 in grants from the Office of the
Chief Scientist, for the development of Visual MainWin(R) for J2EE.

      Software development costs, gross, increased 21% from $9.8 million in 2002
to $11.9 million in 2003. As a percentage of revenues, software development
costs, gross decreased to 22% in 2003 compared to 27% in 2002. This decrease was
part of our cost alignment plan according to which some of our development
activities have been re-allocated to our own offshore subsidiaries, which
perform these activities at lower costs. In addition, some of our development
activities were consolidated into competence centers, where the expertise in
certain areas is concentrated.

      During 2003, our development costs were attributed to the development of
our unique modernization suite of tools. Software development costs are charged
to operations as incurred, unless capitalized according to Financial Accounting
Standards Board Statement No. 86. In 2003, we capitalized software development
costs in an aggregate amount of $3.2 million. Software development costs, net,
increased 10% from $7.4 million in 2002 to $8.1 million in 2003. As a percentage
of revenues, software development costs, net decreased from 20% in 2002 to 15%
in 2003. Net software development costs related to development of tools through
our affiliates are included in our consolidated financial statements under
"Equity in Losses of Affiliated Companies, Net."


                                       49
<PAGE>

      Selling, general and administrative expenses. Selling, general and
administrative expenses consist primarily of wages and related expenses, travel
expenses, third party commissions, selling expenses, marketing and advertising
expenses, rent, insurance, utilities, professional fees, and depreciation.
Selling, general and administrative expenses increased 52% from $13.2 million in
2002 to $20.1 million in 2003. As a percentage of revenues, selling, general and
administrative expenses increased to 37% in 2003 compared to 36% in 2002. This
increase in selling, general and administrative expenses is primarily
attributable to the temporary overlapping functions caused due to the
consolidation of Liraz's business as well as to the enlarged infrastructure
required to support the consolidated company.

      In 2002 and 2003, amortization of goodwill was not included in general and
administrative expenses, pursuant to Financial Accounting Standards Board
Statement No. 141, or SFAS 141. Under SFAS 141, all investments were evaluated
and their utilization was determined according to their anticipated contribution
to the business, and under SFAS 141, no additional write-downs were required to
be made.


      Financial income (expenses), net. Financial income increased in 2003 to
$165,000 compared to financial expenses of $195,000 in 2002. In 2003, financial
income consisted of currency rate differentials with respect to short-term
deposits as a result of the devaluation of the dollar against the NIS and the
devaluation of the dollar against the euro. Income derived from foreign currency
translation adjustments in 2003 was $614,000. In addition, the reduction in the
interest rate on short-term loans and the lower cash balance decreased our
interest income to $109,000. The financial income in 2003 was partially offset
by interest paid to banks on short-term loans in an aggregate amount of
$663,000. In 2002, financial expenses consisted of currency rate differentials
with respect to short-term deposits as a result of the devaluation of the NIS
against the dollar. Expense derived from foreign currency translation
adjustments in 2002 was $64,000. Our interest expenses net for 2002 were
$155,000.

      Gain on realization of shareholdings. In 2003, we converted preferred
shares of Level 8 into 900,035 common shares of Level 8 and sold them. The gain
realized from the sale of these shares was $376,000. In 2002, we had no gain on
realization of shareholdings.


      Other income (expenses), net. Other income, net in 2003 was $567,000
compared to other expenses, net of $1.6 million in 2002. Other income in 2003
consists primarily of the decrease in the bank guarantee that secured an
overdraft of Level 8. This income was partially offset by the write-down of
$350,000 related to loans that were previously made to an investee due to
limited visibility of the repayment. Other expenses in 2002 consist primarily of
a write-down of an investment.

      Income tax expense. In 2003, we had income tax expense of $152,000
compared to income tax expense of $160,000 in 2002. This net aggregate expense
is composed of local taxes paid worldwide by our international subsidiaries.


                                       50
<PAGE>

      Minority interest. The minority interest is comprised of the net profits
or losses assigned to the minority shareholders of our subsidiaries. In 2003,
the net charge was $154,000 compared to $702,000 in 2002. The reduction in
minority interest is attributable to the acquisition of minority interest in
some of our subsidiaries that was completed in 2003.

      Equity in losses of affiliated companies, net. In 2003, equity in losses
of affiliated companies, net, was $900,000. Equity in losses of affiliated
companies in 2003 includes an aggregate amount of $900,000 representing our
share in the losses of our affiliate Intercomp, an amount of $200,000
representing our share in the losses of our affiliates M.S.I. MultiConn and
MultiConn Technologies, partially offset by $200,000 representing our share in
the gains of Tesnet.

YEARS ENDED DECEMBER 31, 2002 AND 2001


      Revenues. Revenues decreased 5% from $38.4 million in 2001 to $36.7
million in 2002. Based on the feedback we receive from our sale forces, as well
as analyses of market trends performed by our marketing department, we believe
that this decrease was primarily attributable to the slow-down in the global
economy that caused customers to delay technology purchase orders. This decrease
was partially offset by $8.8 million of revenues representing the consolidation
of Liraz's results of operations in the fourth quarter of 2002. The acquisition
of Liraz was aimed to increase our business volume and improve our operating
results by leveraging Liraz's international sales force and presence.

      Cost of revenues. Cost of revenues decreased 14% from $17.7 million in
2001 to $15.2 million in 2002. Cost of revenues as a percentage of revenues
decreased to 42% in 2002 compared to 46% in 2001. Cost of revenue includes $4.9
million representing the consolidation of Liraz's results of operations in the
fourth quarter of 2002. This increase was offset by the implementation of our
cost reduction plan in the fourth quarter of 2001 that was aimed at aligning our
cost structure with our revenue stream. According to our cost reduction plan, we
reduced our sale and managerial personnel, decreased wages and tightened our
expense structure.


      Software development costs. Software development costs, gross, decreased
18% from $12.0 million in 2001 to $9.8 million in 2002. This planned decrease
was part of our cost reduction plan. During 2002, our development costs were
attributed to the development of our unique modernization suite of tools. As a
percentage of revenues, software development costs, gross, decreased to 27% in
2002 compared to 31% in 2001. Software development costs are charged to
operations as incurred, unless capitalized according to Financial Accounting
Standards Board Statement No. 86. In 2002, we capitalized software development
costs in an aggregate amount of $3.3 million. Software development costs, net,
decreased 17% from $8.9 million in 2001 to $7.4 million in 2002. As a percentage
of revenues, software development costs, net, decreased from 23% in 2001 to 20%
in 2002. Net software development costs related to development of tools through
our affiliates were included in our consolidated financial statements under
"Equity in Losses of Affiliated Companies, Net."

      Selling, general and administrative expenses. Selling, general and
administrative expenses decreased 33% from $19.8 million in 2001 to $13.2
million in 2002. As a percentage of revenues, selling, general and
administrative expenses decreased to 36% in 2002 compared to 52% in 2001. This
decrease is primarily attributable to the implementation of our cost reduction
plan. In 2001, we charged the amortization of goodwill to general and
administrative expenses. In 2002, no such charges were included pursuant to
Financial Accounting Standards Board Statement No. 141.


                                       51
<PAGE>


      Financial expenses, net. Financial expenses increased in 2002 to $195,000
from $62,000 in 2001. In 2002, financial expenses consisted of currency rate
differentials with respect to short-term deposits as a result of the devaluation
of the NIS against the dollar. The expense derived from foreign currency
translation adjustments in 2002 was $64,000. Our interest expenses net for 2002
were $155,000. In 2001, the expense derived from foreign currency translation
adjustments was $238,000. This expense was mainly attributed to the devaluation
of the NIS against the dollar and the Euro against the dollar. This expense was
partially offset by our interest income, net of $222,000.


      Goodwill impairment, restructuring costs and non-recurring expenses. In
2002, we purchased a 90% interest in Liraz, resulting in $472,000 of
restructuring costs in the fourth quarter of 2002. These costs were attributable
primarily to payments related to dismissal of employees. Our results of
operations in 2001 were materially affected by the implementation of our
restructuring plan, resulting in non-recurring expenses that included $2.8
million of restructuring costs consisting primarily of employee termination
benefits and other exit expenses, and goodwill impairment of $1.7 million
related to an acquisition.


      Gain on realization of shareholdings. In 2002, we had no gain on
realization of shareholdings. In 2001, gain on realization of shareholdings was
$693,000, attributable to a sale of our shareholdings in Polyglot Ltd.


      Other expenses, net. Other expenses, net in 2002 were $1.6 million
compared to other expenses, net of $2.6 million in 2001. Other expenses in 2002
consist primarily of a write-down of an investment. Other expenses in 2001
consist of a write-down of an investment of $2.5 million and loss from disposal
of fixed assets.

      Income tax expense. In 2002, we had income tax expense of $160,000
compared to income tax expense of $115,000 in 2001. This increase is primarily
attributable to local taxation of European subsidiaries that had taxable income.

      Equity in losses of affiliated companies, net. In 2002, equity in losses
of affiliated companies, net, was $1.3 million. Equity in losses of affiliated
companies in 2002 includes aggregate amount of $1.4 million representing our
share in the losses of our affiliate Intercomp, partially offset by $80,000
representing our share in the gains of Tesnet.


                                       52
<PAGE>

B.    LIQUIDITY AND CAPITAL RESOURCES

HOW WE HAVE FINANCED OUR BUSINESS


      In 1997, we consummated two public offerings, and received net proceeds of
$33.9 million after deducting underwriting discounts and commissions and
offering expenses. In the first quarter of 2004, we completed a $5 million
private placement of convertible debentures and warrants to four institutional
investors. In addition, we have entered into credit facilities with Bank
Discount Le'Israel Ltd., Bank Ha'poalim Ltd. and Bank Leumi Le'Israel Ltd., in
the respective amounts of up to $4.3 million, $5.2 million and $2 million. The
respective amounts outstanding under each of these credit facilities as of May
21, 2004 are $3.7 million, $4.3 million and $1.6 million. We may use these
credit facilities from time to time for interim financing, in accordance with
our cash requirements. These credit facilities provide for short-term loans, are
in various currencies and bear various interest rates.


CASH

      On December 31, 2003, we had cash and cash equivalents (including
marketable securities) of $11.5 million and working capital of $246,000. On
December 31, 2002, we had cash and cash equivalents (including marketable
securities) of $15.9 million and working capital of $1.3 million.

      Net cash provided by operating activities was $2.5 million in 2003
compared to $2.8 million in 2002. Cash provided by operating activities in 2002
was primarily the result of add-backs from depreciation and amortization and a
decrease in trade receivables. This was partially offset by our net losses of
$3.6 million and a decrease in trade payables and other accounts payable. Cash
provided by operating activities in 2003 was primarily the result of our $1.9
million net income and add-backs due to depreciation and amortization. This was
partially offset by an increase in trade receivables and a decrease in other
accounts payable.


      As of December 31, 2003, we had short-term bank debt outstanding of $8.3
million, compared to $7.5 million as of December 31, 2002. In connection with
the credit line extended to us by Bank Leumi Le'Israel Ltd., we are committed to
certain covenants related to our operations, such as:

      o     maintaining a minimum level of shareholders' equity of no less than
            40% of our total assets and no less than $40 million;

      o     maintaining a level of operating income before depreciation and
            amortization of no less than $1 million; and

      o     maintaining the ratio of our bank liabilities to current assets,
            excluding other current assets that shall not exceed 55%.


      To date, we have met all such covenants.


      Liraz has a fixed charge in favor of a bank on certain of its assets, as
well as a floating charge on its entire assets, securing Liraz's long-term
credit facility of $4.7 million. This credit facility also covers a guarantee of
$2 million in the aggregate that we extended to banks relating to the credit
line of Level 8. In November 2003, we agreed to extend the term of the guarantee
to November 2004. As consideration for the extension of the term of such
guarantee, we were issued 300,000 Level 8 ordinary shares.

      In addition, we have guaranteed short-term bank loans of an affiliate. As
of May 21, 2004, the aggregate amount of this guarantee was approximately
$300,000.



                                       53
<PAGE>

      In connection with the purchase of Outlook Systems Ltd.'s software
development services activity, in 2004, we extended a guarantee to banks with
respect to loans in an aggregate amount of $720,000 plus interest accrued, to be
repaid by us by February 15, 2007.

      On March 30, 2004, we completed a $5 million private placement to
institutional investors. Under the terms of this transaction, we issued to the
institutional investors convertible debentures, bearing interest at an annual
rate of 2%. In addition, the institutional investors were granted warrants with
an aggregate exercise price of $2.85 million exercisable into BluePhoenix
ordinary shares. The warrants are exercisable during a period of 5 years
commencing on September 2004. Under certain circumstances, the institutional
investors may increase their investment by an additional $3 million of
debentures and receive warrants on the same terms as the initial warrants,
exercisable into such number of BluePhoenix ordinary shares equal to 50% of the
ordinary shares into which the debentures are convertible. Following the
completion of the $5 million private placement in March 2004, we had cash and
cash equivalents of $16.6 million, and short-term bank credit of $7.8 million.
For more information regarding the private placement, see "Item 6.E. Share
Ownership: Arrangements Involving the Issue of BluePhoenix' Shares or Grant of
Options to Purchase Shares--Convertible Debentures and Warrants Purchased by
Institutional Investors."


      Typical modernization projects, which deploy our solutions, are long-term
projects, and therefore, payment for these projects or a substantial portion of
our fees may be delayed until the successful completion of specified milestones
and customer acceptance for the completed work. During 2004 we mutually agreed
with a customer, to terminate a contract. The contract was accounted for under
the percentage of completion method. As a result we recorded a loss of $400,000
in the first quarter of 2004. The payment of our fees is dependent upon customer
acceptance of the completed work, and our ability to collect the fees. Further,
although the timing of receipt of our fees varies, we incur the majority of our
expenses on a current basis. As a result, a delay in the collection of our fees
could result in cash flow shortages.


CAPITAL EXPENDITURES

      Our capital expenditures were $867,000 in 2003 and $823,000 in 2002. Our
capital expenditures in these years related primarily to purchases of computers
and related equipment required to support our software development activities.
In 2003, we invested $200,000 and lent $1.1 million to affiliated companies. In
2002 and 2001, we lent $2.2 million and $4.7 million, respectively, to
affiliated companies.

      In 2002, we purchased a 90% controlling interest in Liraz through a share
exchange transaction that was followed by a cash tender offer. We paid for the
tendered shares aggregate consideration of $1.1 million. During 2003, we
completed an additional tender offer and purchased the remaining outstanding
share capital of Liraz for an aggregate of $1.5 million.


                                       54
<PAGE>


      During 2002, we repurchased 104,465 of our ordinary shares for an
aggregate of $200,000. During 2003, we did not repurchase any additional shares.
As of May 21, 2004, we repurchased 1,870,565 of our ordinary shares under our
buy-back programs, for an aggregate of approximately $14.7 million. Under these
programs, we may purchase our shares from time to time, subject to market
conditions and other relevant factors affecting us. Under the Companies Law, the
repurchased shares are considered dormant shares. We may not resell these shares
unless (i) they are registered for resale under an effective registration
statement pursuant to the Securities Act of 1933, as amended, referred to as the
Securities Act; or (ii) pursuant to an exemption from registration under the
Securities Act. The first buy-back program adopted in May 1998, enables us to
purchase our shares, through a subsidiary, utilizing up to $5.0 million. Under
the second buy-back program adopted in September 1998, and amended in May 1999,
we may purchase, through a subsidiary as a trustee, up to an additional
1,400,000 ordinary shares. Under the two plans we may acquire an additional
1,044,351 shares at the current stock price. The closing price of our ordinary
shares as quoted on the NASDAQ National Market on May 21, 2004 was $5.27. Under
the agreement we entered into in connection with the private placement in March
2004, we are restricted to use only up to $200,000 for the repurchase of our
shares, as long as 20% or more of the debentures are outstanding.


      We believe that cash generated from operations together with existing
sources of liquidity and cash flow, will be sufficient to meet our anticipated
cash needs for at least the next 18 months.

CONTRACTUAL COMMITMENTS AND GUARANTEES


      Under our licensing agreement with Microsoft, Mainsoft is obliged to pay
to Microsoft royalties based upon the licensing of the Visual MainWin(R)
products, which include the software Mainsoft licenses from Microsoft. In
December 2003, we entered into an independent contractor agreement with
Microsoft. In accordance with this agreement, Microsoft agreed to offset the
value of the services we performed under the independent contractor agreement
from accrued royalties of up to $1,605,131. During the year ended December 31,
2003, we accrued royalties due to Microsoft of $2,782,000 and recognized credits
(reductions to expense) related to waivers and to services performed of
$2,466,000 $999,000, respectively. The excess credits over the royalties amount
is related to previous year royalties. For more information about our licensing
agreement with Microsoft, see "Item 10.C. Material Contracts--Licensing
Agreement with Microsoft."


      Under funding agreements two of our subsidiaries have entered into with
the Office of the Chief Scientist, or the OCS, these subsidiaries are obliged to
pay royalties to the OCS at a rate of 3% on sales of the funded products, up to
100% of the dollar-linked grant received in respect of these products from the
OCS. As of December 31, 2003, the aggregate amount of grants received by our
subsidiaries from the OCS was $820,000.

      In the first quarter of 2004, the Singapore-Israel Industrial Research and
Development Foundation agreed to provide CePost together with a company
incorporated in Singapore, financing for the development of Report-IT.
Accordingly, the foundation agreed to award CePost up to $100,000 payable
according to an agreed upon schedule. CePost is required to repay that amount in
payments based on sales of the Report-IT up to the amount of the grant.


                                       55
<PAGE>

      We are obligated to pay to Formula management fees in an annual amount
equal to 3% of our revenues, but no more than the NIS equivalent of $180,000.

      We are committed under operating leases for rental of office facilities
for the years 2004 until 2006. Annual rental fees under current leases are
approximately $1.7 million, and are expected to remain at this level for each of
the next three years. In connection with these leases, we issued bank guarantees
of $113,000 in the aggregate.


      In May 2004, we guaranteed short-term bank loans of MultiConn Technologies
in favor of a bank. As of May 21, 2004, this guarantee amounted to approximately
$300,000. The guarantee is outstanding until May 2005.

      During 2000, Liraz provided a bank guarantee to secure a loan of Level 8.
Liraz recorded a provision of the maximum potential amount of future payment
because the realization of the guarantee was reasonably foreseeable. The
guarantee is outstanding until November 2004. As of December 31, 2003, this
guarantee amounted approximately $2.0 million. In 2003, $541,000 was recorded as
gain due to a repayment of the loan by Level 8, which resulted in a decrease of
the guaranteed amount to the bank. Level 8 committed to utilize 10% of any
capital funding to repay the loan and reduce the amount of the guarantee
accordingly.


      In connection with the purchase of Outlook Systems Ltd.'s software
development services activity, in 2004, we extended a guarantee to banks with
respect to loans in an aggregate amount of $720,000 plus interest accrued, to be
repaid by us by February 15, 2007. For more information, see "Item 4.B. Business
Overview--Investments and Acquisitions--Outlook."


      In January 2001, we granted FIMI, a creditor of Intercomp, a put option to
sell to us promissory notes issued by Intercomp in an aggregate principal amount
of $3.5 million plus interest accrued since January 2001 at an annual rate of
5%, which could be paid, subject to FIMI's approval, in BluePhoenix ordinary
shares. The total outstanding amount of principal and interest accrued as of
December 31, 2003, and as of March 31, 2004 was $4.01 million and $4.06 million,
respectively. The number of ordinary shares subject to the option will be
calculated based on the average market price of the shares during the 14 trading
days prior to the exercise of the option. In August 2003, the terms of FIMI's
option were amended, allowing FIMI to exercise its option in three installments
during June 2004, June 2005 and June 2006. At our option, we may pay FIMI the
consideration in BluePhoenix ordinary shares. However, within 7 business days
following our notice to FIMI of our election to pay the consideration in
BluePhoenix ordinary shares, FIMI may notify us that it refuses to receive the
shares and requires instead, a payment in cash. In such an event, we shall have
to pay FIMI the corresponding cash amount, but shall be entitled to defer such
payment until September 30, 2006. FIMI submitted a notice to exercise the June
2004 installment for cash, thus postponing the payment of the respective portion
of the consideration to September 30, 2006. After accounting for this payment,
there remains $2.33 million of the principal amount of the promissory notes plus
interest accrued that may be paid, subject to FIMI'S approval as described
above, in BluePhoenix ordinary shares. In addition, as part of the
consideration, we are obliged to issue to FIMI warrants to purchase up to
336,000 of our ordinary shares exercisable until June 30, 2007, at an exercise
price of $4.00 per share.



                                       56
<PAGE>


      In April 2004, a shareholder of Intercomp comprised of several funds
acting through their general partner, Israel Infinity Venture Capital Partners
Ltd., referred to as Infinity, granted us a call option to purchase its entire
holdings in Intercomp, exercisable until April 1, 2006. If we do not exercise
such option, Infinity will have a put option to cause us to purchase Infinity's
entire holdings in Intercomp, exercisable during a period of six months
commencing in April 2006. If either of the options is exercised, we shall be
obliged to issue to Infinity, as consideration for Intercomp's shares, 100,000
BluePhoenix ordinary shares and an additional amount of shares to be calculated
based on revenues generated from the sale of licenses to use Intercomp's
products during a 3-year period commencing on April 1, 2003. The shares will be
subject to a lock-up period until April 1, 2006. We may, at our option, pay to
Infinity the cash equivalent of such shares which will be calculated according
to the average closing price of BluePhoenix shares during the 20 trading days
prior to the exercise of any of the options.

      In February 2003, the Israeli Income Tax Authorities issued to BluePhoenix
an income tax assessment for the tax year ended December 31, 1997 in the amount
of approximately $1.5 million. Following an appeal we filed on this assessment,
we received a revised tax assessment for the tax years ended December 31, 1997
through 2001 of approximately $1.2 million. As agreed with the tax authorities,
although the revised assessment is not yet final, we are required to pay a down
payment of approximately $800,000 in 24 monthly installments until December
2005. Based on consultation with our tax counsel, we believe that while the
outcome of any controversy cannot be predicted with complete certainty, the
payment of $800,000 mentioned above constitutes the final settlement of this
dispute with the Israeli income tax authorities. This tax expense is fully
offset against previously existing tax reserves and will not have a material
adverse effect on our financial statements as a whole.


      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."

EFFECTIVE CORPORATE TAX RATES

      In 1996, 1997 and 1998, certain of our operations were granted "approved
enterprise" status under the Law for the Encouragement of Capital Investments
1969, known as the Investments Law. If we comply with all requirements, we shall
be eligible for certain tax benefits with respect to these operations, for the
first seven years in which they generate taxable income. Income derived from our
approved enterprise programs will be tax exempt for a period of two years after
we have taxable income, and will be subject to a 25% company tax rate for the
following five years. We completed the tax exemption period of some of our
qualified "approved enterprise" operations and, therefore, these operations are
subject to a 25% income tax commencing 1999. If the percentage of our share
capital held by foreign shareholders exceeds 25%, future approved enterprises
would qualify for reduced tax rates for an additional three years, after the
seven years mentioned above. However, we cannot assure you that we will obtain
additional "approved enterprise" status for our operations, or that the
provisions of the Investments Law will not change, or that the above-mentioned
shareholding portion will be reached or maintained for each subsequent year.


                                       57
<PAGE>

      On January 1, 2003, Israel's tax laws underwent a significant tax reform
(Amendment 132 to the Income Tax Ordinance (New Version) - 1961), referred to as
the New Law. The underlying principle of the New Law is to broaden the
categories of taxable income, and reduce the tax rates imposed on employment
income. Among the key provisions of this reform legislation are (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.

      Our international operations are taxed at the local effective corporate
tax rate in the countries of our subsidiaries' residence. We believe that in the
future we will derive an increasing percentage of our income from operations
outside of Israel and that, accordingly, our effective tax rate may increase.
However, we expect that this increase will be offset by carried forward
accumulated losses of consolidated companies. As a result, we anticipate that
our net effective tax rate in the foreseeable future shall be lower than 25%.

C.    RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES

      For a description of our research and development activities, see "Item
4.B. Business Overview-Research and Development."

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

D.    TREND INFORMATION

      We have been affected by global economic changes, in particular the sharp
decline in capital spending in the information technology, or IT, sector and the
overall business slow-down in North America and Europe, as well as in Israel.
Uncertainties in the North American and European 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
affect our operating results. Our revenues decreased from $49.2 million in 2000
to $38.4 million in 2001 and to $36.7 million in 2002. In 2003, as a result of a
slight recovery of the market, and the impact of a strategic acquisition we
completed, this trend changed, and our revenues increased to $54.3 million. We
cannot know whether the global market will recover in the future, and how the
economic conditions will continue to affect our business. As we continue to
market new products and penetrate international markets, we expect our selling,
general and administrative expenses to continue to be relatively high.


                                       58
<PAGE>

      In March 2003, we completed the acquisition of the entire outstanding
share capital of Liraz. While we have already concluded the integration of
Liraz's infrastructure, management, personnel and sales and marketing activities
within our business, we are still in the process of integrating Liraz's
technology, products, service offerings and research and development activities.
We expect that as a result of the integration of our business with that of
Liraz, the combined companies will be able to realize greater operating
efficiencies and will benefit from a broader product line with a larger and more
diversified marketing and support network. In addition, we anticipate that the
combination of our respective technical personnel will enhance our product
development capabilities. The achievement of these benefits depends, however, on
our ability to successfully complete the integration of Liraz's business in our
business. We may also encounter difficulties in penetrating markets in which we
have no or limited experience. We cannot assure you that we will be able to
successfully complete the integration of Liraz's business with our own without
encountering difficulties. This in turn may materially adversely affect our
business, financial condition and our quarterly and annual results of
operations.

E.    OFF-BALANCE SHEET ARRANGEMENTS

      The Company has no off-balance sheet arrangements.

F.    TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

      The following table summarizes our contractual obligations and commitments
as of December 31, 2003:

<TABLE>
<CAPTION>
                                                     PAYMENT DUE BY PERIOD
                                                     ---------------------
                                                                                     MORE
                                                 LESS THAN 1    1-3        3-5      THAN 5
                                        TOTAL       YEAR       YEARS      YEARS      YEARS
                                        ------     ------     ------     ------     ------
                                                           $ in thousands
<S>                                     <C>         <C>       <C>        <C>        <C>
Long term debt obligations              12,138      1,964     10,174         --         --

Capital (finance) lease obligations      3,300      1,565      1,733          2         --

Operating lease obligations              1,050        656        391          3         --
                                        ------     ------     ------     ------     ------

TOTAL                                   16,488      4,185     12,298          5         --
</TABLE>


      The above table does not include royalties that we may be required to pay
to the OCS and which may reach, in the aggregate, $820,000, as of January 1,
2004 (see "Item 4.B. Business Overview--Research and Development."). We are
unable to reasonably estimate the time and the amounts that we will eventually
be required to pay to the OCS, if at all, since these amounts depend on our
ability to sell products based on the OCS-funded technologies and the timing of
such sales, if any. Our option agreement with Infinity which provides for put
and call options was executed in April 2004, and therefore, is not included in
this table.

      The long term debt obligations include our obligations towards FIMI
pursuant to its put option to sell to us promissory notes issued by Intercomp in
an aggregate principal amount of $3.5 million plus accrued interest. For
additional information regarding the terms of FIMI put option and our option
agreement with Infinity, see "Item 5.B. Liquidity and Capital
Resources--Contractual Commitments and Guarantees."


                                       59
<PAGE>

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A.    DIRECTORS AND SENIOR MANAGEMENT

      The following table describes information about our executive officers and
directors as of May 21, 2004.

NAME                        AGE                          POSITION
----                        ---                          --------

Gad Goldstein                45     Chairman of the Board

Aaron Crystal                60     Vice Chairman of the Board, President

Arie Kilman                  51     Chief Executive Officer, Director

Iris Yahal                   43     Chief Financial Officer, Director

Dan Goldstein                50     Director

Shai Beilis                  55     Director

Chanan Weiss                 57     Director

Michael Chill (1)            37     Director

Katriel Zimet (1)            76     Director

---------------

      (1)   An outside director

      GAD GOLDSTEIN has served as a chairman of our board of directors since
April 1998 and as a director of Formula since January 1985. Mr. Goldstein was
the vice president of Formula from 1985 through 1995 and was appointed president
of Formula in 1995. He is also a director of other companies within the Formula
Group, including Matrix IT Ltd., or Matrix, Magic Software Enterprise Ltd., or
Magic, Formula Vision Technologies (F.V.T.) Ltd. and Sapiens International
Corporation N.V., all of which are publicly traded companies. Mr. Goldstein
holds a BA in economics and an MA in business administration, both from Tel Aviv
University. Gad Goldstein is the brother of Dan Goldstein, one of our directors.

      AARON CRYSTAL served as our president, chief executive officer and
director since our formation in 1987 to December 1996 and continues to serve as
our president and one of our directors. Since November 1999, he has also served
as vice chairman of the board of directors. From 1983 to 1987 Mr. Crystal was
vice president--technical support of Mehish Computer Services.

      ARIE KILMAN has served as our chief executive officer since May 2003. Mr.
Kilman has also served as president and chief executive officer of BluePhoenix
Solutions B.V. since its inception in October 2001. Mr. Kilman previously served
as the president of Liraz, which he founded in 1984, and managed since then.
From 1998 to 2000, Mr. Kilman served as chief executive officer of Level 8. Mr.
Kilman holds a BA degree in economics and computer science from New York
University.

      IRIS YAHAL has served as one of our directors since January 1, 1999 and as
our chief financial officer since October 1995. In addition, Ms. Yahal served as
the controller of several other Formula subsidiaries until December 1996. From
1991 until 1996, Ms. Yahal served as the controller of Transtech Control Ltd., a
subsidiary of Formula. Prior to 1991, Ms. Yahal worked as an auditor with
Wallenstein and Co., a public accounting firm. Ms. Yahal holds a BA in
accounting and an MA in business administration, both from Tel Aviv University
and is a certified public accountant in Israel.


                                       60
<PAGE>

      DAN GOLDSTEIN has served as one of our directors since March 1993. Mr.
Goldstein has served as chairman of the board of directors and chief executive
officer of Formula since 1985. Mr. Goldstein is also chairman of the board of
Formula Vision and Matrix and is a director of Magic and Sapiens. Mr. Goldstein
holds a BA in mathematics and computer sciences and an MA in business
administration, both from Tel Aviv University. Dan Goldstein is the brother of
Gad Goldstein.

      SHAI BEILIS served as chairman of our board of directors from December
1995 until April 1998 and as vice chairman of our board of directors from April
1998 until November 1999. Mr. Beilis continues to serve as one of our directors
and as a member of our audit committee. Mr. Beilis currently serves as chairman
and chief executive officer of Formula Ventures. Mr. Beilis has also served as a
director of Formula since December 1997. From July 1993 to the beginning of
1995, Mr. Beilis served as the managing director of Clal Computers and
Technology Ltd., an Israeli information technology company. Mr. Beilis holds a
B.Sc. in mathematics and economics from the Hebrew University in Jerusalem and
an MA in computer science from the Weizmann Institute of Science.

      CHANAN WEISS joined us in April 2001 as a managing director. From February
2002 through May 2003, he served as our chief executive officer. Since February
2002, Mr. Weiss has also served as one of our directors. From February 2000
until April 2001, Mr. Weiss served as an executive vice president and chief
operating officer of Matrix. Prior to that, from April 1999, Mr. Weiss served as
managing director of Nikuv Computers (Israel) Ltd., a subsidiary of Matrix. From
1988 through 1999 Mr. Weiss occupied various managerial positions in IBM Israel.
Mr. Weiss holds a B.Sc. degree in Physics from the Technion in Haifa.

      KATRIEL ZIMET has served as one of our independent directors and a member
of our audit committee since January 1999. On December 31, 1999, he was
appointed as one of our outside directors, under the Companies Law. From 1992
until November 1997, Mr. Zimet served as a director of Formula. Since 1987, Mr.
Zimet has served as an independent consultant for information systems technology
to the Israeli national board of education. Until 1986, Mr. Zimet was director
of computing facilities of Telrad Networks Ltd., a major Israeli
telecommunications company.

      MICHAEL CHILL has served as one of our independent directors and a member
of our audit committee since July 2003. From July 2003, Mr. Chill has served as
an investment analyst at the hedge fund Vertical Ventures LLP. Prior to that,
Mr. Chill was an independent advisor to various high technology companies and
venture capital firms both in Israel and the United States. During 2000 and the
first half of 2001, Mr. Chill served as the president and head of investment
banking department at Jerusalem Global Ltd., a venture capital and investment
banking firm. Prior to that, from 1999, Mr. Chill served as a managing director
in the technology investment banking group at Gruntal and Co. Mr. Chill holds a
B.S. in accounting from the Sy Syms School of Business at Yeshiva University and
an MBA from the Columbia Business School.


                                       61
<PAGE>

B.    COMPENSATION

      During the year ended December 31, 2003, we paid to our outside directors
and executive officers aggregate remuneration of approximately $622,000. 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.
This amount includes amounts set aside or accrued to provide pension, social
security or similar benefits but does not include amounts expended by us for
automobiles made available to our officers and expenses (including business
travel, professional and business association dues and expenses) reimbursed to
officers.

      The aggregate remuneration set forth in the foregoing paragraph does not
include amounts we paid to Formula under the terms of a management agreement, as
consideration for management services rendered to us by certain directors
designated by Formula. These directors currently include Gad Goldstein, Dan
Goldstein and Shai Beilis. See "Item 7.B. Related Party Transactions."


      We maintain written employment agreements with Arie Kilman, Iris Yahal and
Aaron Crystal. The employment agreements are not for a specific term and we may
terminate any of them upon prior notice of between three and six months. If we
terminate any of these employment agreements, we will have to pay the usual
severance pay required under Israeli law for all employees. The directors are
not entitled to any other benefits upon termination. These agreements provide
for annual base salaries and other benefits like vacation, sick leave, provision
of automobiles, insurance contributions and non-compete and confidentiality
agreements. The agreements also entitle Mr. Kilman and Ms. Yahal to bonuses
based on achieving targets set by our board of directors. Under the terms of Mr.
Crystal's employment agreement, upon our initial investment in an unaffiliated
entity, Mr. Crystal has the right to co-invest, on the same terms as we invest,
in an amount equal to 10% of our initial investment.


      Mr. Kilman, in his former position as Liraz's chairman of the board of
directors was granted by Liraz in May 2002 a loan of approximately NIS 1.2
million (approximately $300,000), linked to the Israeli consumer price index,
and bearing annual interest at a rate of 4%. Under the terms of the loan, the
loan should be repaid to Liraz in four equal annual installments until 2006, but
no later than termination of Mr. Kilman's employment. Mr. Kilman pledged in
favor of Liraz 200,000 Liraz's shares he owned as a security for repayment of
the loan. Following the share exchange transaction between us and Liraz's
shareholders effective as of November 14, 2002, Mr. Kilman replaced the pledged
shares with 119,760 BluePhoenix shares. The amount of BluePhoenix shares pledged
by Mr. Kilman was based on the exchange ratio determined in the share exchange
agreement, pursuant to which every 1.67 shares of Liraz were exchanged for one
BluePhoenix ordinary share. Except for the replacement of the pledged shares,
the terms of the loan were not amended in any way. As of May 21, 2004, Mr.
Kilman repaid $150,000 of the principal amount of the loan plus linkage
differentials and accrued interest. Accordingly, one half of the pledged shares
were released from the pledge. To date, Mr. Kilman has complied with all loan
payment obligations under the loan agreement. An amount of $160,000 (including
linkage differentials and accrued interest) is still outstanding.



                                       62
<PAGE>

C.    BOARD PRACTICES

      Pursuant to our articles of association, directors are elected at a
general meeting of our shareholders by a vote of the holders of a majority of
the voting power represented at the meeting. Additional directors may be elected
between general meetings by a majority of our directors. Our board is comprised
of 9 persons, of which 2 have been determined to be independent within the
meaning of the applicable NASDAQ requirements. 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. We compensate
our outside directors in an annual amount of $12,000 each. We do not compensate
our other directors for their services as directors (other than compensation we
pay to Formula pursuant to our management agreement with it). For information
regarding the employment agreements of our officers, see "Item 6.B.
Compensation." For additional information, see "Item 7.B. Related Party
Transactions."


      Our board of directors has appointed a compensation committee, comprised
of Messrs. Gad Goldstein, Shai Beilis and Arie Kilman. The compensation
committee is responsible for making recommendations to the Board with respect to
the granting of options to employees and setting the compensation of our
executive officers.


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

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. The Companies 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:

      o     an employment relationship;

      o     a business or professional relationship maintained on a regular
            basis;

      o     control; and

      o     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. Outside directors are
elected by a majority vote at a shareholders' meeting, provided that either:


                                       63
<PAGE>

      (1) the majority of shares voted at the meeting, including at least
one-third of the shares of non-controlling shareholders or their representatives
voted at the meeting, vote in favor of election; or

      (2) the total number of shares of non-controlling shareholders voted
against the election of the outside director does not exceed one percent of the
aggregate voting rights in the company.

      The initial term of an outside director is three years and may be extended
for an additional three years. At present, Mr. Michael Chill and Mr. Katriel
Zimet serve as our outside directors, Mr. Chill to hold office until July 2006
and Mr. Zimet until December 2004.

      Each committee exercising the powers of the board of directors is required
to include at least one outside director. However, the audit committee should
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. We compensate our two outside directors in accordance
with regulations promulgated under the Israeli Companies Law, 1999.

AUDIT COMMITTEE

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

      In addition, under applicable NASDAQ rules, we are currently required to
have at least two independent directors and to maintain an audit committee, at
least a majority of whose members are independent of management. Our outside
directors qualify as independent directors under the applicable NASDAQ rules and
those of the Securities and Exchange Commission. We have established an audit
committee, consisting of our two outside directors, Mr. Michael Chill and
Katriel Zimet, as well as Shai Beilis. The board has determined that that
Michael Chill is an "audit committee financial expert" as defined by applicable
SEC regulations. See "Item 16A. Audit Committee Financial Expert."

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


                                       64
<PAGE>

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
affiliate, or a relative of an office holder or affiliate, and he may not be the
company's independent accountant or its representative.

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 Israeli 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 its articles of
association, the approval of the audit committee and the approval of the board
of directors, as well as shareholder approval. An office holder who has a
personal interest in a matter that 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.


                                       65
<PAGE>

      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 who is an office holder, 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 present, in person or by
proxy, at the meeting 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.

      In a private placement of securities that will increase the relative
holdings of a shareholder that holds five percent or more of the company's
outstanding share capital (assuming the exercise or conversion of all securities
held by such person that are exercisable for or convertible into shares) or that
will cause any person to become, as a result of the issuance, a holder of more
than five percent of the company's outstanding share capital, the Companies Law
requires that the company receive its shareholders' approval. In certain cases
provided in regulations promulgated under the Companies Law, shareholder
approval is not required.

      Under the Companies Law, a shareholder has a duty to act in good faith
towards the company and other shareholders and to refrain from abusing his power
in the company including, among other things, voting in a general meeting of
shareholders on the following matters:

      o     any amendment to the articles of association;

      o     an increase of the company's authorized share capital;

      o     a merger; or

      o     approval of interested party transactions that require shareholder
            approval.

      In addition, any controlling shareholder, any shareholder who knowingly
possesses power to determine the outcome of a shareholder vote and any
shareholder who, pursuant to the provisions of a company's articles of
association, has the power to appoint or prevent the appointment of an office
holder in the company, is under a duty to act with fairness towards the company.
The Companies Law does not describe the substance of this duty.

      For information concerning personal interests of certain of our office
holders and our principal shareholders in certain transactions with us, see
"Item 7.B. Related Party Transactions."


                                       66
<PAGE>

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.

      Office Holder Insurance

      Our articles of association provide that, subject to the provisions of the
Companies Law, we may enter into a contract for insurance of all or a part 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, in
respect of each of the following:

      o     a breach of his duty of care to us or to another person;

      o     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
            such act would not prejudice our interests; or

      o     a financial obligation imposed on him or her in favor of another
            person.

      Indemnification of Office Holders

      Our articles of association provide that, subject to the provisions of the
Companies Law, we may indemnify our office holders in respect of an obligation
or expense specified below imposed on an office holder in respect of an act
performed in his or her capacity as an office holder, as follows:

      o     a financial obligation imposed on him or her in favor of another
            person by a court judgment, including a compromise judgment or an
            arbitrator's award approved by court;

      o     reasonable litigation expenses, including attorney's fees, expended
            by an office holder or charged to the office holder by a court, in a
            proceeding instituted against the office holder by us or on our
            behalf or by another person, or in a criminal charge from which the
            office holder was acquitted, or in a criminal proceeding in which
            the office holder was convicted of an offense that does not require
            proof of criminal intent.

      We may undertake to indemnify an office holder as aforesaid, (a)
prospectively, provided that the undertaking is limited to categories of events
which in the opinion of our board of directors can be foreseen when the
undertaking to indemnify is given, and to an amount set by our board of
directors as reasonable under the circumstances and (b) retroactively.

      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."


                                       67
<PAGE>

      Limitations on Insurance and Indemnification

      The Companies Law provides that a company may not indemnify an office
holder nor enter into an insurance contract that would provide coverage for any
monetary liability incurred as a result of any of the following:

      o     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;

      o     a breach by the office holder of his duty of care if the breach was
            done intentionally or recklessly;

      o     any act or omission done with the intent to derive an illegal
            personal benefit; or

      o     any fine levied against 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 procured directors' and officers' liability insurance and obtained
all necessary approvals.

D.    EMPLOYEES

      The table below presents certain information regarding the number of our
employees, the sector in which they are employed and their geographical area of
employment, in the periods indicated.


                                  2003             2002             2001
                                  ----             ----             ----
Technical Experts                  250              280              145
Research and Development           120              140               60
Sales and Marketing                 40               50               50
General and Administrative          75               70               45
                                    --               --               --
                                  ----             ----             ----
TOTAL                              485              540              300
                                  ====             ====             ====

In Israel                          175              230              200
Outside Israel                     311              310              100


      These employees include expert consultants who we train for the
implementation of our modernization tools and methodologies.


                                       68
<PAGE>

      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 and regulations govern matters
such as the length of the workday, minimum wages, other terms of employment and
restrictions on discrimination. We are also subject to the labor laws and
regulations of other jurisdictions in the world where we have employees.

E.    SHARE OWNERSHIP

      The following table presents information regarding the ownership of our
ordinary shares by the persons listed in the table under "Directors and Senior
Management," as of May 21, 2004. The percentage of outstanding ordinary shares
is based on 13,522,139 ordinary shares outstanding as of May 21, 2004,
(excluding 1,870,565 shares held by two of our wholly owned subsidiaries).

<TABLE>
<CAPTION>
      NAME                                  SHARES BENEFICIALLY OWNED (1)               OPTIONS TO PURCHASE
                                                                                          ORDINARY SHARES

                                         NUMBER                PERCENTAGE OF                 NUMBER
                                                               OUTSTANDING
                                                             ORDINARY SHARES
<S>                                 <C>                      <C>                         <C>
Arie Kilman (2)                         591,814                     4.4%                    211,111 (2)

Dan Goldstein                           424,510                     3.1%

Gad Goldstein                           330,628                     2.4%

Aaron Crystal                         1,193,700(3)                  8.8%

Shai Beilis(1)                            ___                       ___

Iris Yahal(1)                             ___                       ___

Katriel Zimet(1)                          ___                       ___

Michael Chill(1)                          ___                       ___

Chanan Weiss(1)                           ___                       ___

All directors and officers as          2,927,763                   21.0%                     387,111(4)
a group (10 persons) (4)
</TABLE>

----------------


(1)   Each of the directors and executive officers whose holdings are not
      separately specified in the above table beneficially owns less than one
      percent of our outstanding ordinary shares (including options held by each
      of these persons).

(2)   Mr. Kilman was granted options to purchase ordinary shares under the
      following terms: (i) Options to purchase 375,000 ordinary shares
      exercisable at $2.25 per share and (ii) Options to purchase 200,000
      ordinary shares exercisable at $4.00 per share. Of these grants, options
      to purchase 150,000 and 61,111 ordinary shares, respectively, are
      currently exercisable.



                                       69
<PAGE>

(3)   Includes 294 shares that Anat Crystal, Mr. Crystal's spouse, beneficially
      owns.

(4)   Includes options to purchase 387,111 ordinary shares currently exercisable
      at a price and during the terms indicated in the table below:

      NUMBER OF ORDINARY SHARES          EXERCISE         EXPIRATION
        UNDERLYING THE OPTIONS            PRICE

                191,000                    2.25         April 2013
                 80,000                    3.00         February 2012
                  5,000                    3.50         September 2013
                 61,111                    4.00         September 2013
                 10,000                    4.50         April 2013
                 10,000                    5.50         October 2010
                 15,000                    6.50         November 2006
                 15,000                   10.50         April 2010

ARRANGEMENTS INVOLVING THE ISSUE OF BLUEPHOENIX' SHARES OR GRANT OF OPTIONS TO
PURCHASE SHARES

      The 1996 Share Option Plan

      In 1996, we adopted two option plans. One of these option plans has been
terminated after all options granted under it have been exercised. Pursuant to
our other 1996 option plan, as amended, we reserved 3,200,000 ordinary shares
for issuance to our and our subsidiaries' directors, officers, consultants and
employees. As of May 21, 2004, options to purchase 2,287,500 ordinary shares
were outstanding under the plan. The exercise price of the options granted under
the 1996 option plan ranges from $2.25 to $10.50.

      Our board of directors administers our 1996 option plan. Under the 1996
option plan, as amended, options to purchase our ordinary shares may be granted
to our and our subsidiaries' directors, officers, consultants and employees. Our
board of directors is empowered, among other things, to designate the grantees,
dates of grant, the exercise price of the options and the terms of exercise of
the options. Unless determined otherwise by the board, the options generally
vest over a three-year period. Unvested options are forfeited upon termination
of employment, unless otherwise agreed. Under the 1996 option plan, the grantee
is responsible for all personal tax consequences of the grant and the exercise
of the options. Each option granted under the 1996 option plan is exercisable
during a term of ten years from the date of grant of the option. The 1996 option
plan will expire on August 6, 2013, except as to options outstanding on that
date.

      Options Granted to Employees of One of Our Subsidiaries

      In August 2000, in connection with the purchase of a controlling interest
in IntraComp Group Incorporated, we granted to certain employees of IntraComp
options to purchase an aggregate of 125,000 of our ordinary shares of which
55,000 were cancelled. All of the remaining options are currently exercisable at
an exercise price of $9.625 per share. The options shall expire in August 2010.


                                       70
<PAGE>

      Options Granted to FIMI

      In January 2001, we granted FIMI, a creditor of our affiliate, Intercomp,
a put option to sell to us promissory notes issued by Intercomp in an aggregate
principal amount of $3.5 million plus interest accrued since January 2001 at an
annual rate of 5%, which could be paid, subject to FIMI's approval, in
BluePhoenix ordinary shares. For additional information regarding the terms of
this put option, see "Item 5.B. Liquidity and Capital Resources--Contractual
Commitments and Guarantees."

      Issuance of Shares in connection with Call and Put Options in respect of
Infinity's Holdings in Intercomp

      In April 2004, a shareholder of Intercomp represented by Infinity, granted
to us a call option to purchase its entire holdings in Intercomp, exercisable
until April 1, 2006. If we do not exercise our option, Infinity will have a put
option to cause us to purchase Infinity's entire holdings in Intercomp,
exercisable from April 2006 until September 2006. If either of the options is
exercised by us or by Infinity, we shall be obliged to issue to Infinity, as
consideration for Intercomp's shares, 100,000 BluePhoenix ordinary shares and an
additional amount of shares to be calculated based on revenues generated from
the sale of licenses to use Intercomp's products. The shares will be subject to
a lock-up period until April 1, 2006. We may, at our option, pay to Infinity the
cash equivalent of such shares.

      Convertible Debentures and Warrants Purchased by Institutional Investors

      On March 30, 2004, we completed a $5 million private placement to four
institutional investors. Under the terms of this transaction, we issued to each
investor a 32-month debenture, bearing interest at an annual rate of 2%, payable
quarterly, at our option, in cash or in BluePhoenix ordinary shares. The
debentures are convertible, at the investors' option, into BluePhoenix ordinary
shares at a conversion price of $5.70 per share. In the event that the market
price of the shares, calculated on a weighted average basis, exceeds $7.125 for
20 consecutive trading days, we have the option to force the institutional
investors to convert the outstanding amount of the debentures into BluePhoenix
shares.

      As part of the transaction, the institutional investors were also granted
warrants exercisable into BluePhoenix ordinary shares at an exercise price of
$6.50 per share. The warrants are exercisable during a period of 5 years
commencing in September 2004. If such warrants are exercised in full, we shall
receive an aggregate consideration of $2.85 million.

      If the debentures issued to the institutional investors are fully
converted and the warrants are fully exercised, we would be required to issue to
the investors up to 1,708,411 ordinary shares, subject to adjustments.


                                       71
<PAGE>


      If, during a period of 180 days after the date in which the registration
statement with respect to the shares underlying the debentures, is declared
effective, the volume weighted average price per BluePhoenix ordinary share
equals or exceeds the market price per share of BluePhoenix's ordinary shares on
March 30, 2004, the institutional investors may purchase from us additional
debentures for an aggregate purchase price of up to $3 million and receive
warrants on the same terms as the initial warrants, exercisable into such number
of BluePhoenix ordinary shares equal to 50% of the ordinary shares into which
the debentures are convertible.

      If, during such period mentioned above, the volume weighted average price
per BluePhoenix ordinary share during any 10 consecutive trading days exceeds
$12.825, we may require the institutional investors to purchase additional
debentures for an aggregate purchase price of up to $3 million and warrants
under the same terms as the initial warrants, exercisable into such number of
BluePhoenix ordinary shares equal to 50% of the ordinary shares into which the
debentures are convertible.


      If these additional debentures are fully converted and the additional
warrants are exercised in full, we would be required to issue to the investors
up to an additional 1,025,047 ordinary shares.

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A.    MAJOR SHAREHOLDERS

      The following table presents information regarding the ownership of our
ordinary shares at May 21, 2004 by each person known to us to be the beneficial
owner of 5% or more of our ordinary shares. Except where we indicated otherwise,
we believe, based on information furnished by these owners, that the beneficial
owners of our shares listed below have sole investment and voting power with
respect to the shares.

                                                 ORDINARY SHARES
NAME AND ADDRESS                                BENEFICIALLY OWNED
----------------                                ------------------

                                             NUMBER            PERCENT (1)
                                             ------            -----------

Formula Systems (1985) Ltd.               7,928,320               64.2% (2)
3 Hagalim Boulevard
Herzlia 46725, Israel

Aaron Crystal                             1,193,700 (3)           8.8%

Arie Kilman (4)                             802,925               5.8%

-----------------

(1)   Percentages in the above table are based on 13,522,139 ordinary shares
      outstanding as of May 21, 2004, and do not include 1,870,565 ordinary
      shares that two of our subsidiaries hold.

(2)   Formula owns of record 7,928,320 ordinary shares. Messrs. Dan Goldstein
      and Gad Goldstein have entered into agreements, which require them to vote
      their ordinary shares (an aggregate of 755,138 shares) as instructed by
      Formula. As a result of these voting agreements, Formula beneficially owns
      approximately 64.2% of our outstanding shares. Dan Goldstein is chairman
      of the board and chief executive officer of Formula and owns 20.0% of the
      outstanding shares of Formula. Gad Goldstein is a director and president
      of Formula and owns 3.3% of the outstanding shares of Formula. Messrs. Dan
      and Gad Goldstein are brothers. Based on the foregoing, Dan Goldstein and
      Gad Goldstein each may be deemed to share with Formula the power to vote
      and dispose of our ordinary shares beneficially owned by Formula. Each of
      Dan Goldstein and Gad Goldstein disclaims beneficial ownership of the
      ordinary shares beneficially owned by Formula.


                                       72
<PAGE>

(3)   Includes 294 shares that Anat Crystal, Mr. Crystal's spouse, beneficially
      owns.

(4)   Includes currently exercisable options to purchase 211,111 ordinary
      shares.

      All of our ordinary shares have equal voting rights. Under our two
buy-back programs (as described in "Item 5.B. Liquidity and Capital Resources"),
two of our subsidiaries purchased 1,870,565 of our ordinary shares, as of May
21, 2004. Under applicable Israeli law, the shares held by our subsidiaries have
no voting rights and, therefore, are excluded from the number of our outstanding
shares. If our subsidiaries purchase additional shares, the percentage of our
outstanding shares controlled by Formula would increase.

      In November 2002, we purchased through a share exchange transaction 86% of
the outstanding share capital of Liraz. As part of the transaction, we issued to
Liraz's selling shareholders, including Formula, 3,478,624 of our ordinary
shares, constituting an aggregate of 26% of our outstanding share capital. Of
these shares, we issued to Formula 2,343,113 ordinary shares.

      As of April 30, 2004, there were 33 record holders of our ordinary shares.
Of these record holders, 19 holders had mailing addresses in the United States
owning an aggregate of approximately 45.4% of our outstanding ordinary shares,
excluding the shares that our subsidiaries hold.


                                       73
<PAGE>

B.    RELATED PARTY TRANSACTIONS

      Management Agreement with Formula


      On January 1, 1996, we signed a letter agreement with Argotec Ltd., at
that time our parent company wholly owned by Formula, pursuant to which Formula
provides us with administrative and management support. Under the agreement,
Formula provides three of our directors, including our Chairman of the Board,
who is active in the direction of our business. Additionally, Formula arranges
to have certain volume discounts extended to us as part of Formula's control
group, and Formula provides us with administrative services, including services
relating to insurance, human resources, global planning, real property leasing,
and the department of motor vehicles.

      Pursuant to the letter agreement, we pay to Formula in return for its
services, a management fee equal to 3.0% of our revenues, up to a maximum of
$180,000 per year. The amount of management fee was negotiated between us and
Argotec in 1996 when we initially entered into the letter agreement. The amount
of the fee was determined based primarily on the parties' good faith estimates
of the value of services to be provided by the three directors seconded to us by
Formula and the extent of our expected cost savings to be generated by Formula's
assistance in obtaining volume discounts and the provision of administrative
support. Although we did not engage in actual negotiations with potential
third-party providers of comparable services, the fee was based in part on our
market knowledge of the cost of obtaining such services from third parties
and/or developing the internal resources necessary to carry out these functions
ourselves.

      We pay the management fee to Formula in installments at the end of each
quarter. For the year ended December 31, 2003, a management fee of $180,000 was
payable to Formula under this agreement, representing 0.3% of our revenues in
2003. In addition, we reimburse Formula from time to time for expenses Formula
incurred on our behalf.


      For more information regarding the positions that some of our directors
hold in Formula and their holdings in Formula's shares, see "Item 6.A. Directors
and Senior Management" and "Item 7.A. Major Shareholders."

      Registration Rights Agreements, Voting Agreements

      In 1997, we entered into a registration rights agreement with Formula, Dan
Goldstein, Gad Goldstein, Aaron Crystal and an additional shareholder, referred
to collectively as the holders. Under this registration rights agreement, the
holders have certain registration rights with respect to their ordinary shares,
beginning January 31, 1998. We have agreed that, beginning January 31, 1998, at
the request of the holders of a majority of the shares held by the persons and
entities who signed the agreement, and on no more than two occasions, we will
file a registration statement under the Securities Act for an offering of their
shares with respect to which registration is requested. In addition, if we
otherwise propose to register our ordinary shares under the Securities Act,
these holders may request that we register their shares as well, subject to
certain limitations. We 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 October 2002, we granted certain registration rights to Formula, Mr.
Arie Kilman and other shareholder of Liraz in the Share Exchange Agreement with
those shareholders. Under this agreement, we 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, we
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 we otherwise propose to register our
ordinary shares under the Securities Act, these holders may request that we
register their shares as well, subject to certain limitations. We 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.



                                       74
<PAGE>

      In May 2004, our board of directors approved to include 400,000
BluePhoenix shares held by certain directors and officers in a registration
statement to be filed by us in May 2004 under the Securities Act.

      Messrs. Dan Goldstein and Gad Goldstein have entered into voting
agreements that require them to vote their ordinary shares as instructed by
Formula.

      Transactions Between Us and Our Subsidiaries

      In the fourth quarter of 2000, we increased our shareholdings in our
subsidiary, IntraComp, by investing $240,000 and reaching a 53% controlling
interest. In addition, as of May 21, 2004, we lent to IntraComp an aggregate
amount of $2.3 million. For more information about IntraComp, see "Item 4.B.
Business Overview--Investments and Acquisitions--IntraComp."

      We currently hold 40% of the outstanding share capital of MultiConn
Technologies, an affiliate of our subsidiary, M.S.I. MultiConn, and have an
option to increase our holdings in MultiConn Technologies to 60%. In May 2004,
we provided on behalf of MultiConn Technologies a guarantee in the amount of
$300,000. For more information about M.S.I. MultiConn and MultiConn
Technologies, see "Item 4.B. Business Overview--Investments and
Acquisitions--MultiConn."

      In the fourth quarter of 2003, we exercised an option to purchase from
Intercomp certain technology for an aggregate of $1.9 million. In addition, we
undertook to pay to Intercomp royalties of 25% of the revenues generated from
the purchased technology. In connection with the purchase of Intercomp's
technology, we assumed the rights and obligations of Intercomp under a
distribution agreement, pursuant to which Intercomp granted rights to a
distributor to further develop and distribute Intercomp's products. As of
December 31, 2003, we lent to Intercomp an aggregate of approximately $1.8
million, which are convertible into preferred shares of Intercomp, subject to
certain conditions. For more information about Intercomp, see "Item 4.B.
Business Overview--Investments and Acquisitions--Intercomp."

      Transactions Between Us and Our Chief Executive Officer

      Mr. Kilman, in his former position as Liraz's chairman of the board of
directors, was granted by Liraz in May 2002 a loan of approximately NIS 1.2
million (approximately $300,000). As of May 21, 2004, Mr. Kilman repaid $150,000
of the principal amount of the loan plus linkage differentials and accrued
interest. For more information relating to the loan granted to Mr. Kilman, see
"Item 6.B. Compensation."

      Indemnification of Office Holders

      In July 2003, we granted to each of our office holders an indemnification
letter, pursuant to which we undertook to indemnify each office holder in
respect of an obligation or expense imposed on the office holder in respect of
an act performed in his or her capacity as an office holder, provided, however,
that the undertaking is limited to categories of events specified in the
indemnification letter and subject to the provisions of any law, as follows:


                                       75
<PAGE>

      (i)   a financial obligation imposed on him or her in favor of another
            person by a court judgment, including a compromise judgment or an
            arbitrator's award approved by court; and

      (ii)  reasonable litigation expenses including attorneys' fees, expended
            by an office holder or charged to the office holder by a court, in a
            proceeding instituted against the office holder by the company or on
            its behalf or by another person, or in a criminal charge from which
            the office holder was acquitted, or in a criminal proceeding in
            which the office holder was convicted of an offense that does not
            require proof of criminal intent.

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

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

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

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

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

      (iv)  any fine levied against the office holder.

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

      Office Holders Insurance

      We have obtained an insurance policy covering our directors' and officers'
liability. Our subsidiaries participate in the premium payments of the
insurance, on a proportional basis. The total premium we paid during 2003 was
approximately $127,000.


                                       76
<PAGE>

C.    INTERESTS OF EXPERT 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.


      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 us, as a
class action. The claim relates to the acquisition of Liraz shares, which we
completed in March 2003. The shareholder alleges that the share price we 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. Under Israeli law, the court's
approval is required for the plaintiff to represent all of the shareholders of
Liraz who sold their shareholdings to us pursuant to the tender offer and the
mandatory acquisition. The plaintiff has applied for such approval in the
lawsuit. No hearing has yet been scheduled for this lawsuit. Based on our
analysis of the statement of claim, including an evaluation of the fair value of
the Liraz shares, and the price paid for Liraz shares in a previous transaction
immediately prior to the tender offer, we believe that the allegations against
us in this proceeding are without merit and we intend to vigorously defend the
claim and contest the allegations made therein.


      Sogeti Nederland B.V., referred to as Sogeti, a Dutch company, has
notified us of the termination of a migration project which was performed
jointly by Sogeti and one of our wholly owned subsidiaries, ASE B.V., for a
Dutch customer, NV Interpolis BTL, due to an alleged breach on our part. The
project was performed by Sogeti as prime contractor and by ASE as subcontractor.
BluePhoenix acted as subcontractor of ASE. In March 2004, Sogeti was granted by
the district court in Amsterdam leave to put a lien over a bank account of ASE
pursuant to an ex parte application. In the application, Sogeti claims that it
has to make, or has made, a refund to Interpolis of 2.2 million euro and that it
may suffer losses of a least 150,000 euro. For purposes of the lien application,
Sogeti estimates the aggregate amount of the claim at 3 million euro. Sogeti has
to file a claim against ASE B.V. by the end of June 2004.


                                       77
<PAGE>


      Our management examined the work done by us and concluded that we had
performed our obligations in connection with this project. Therefore, we believe
that the alleged claim of Sogeti as described in the application for the lien
has no grounds and is without merit. If a claim is filed against us we intend to
vigorously defend it.


DIVIDEND POLICY

      We have never declared or paid dividends to our shareholders and we do not
intend to pay dividends in the future. We anticipate that we will retain all of
our future earnings for use in the expansion and operation of our business.

B.    SIGNIFICANT CHANGES

      Except as otherwise disclosed in this annual report, there has been no
material change in our financial position since December 31, 2003.


                                       78
<PAGE>

ITEM 9. THE OFFER AND LISTING

A.    OFFER AND LISTING DETAILS

      The following table shows the high and low closing price for our ordinary
shares on the NASDAQ National Market for the periods indicated.

CALENDAR PERIOD                                  CLOSING PRICE PER SHARE
---------------                                  -----------------------

                                               HIGH                LOW
                                               ----                ---
                                                        (IN $)

1999                                           18.69               6.56
2000                                           19.50               5.63
2001                                            8.69               2.05

2002                                            4.15               2.00
  First Quarter                                 4.15               3.50
  Second Quarter                                4.00               2.80
  Third Quarter                                 3.00               2.24
  Fourth Quarter                                2.38               2.00

2003                                            7.04               2.10
  First Quarter                                 2.41               2.10
  Second Quarter                                3.25               2.18
  Third Quarter                                 4.00               3.05
  Fourth Quarter                                7.04               3.75
    November                                    5.50               4.25
    December                                    7.04               5.20

2004

  First Quarter                                 7.49               4.63
    January                                     7.49               5.64
    February                                    7.08               5.51
    March                                       5.46               4.63
    April                                       5.46               5.03
    May (through May 21)                        5.39               4.98

      The following table shows the high and low closing price for our ordinary
shares on the TASE for the periods indicated.

CALENDAR PERIOD                                 CLOSING PRICE PER SHARE
---------------                                 -----------------------

                                                HIGH               LOW
                                                ----               ---

                                                       (IN NIS)

2001(from January 21)                          35.70              10.50

2002                                           20.10               8.01
  First Quarter                                20.10              14.99
  Second Quarter                               19.00              19.00
  Third Quarter                                19.00               8.01
  Fourth Quarter                               12.00              12.00


                                       79
<PAGE>

CALENDAR PERIOD                                 CLOSING PRICE PER SHARE
---------------                                 -----------------------

                                                HIGH               LOW
                                                ----               ---

                                                       (IN NIS)

2003                                           29.20              11.49
  First Quarter                                12.00              11.49
  Second Quarter                               13.00              11.49
  Third Quarter                                16.50              13.00
  Fourth Quarter                               29.20              16.50
    November                                   24.41              19.04
    December                                   29.20              22.44

2004
  First Quarter                                33.80              22.50
    January                                    33.50              25.99
    February                                   33.80              27.04
    March                                      27.76              22.50
    April                                      26.59              23.00
    May (through May 23)                       25.49              25.00

B.    PLAN OF DISTRIBUTION

Not applicable.

C.    MARKETS


      Our ordinary shares have been traded in the United States on the NASDAQ
National Market since our initial public offering on January 30, 1997 and were
not publicly traded prior to this date. The symbol on the NASDAQ National Market
for our ordinary shares is BPHX. On January 21, 2001 we listed our ordinary
shares for trading on the Tel Aviv Stock Exchange, referred to as the TASE. As
of December 2, 2004, we had 1,209 beneficial shareholders.


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.


                                       80
<PAGE>

B.    MEMORANDUM AND ARTICLES OF ASSOCIATION

      We are registered with the Israeli Companies Register under the number
52-004306-8. Our objects are specified in our memorandum of association. These
objects include:

      o     operating within the field of informational and computer systems;

      o     providing management, consulting and sale services for computers,
            computer equipment, software for computers and for information
            systems;

      o     the business of systems analysis, systems programming and computer
            programming; and

      o     establishing facilities for instruction and training for computers
            and digital systems.

DESCRIPTION OF OUR SHARE CAPITAL

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

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.

DIVIDEND RIGHTS 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 pay the dividend
as an allotment of shares or a distribution of assets. If we do decide to issue
dividends by an allotment of shares at a price lower than the nominal value of
those shares, we must convert a portion of our profits or any other source of
equity to share capital in an amount equal to the difference between the nominal
value of the shares and the price paid in the dividend. If dividends remain
unclaimed for seven years from the date we declared the dividend, they lapse and
revert 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.


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REDEMPTION PROVISIONS

      In accordance with our articles of association, we may issue redeemable
shares and accordingly redeem those shares. Our board may attach to redeemable
shares the attributes of shares, including voting rights and the right to
participate in profits.

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, whenever it decides it is appropriate, and shall, within 21
days after receiving a written demand from one director or from one or more
shareholders representing at least 10% of the outstanding share capital and 1%
of the voting power, 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 35% 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 to another later time if
such time is specified in the original notice convening the general meeting or
if we give notice to the shareholders of another time at least 72 hours before
the date fixed for the adjourned meeting. At the reconvened meeting, if a quorum
is not present within half an hour from the time appointed for holding the
meeting, the required quorum will consist of two shareholders present in person
or by proxy.

      Under the Companies Law, unless otherwise provided in the articles of
association or applicable law, all resolutions of the shareholders require a
simple majority, except in certain circumstances provided for under the
Companies Law, which require a majority of at least 75% of the shares present at
the meeting. In accordance with the Companies Law, all shareholders meetings
require prior notice of at least 21 days.

      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:

      o     any amendment to the articles of association;

      o     an increase of the company's authorized share capital;

      o     a merger; or

      o     approval of some of the acts and transactions that require
            shareholder approval.


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

ELECTION OF DIRECTORS

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

ANTI-TAKEOVER PROVISIONS; MERGERS AND ACQUISITIONS UNDER ISRAELI LAW

      Mergers

      The Companies Law includes provisions that allow a merger transaction and
requires that each company that is party to a merger approve the transaction by
its board of directors and a vote of the majority of its shares voting on the
proposed merger at a shareholders' meeting called on at least 21 days' prior
notice. In determining whether a majority has approved the merger, shares held
by the other party to the merger or any person holding at least 25% of the other
party to the merger are excluded from the vote. The Companies Law does not
require court approval of a merger other than in specified situations. Upon the
request of a creditor of either party to the proposed merger, the court may
delay or prevent the merger if it concludes that there exists a reasonable
concern that as a result of the merger, the surviving company will be unable to
satisfy the obligations of any of the parties to the merger. In addition, a
merger may not be completed unless at least 70 days have passed from the time
that a proposal for approval of the merger has been filed with the Israeli
registrar of companies.

      Tender Offers

      The Companies Law also provides that an acquisition of shares of a public
company on the open market must be made by means of a tender offer if as a
result of the acquisition the purchaser would become a 25% shareholder of the
company. The rule does not apply if there is already another 25% shareholder of
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 45% shareholder, unless there is a
50% shareholder of the company. These rules do not apply if the acquisition is
made by way of a merger as opposed to a tender offer. 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


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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 agreements related to the $5 million private placement of
convertible debentures and warrants completed in March 2004, the acquisition of
Liraz's shares and our investments in Mainsoft Corporation, IntraComp Group Inc.
and Intercomp Ltd. as material contracts. For a summary of the terms of these
investments, see "Item 4.B. Business Overview--Investments and Acquisitions" and
"Item 5.B. Liquidity and Capital Resources." In addition, the following
agreements with Microsoft, Liraz's shareholders and SDC Udvikling are material
to our business.

      Licensing Agreement with Microsoft

      In August 1998, we entered into a Windows source code license agreement
with Microsoft that terminated and superseded our prior arrangement with
Microsoft. In May 2002, the parties entered into an amendment to the license
agreement that expanded our access to certain Microsoft development
technologies.

      Under the terms of the agreement, as amended, we continue to have access
to specified software code and documentation for specified versions of Windows,
Windows NT, and Windows XP, collectively referred to as the licensed software.
The agreement grants us the right to distribute the licensed software as a
component of our Visual MainWin(R) development kit and runtime products. The
agreement provides for the payment of royalties to Microsoft that are based upon
the licensing of our Visual MainWin(R) products, which include the licensed
software. The agreement has a perpetual term although it may be terminated
earlier under certain circumstances, including in the event of change of control
of either of the parties.

      The agreement provides that in the event that we cease the active
distribution or licensing of our Visual MainWin(R) products for more than one
year, we will be deemed to have granted to Microsoft a worldwide, exclusive,
perpetual, irrevocable, royalty-free license to our Visual MainWin(R) products.

      The agreement provides for a procedure under which we may be granted by
Microsoft a waiver of payment of certain royalties to Microsoft relating to
specific customers. Upon recording revenue from a customer, we accrue the
royalties due to Microsoft in product cost of revenues and often apply for a
waiver. We recognize a reduction in product cost of revenues when a waiver is
approved by Microsoft.


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      In December 2003, we entered into an independent contractor agreement with
Microsoft. In accordance with this agreement, Microsoft agreed to offset the
value of the services we performed under the independent contractor agreement
from accrued royalties of up to $1,605,131. During the year ended December 31,
2003, we accrued royalties due to Microsoft of $2,782,000, and recognized
credits (reductions to expense) related to waivers and to services performed of
$2,466,000 and $999,000, respectively. The excess credits over the royalties
amount is related to previous year royalties.

      Our ability to develop, sell and market our Visual MainWin(R) products
that use the licensed software is dependent upon the continued access to the
licensed software and updated and additional source code. While we believe that
our relationship with Microsoft will continue on terms acceptable to us, a
change in or termination of the agreement could prevent us from developing and
selling certain products and materially adversely affect our business, results
of operations and financial condition.

      Acquisition of Liraz

      In November 2002, we purchased through a share exchange transaction,
approximately 86% of the outstanding share capital of Liraz, then publicly
traded on the TASE. As part of the share exchange transaction, we issued to
Liraz's selling shareholders, including Formula, 3,478,624 of our ordinary
shares, constituting an aggregate of 26% of our outstanding share capital. In
two public tender offers that we published in December 2002 and March 2003, we
purchased additional shares of Liraz representing 9% of the outstanding share
capital of Liraz. In March 2003, pursuant to the provisions of the Israeli
Companies Law, we purchased the remaining outstanding share capital of Liraz.
The total aggregate amount of those cash purchases was $2.7 million. Following
these transactions, we currently hold the entire outstanding share capital of
Liraz.

      Services Agreement with SDC Udvikling

      In October 2002, we entered into a services agreement with an affiliated
company of SDC, named SDC Udvikling A/S, for the provision of IT development
services related to our tool, the AppBuilder. Under the agreement, this customer
purchased from us services to be rendered beginning on the date of signing of
the agreement through the end of 2004, as will be specified in purchase orders
to be issued by the customer from time to time.


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. 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 securities pursuant
to the general permit issued under the Israeli Currency Control Law, 1978.
Neither our memorandum of association nor the laws of the State of Israel
restrict in any way the ownership of our ordinary shares by non-residents,
except that these restrictions may exist with respect to citizens of countries
which are in a state of war with Israel.

E.    TAXATION

ISRAELI TAXATION


      The following is a description of material tax consequences regarding the
ownership and disposition of the Company's ordinary shares under Israeli tax
laws to which U.S. and other non-Israeli shareholders may be subject. The
information below does not apply to specified persons or cover specified
situations. Therefore, you are advised to consult your own tax advisor as to
particular tax consequences unique to you related to an investment in our
ordinary shares 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.

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

      Pursuant to the convention between the Government of the United States of
America and the Government of Israel with respect to taxes on income (the
U.S.-Israel tax treaty), the sale, exchange or disposition of our ordinary
shares by a person who qualifies as a resident of the United States under the
treaty and who is entitled to claim the benefits afforded to him by the treaty,
will generally not be subject to Israeli capital gains tax. This exemption shall
not apply to a person who held, directly or indirectly, shares representing 10%
or more of the voting power in our company during any part of the 12-month
period preceding the sale, exchange or disposition, subject to certain
conditions. A sale, exchange or disposition of our shares by a U.S. resident
qualified under the treaty, who held, directly or indirectly, shares
representing 10% or more of the voting power in our company at any time during
the preceding 12-month period would be subject to Israeli tax, to the extent
applicable; however, under the treaty, this U.S. resident would be permitted to
claim a credit for these taxes against the U.S. income tax with respect to the
sale, exchange or disposition, subject to the limitations in U.S. laws
applicable to foreign tax credits in accordance with tax treaties.


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      Non-residents of Israel are subject to income tax on passive income
accrued or derived from sources in Israel, like dividends, royalties and
interest, as well as non-passive income from services rendered in Israel. On
distributions of dividends other than bonus shares (stock dividends) we
generally withhold at source income tax at a rate of 25%, unless a different
rate applies under a treaty between Israel and the shareholder's country of
residence. Under the U.S.-Israel tax treaty, the maximum tax on dividends paid
to a holder of our ordinary shares who is a resident of the United States will
be 25% or 12.5% if certain conditions are met, including, inter alia that the
holder is a corporation which holds, directly or indirectly, shares representing
10% or more of the voting power in our company during any part of the 12-month
period preceding the date of payment of the dividend. However, under the Law for
the Encouragement of Capital Investments, 1959 (the Investments Law), dividends
generated by an approved enterprise are taxed at the rate of 15%.

UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS

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

      o     an individual citizen or resident of the U.S.;

      o     a corporation (or another entity taxable as a corporation for U.S.
            federal income tax purposes) created or organized under the laws of
            the United States or any political subdivision thereof;

      o     an estate, the income of which is subject to U.S. federal income tax
            regardless of its source; or

      o     a trust (i) if, in general, a U.S. court is able to exercise primary
            supervision over its administration and one or more U.S. persons
            have the authority to control all of its substantial decisions or
            (ii) that has in effect a valid election under applicable U.S.
            Treasury regulations to be treated as a U.S. person.

      Unless otherwise specifically indicated, this discussion does not consider
the U.S. tax consequences to a person that is not a U.S. holder and considers
only U.S. holders that will own the ordinary shares 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 U.S. federal income taxation that may be relevant to any
particular U.S. holder based on the U.S. holder's individual circumstances. In
particular, this discussion does not address the U.S. federal income tax
consequences to U.S. holders who are broker-dealers or who


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own, directly, indirectly or constructively, 10% or more of our outstanding
voting shares, U.S. holders holding the ordinary shares as part of a hedging,
straddle or conversion transaction, U.S. holders whose functional currency is
not the U.S. dollar, insurance companies, tax-exempt organizations, financial
institutions, persons who acquired their shares upon the exercise of employee
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 through, a partnership or other pass-through entity is not considered,
nor is the possible application of U.S. federal estate or gift taxes or any
aspect of state, local or non-U.S. tax laws.

      YOU ARE ADVISED TO CONSULT YOUR TAX ADVISOR WITH RESPECT TO THE SPECIFIC
U.S. FEDERAL, STATE, LOCAL AND FOREIGN INCOME TAX CONSEQUENCES TO YOU OF
PURCHASING, HOLDING OR DISPOSING OF OUR ORDINARY SHARES.

      Taxation on Distributions on the Ordinary Shares

      We have never paid dividends, and currently do not intend to pay dividends
in the future. If we make distributions in the future, the amount of the
distribution with respect to the ordinary shares 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 "Taxation--Israeli
Taxation." Subject to the discussion below under "Tax Consequences if We are a
Passive Foreign Investment Company," a distribution paid by us with respect to
the ordinary shares to a U.S. 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 U.S. federal income tax purposes.
Dividends that are received by U.S. 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 U.S. holders, are taxed at ordinary income
rates. No dividend received by a U.S. holder will be a qualified dividend (1) if
the U.S. holder held the ordinary share 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 U.S. 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 substantially identical securities); or (2) to the extent
that the U.S. 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 with respect to which the
dividend is paid. If we were to be a "passive foreign investment company," a
"foreign personal holding company" or a "foreign investment company" (as such
terms are defined in the Code) for any year, dividends paid on our ordinary
shares in such year or in the following year would not be qualified dividends.
In addition, a non-corporate U.S. 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.


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<PAGE>

      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
U.S. holder's tax basis in its ordinary shares to the extent thereof, and then
as capital gain from the deemed disposition of the ordinary shares. Corporate
holders will not be allowed a deduction for dividends received in respect of the
ordinary shares.

      Dividends paid by us in NIS will be included in the income of U.S. holders
at the dollar amount of the dividend (including any Israeli taxes withheld
therefrom), based upon the spot rate of exchange in effect on the date of the
distribution. U.S. holders will have a tax basis in NIS for U.S. 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 U.S.
source ordinary income or loss.

      Subject to the limitations set forth in the Code and the Treasury
regulations thereunder, U.S. holders may elect to claim as a foreign tax credit
against their U.S. federal income tax liability the Israeli income tax withheld
from dividends received in respect of the ordinary shares. 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 U.S. 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." U.S. 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
U.S. holder will be denied a foreign tax credit for Israeli income tax withheld
from a dividend received on the ordinary shares (i) if the U.S. holder has not
held the ordinary shares for at least 16 days of the 30-day period beginning on
the date which is 15 days before the ex-dividend date with respect to such
dividend or (ii) to the extent the U.S. holder is under an obligation to make
related payments with respect to positions in substantially similar or related
property. Any days during which a U.S. holder has substantially diminished its
risk of loss on the ordinary shares are not counted toward meeting the required
16-day holding period.

      Taxation on Disposition of the Ordinary Shares

      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, a U.S. holder will recognize capital gain or
loss in an amount equal to the difference between the amount realized on the
disposition and the U.S. holder's tax basis in the ordinary shares. The gain or
loss recognized on the disposition will be long-term capital gain or loss if the
U.S. holder held the ordinary shares for more than one year at the time of the
disposition. Gain or loss recognized by a U.S. holder on a sale, exchange or
other disposition of ordinary shares will be treated as U.S. source income or
loss for U.S. foreign tax credit purposes.


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      A U.S. 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 U.S. 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 U.S. 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 U.S. holder that receives foreign currency
upon disposition of ordinary shares and converts the foreign currency into
dollars after the settlement date or trade date (whichever date the U.S. 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 U.S.
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) 50% or more of the value, determined on the basis of a
quarterly average, of our assets in the taxable year produce, or are held for
the production of, passive income. If we own (directly or indirectly) at least
25% by value of the stock of another corporation, we will be treated for
purposes of the foregoing tests as owning our proportionate share of the other
corporation's assets and as directly earning our proportionate share of the
other corporation's income. If we are a PFIC, a U.S. holder must determine under
which of three alternative taxing regimes it wishes to be taxed:

      o     The "QEF" regime applies if the U.S. holder elects to treat us as a
            "qualified electing fund" ("QEF") for the first taxable year in
            which the U.S. holder owns our ordinary shares 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 U.S. 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 U.S. holder for
            its taxable year in which our taxable year ends, whether or not such
            amounts are actually distributed to the U.S. holder. A U.S. holder's
            basis in our ordinary shares 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
            U.S. holder to treat any gain realized on the disposition of his
            ordinary shares as capital gain.

            Once made, the QEF election applies to all subsequent taxable years
            of the U.S. holder in which it holds our ordinary shares 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
            U.S. holder holds our ordinary shares and we are a PFIC, then
            special rules would apply.


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      o     A second regime, the "mark-to-market" regime, may be elected so long
            as our ordinary shares are publicly traded. Pursuant to this regime,
            an electing U.S. holder's ordinary shares are marked-to-market each
            year and the U.S. 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 and the U.S.
            holder's adjusted tax basis therein. Losses are allowed only to the
            extent of net mark-to-market gain previously included by the U.S.
            holder under the election for prior taxable years. An electing U.S.
            holder's adjusted basis in our ordinary shares 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 is treated as ordinary income, and loss on the sale of our
            ordinary shares, 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 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 U.S. holder holds our ordinary shares and we are a PFIC,
            then special rules would apply.

      o     A U.S. 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 that is greater than 125% of the average
            distributions received by the U.S. holder from us over the shorter
            of either the preceding three years or such U.S. holder's holding
            period for our ordinary shares, or (2) 100% of the gain from the
            disposition of our ordinary shares (including gain deemed recognized
            if the ordinary shares are used as security for a loan).

                  Excess distributions must be allocated ratably to each day
            that a U.S. holder has held our ordinary shares. A U.S. 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 U.S.
            holder would be taxed at the highest tax rate for each such other
            year applicable to ordinary income. The U.S. 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 U.S. holder that is an individual is not
            allowed a deduction for interest on the deferred tax liability. The
            portions of distributions that are not characterized as "excess
            distributions" are subject to tax in the current year under the
            normal tax rules of the Code.

                  A U.S. person who inherits shares 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 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.


                                       91
<PAGE>

      We believe that in 2002 we were not a PFIC and currently we expect that we
will not be a PFIC in 2003. 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, 2003 or in a future year. We will notify U.S. holders in the event
we conclude that we will be treated as a PFIC for any taxable year to enable
U.S. holders to consider whether or not to elect to treat us as a QEF for U.S.
federal income tax purposes or to "mark to market" the ordinary shares or to
become subject to the "excess distribution" regime.

      U.S. 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 U.S. 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. Backup withholding will not apply with respect to payments made to
exempt recipients, including corporations and tax-exempt organizations, or if a
U.S. 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 U.S. federal income tax liability of a U.S. holder, or
alternatively, the U.S. 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-U.S. holders of Ordinary Shares

      Except as provided below, a non-U.S. holder of ordinary shares (except
certain former U.S. citizens and long-term residents of the United States) will
not be subject to U.S. federal income or withholding tax on the receipt of
dividends on, and the proceeds from the disposition of, an ordinary share,
unless that item is effectively connected with the conduct by the non-U.S.
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-U.S. holder will be subject to
tax in the United States if the non-U.S. holder is present in the United States
for 183 days or more in the taxable year of the sale and other conditions are
met.

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


                                       92
<PAGE>

      Non-U.S. 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 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-U.S. 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 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-U.S. holder's foreign status or the non-U.S.
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 U.S. federal income tax liability of a non-U.S. holder, or
alternatively, the non-U.S. 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 AGENTS

Not applicable.

H.    DOCUMENTS ON DISPLAY

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

      The SEC maintains an Internet Web site at HTTP://WWW.SEC.GOV that contains
reports and other material that are filed through the SEC's Electronic Data
Gathering, Analysis and Retrieval ("EDGAR") system. BluePhoenix began filing
through the EDGAR system beginning on November 14, 2002.

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


                                       93
<PAGE>

      Information about us is also available on our Web site at
HTTP://WWW.BPHX.COM. Such information on our Web site is not part of this annual
report.

      BluePhoenix, as a foreign private issuer, is exempt from the rules under
the Exchange Act prescribing the furnishing and content of proxy statements, and
BluePhoenix's officers, directors and principal shareholders are exempt from the
reporting and "short-swing" profit recovery provisions contained in Section 16
of the Exchange Act. In addition, BluePhoenix is not required under the Exchange
Act to file periodic reports and financial statements with the Securities and
Exchange Commission as frequently or as promptly as United States companies
whose securities are registered under the Exchange Act. 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 RISK

      In light of the nature of our activities, we invest our cash and cash
equivalents, in short-term time deposits. As of December 31, 2003, we invested
substantially all of the cash we held in dollars, euro and DKK currency
accounts. In addition, we had outstanding short-term loans in dollars, euro and
NIS. Fluctuations in foreign currency exchange rates, such as euro or NIS versus
the dollar may have a negative impact on our operating results and financial
condition. Depending upon the circumstances, we will consider entering into
currency hedging transactions to decrease the risk of financial exposure from
fluctuations in the exchange rate of the dollar versus any other applicable
foreign currencies.

      We do not engage in currency speculation. We do not hold nor have we
issued any derivatives or other financial instruments for trading purposes. In
case we use financial instruments, we include the gains and losses on these
transactions in the statement of operations in the period in which the changes
in the exchange rates occur.

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

Not applicable.


                                       94
<PAGE>

                                   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 our internal control over financial reporting and 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 in assuring that all material information relating to our company is
made known to them.

      (b) Internal Controls. Since the date of the evaluation described above,
there have been no significant changes in our internal controls over financial
reporting or in other factors 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. Michael Chill, a member of
our audit committee, is an audit committee financial expert, as defined by
applicable SEC regulations.

ITEM 16B. CODE OF ETHICS


      BluePhoenix 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 every BluePhoenix employees, investors and others upon request
to its general counsel. Any waiver of this code for executive officers or
directors will be disclosed through the filing of a Form 6-K.



                                       95
<PAGE>

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

POLICY ON PRE-APPROVAL OF AUDIT AND NON-AUDIT SERVICES OF INDEPENDENT AUDITORS

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

PRINCIPAL ACCOUNTANT FEES AND SERVICES

      BluePhoenix paid the following fees for professional services rendered by
Ziv Haft certified public accountants (Isr.) and other BDO member firm, for the
years ended December 31, 2003:

                                           2003              2002
                                           ----              ----
                                            ($ in thousands)
                                      ------------------------------
Audit Fees                                   $284              $152
Audit-Related Fees                             28                27
Tax Fees                                       52                33
All Other Fees                                  -                 -
                                      ------------      ------------
TOTAL                                        $364              $212

      The audit fees for the years ended December 31, 2003 and 2002 were for
professional services rendered for the audits of our annual consolidated
financial statements, review of our consolidated quarterly financial statements,
statutory audits of BluePhoenix and its 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, 2003 and 2002 were
for assurance and related services related to accounting consultations and
audits in connection with acquisitions and employee benefit plan audits.

      Tax fees for the years ended December 31, 2003 and 2002 were for services
related to tax compliance, including the preparation of tax returns and claims
for refund, and tax planning and tax advice, including assistance with tax
audits and appeals, tax services for employee benefit plans and assistance with
respect to requests for rulings from tax authorities.


                                       96
<PAGE>

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.


                                       97
<PAGE>

                                   P A R T III
                                   ===========

ITEM 17. FINANCIAL STATEMENTS

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

ITEM 18. FINANCIAL STATEMENTS

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

ITEM 19. EXHIBITS

EXHIBIT NO.
-----------

1.1         English translation of the Memorandum of Association as amended on
            July 23, 2003*

1.2         Articles of Association as amended on January 15, 2001**

4.1         Cooperation agreement dated August 10, 1999, between ForSoft Ltd.
            and the Registrant (English summary accompanied by Hebrew
            original) ***

4.2         Agreement dated June 12, 2003, among the Registrant, the owners of
            all of the issued and outstanding common stock of IntraComp Group
            Incorporated ****

4.3         Agreement dated January 11, 2001 among the Registrant, the Israel
            Mezzanine Fund L.P., The Israel Mezzanine Fund, The Jordan
            (Bermuda) Investment Company Ltd.* *


4.4         Amendment dated August 7, 2003 to agreement among the Registrant,
            the Israel Mezzanine Fund L.P., The Israel Mezzanine Fund and The
            Jordan (Bermuda) Investment Company Ltd. dated January 11, 2001+


4.5         Share Purchase Agreement dated March 30, 2004, among the
            Registrant and four institutional investors in connection with a
            $5 million private placement*****

4.6         Registration Rights Agreement dated March 30, 2004, among the
            Registrant and four institutional investors in connection with a
            $5 million private placement*****

4.7         Share Exchange Agreement dated October 13, 2002 among the
            Registrant, Formula Systems (1985) and certain shareholders of
            Liraz Systems Ltd.****


                                       98
<PAGE>

EXHIBIT NO.
-----------

4.8         The 1996 Share Option Plan--Part One, as amended on January 28,
            1997, December 5, 1999, December 18, 2000, December 26, 2000 and
            August 6, 2003******

4.9         Agreement dated January 1, 1996 among the Registrant and Argotec
            Ltd.*******

4.10        Form of voting agreement dated September 30, 1996 between Argotec
            Ltd. and each of Dan Goldstein and Gad Goldstein*******


4.11        English translation of Loan Agreement between Liraz Systems Ltd.
            and Arie Kilman dated April 2000 as amended by the Addendum dated
            April 2002+

4.12        Form of Indemnification Letter dated July 2003 between the
            Registrant and certain office holders+

4.13        Summary of credit line Letter Agreement between the Registrant and
            Bank Leumi Le'Israel Ltd.+


8           List of Subsidiaries******

10.1        Consent of Ziv Haft certified public accountants (Isr.) BDO member
            firm

12.1        Certification of the Chief Executive Officer pursuant to ss.302 of
            the Sarbanes-Oxley Act

12.2        Certification of the Chief Financial Officer pursuant to ss.302 of
            the Sarbanes-Oxley Act

13.1        Certification of the Chief Executive Officer pursuant to 18 U.S.C.
            ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act

13.2        Certification of the Chief Financial Officer pursuant to 18 U.S.C.
            ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act

------------
* Incorporated by reference to the Registration Statement on Form F-1 filed
with the Securities and Exchange Commission on December 24, 1996.

** Incorporated by reference to the Registrant annual report on Form 20-F
filed with the Securities and Exchange Commission on June 29, 2001.



                                       99
<PAGE>


*** Incorporated by reference to the Registrant annual report on Form 20-F
filed with the Securities and Exchange Commission on June 28, 2002.

**** Incorporated by reference to the Registrant annual report on Form 20-F
filed with the Securities and Exchange Commission on June 19, 2003.

***** Incorporated by reference to the Registration Statement on Form F-3
filed with the Securities and Exchange Commission on June 1, 2004.

****** Incorporated by reference to the Registrant annual report on Form 20-F
filed with the Securities and Exchange Commission on June 1, 2004.

******* Incorporated by reference to Amendment No.1 to the Registration
Statement on Form F-1 filed with the Securities and Exchange Commission on
January 28, 1997.


+ Previously submitted.



                                      100
<PAGE>

                                   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.

                                        BLUEPHOENIX SOLUTIONS LTD.
                                           (Registrant)



                                        By: /s/ Iris Yahal
                                            -----------------------
                                            Iris Yahal
                                            Chief Financial Officer

Date: January 18, 2005

<PAGE>

EXHIBIT INDEX

EXHIBIT NO.
-----------

1.1         English translation of the Memorandum of Association as amended on
            July 23, 2003*

1.2         Articles of Association as amended on January 15, 2001**

4.1         Cooperation agreement dated August 10, 1999, between ForSoft Ltd.
            and the Registrant (English summary accompanied by Hebrew
            original) ***

4.2         Agreement dated June 12, 2003, among the Registrant, the owners of
            all of the issued and outstanding common stock of IntraComp Group
            Incorporated ****

4.3         Agreement dated January 11, 2001 among the Registrant, the Israel
            Mezzanine Fund L.P., The Israel Mezzanine Fund, The Jordan
            (Bermuda) Investment Company Ltd.**


4.4         Amendment dated August 7, 2003 to agreement among the Registrant,
            the Israel Mezzanine Fund L.P., The Israel Mezzanine Fund and The
            Jordan (Bermuda) Investment Company Ltd. dated January 11, 2001+


4.5         Share Purchase Agreement dated March 30, 2004, among the
            Registrant and four institutional investors in connection with a
            $5 million private placement*****

4.6         Registration Rights Agreement dated March 30, 2004, among the
            Registrant and four institutional investors in connection with a
            $5 million private placement*****

4.7         Share Exchange Agreement dated October 13, 2002 among the
            Registrant, Formula Systems (1985) and certain shareholders of
            Liraz Systems Ltd.****

4.8         The 1996 Share Option Plan--Part One, as amended on January 28,
            1997, December 5, 1999, December 18, 2000, December 26, 2000 and
            August 6, 2003******

4.9         Agreement dated January 1, 1996 among the Registrant and Argotec
            Ltd.*******

4.10        Form of voting agreement dated September 30, 1996 between Argotec
            Ltd. and each of Dan Goldstein and Gad Goldstein*******


4.11        English translation of Loan Agreement between Liraz Systems Ltd.
            and Arie Kilman dated April 2000 as amended by the Addendum dated
            April 2002+


<PAGE>

EXHIBIT NO.
-----------


4.12        Form of Indemnification Letter dated July  2003 between the
            Registrant and certain office holders+

4.13        Summary of credit line Letter Agreement between the Registrant and
            Bank Leumi Le'Israel Ltd.+


8           List of Subsidiaries******

10.1        Consent of Ziv Haft certified public accountants (Isr.) BDO member
            firm

12.1        Certification of the Chief Executive Officer pursuant to ss.302 of
            the Sarbanes-Oxley Act

12.2        Certification of the Chief Financial Officer pursuant to ss.302 of
            the Sarbanes-Oxley Act

13.1        Certification of the Chief Executive Officer pursuant to 18 U.S.C.
            ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act

13.2        Certification of the Chief Financial Officer pursuant to 18 U.S.C.
            ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act

--------
* Incorporated by reference to the Registration Statement on Form F-1 filed
with the Securities and Exchange Commission on December 24, 1996.

** Incorporated by reference to the Registrant annual report on Form 20-F
filed with the Securities and Exchange Commission on June 29, 2001.

*** Incorporated by reference to the Registrant annual report on Form 20-F
filed with the Securities and Exchange Commission on June 28, 2002.

**** Incorporated by reference to the Registrant annual report on Form 20-F
filed with the Securities and Exchange Commission on June 19, 2003.

***** Incorporated by reference to the Registration Statement on Form F-3
filed with the Securities and Exchange Commission on June 1, 2004.

****** Incorporated by reference to the Registrant annual report on Form 20-F
filed with the Securities and Exchange Commission on June 1, 2004.

******* Incorporated by reference to Amendment No. 1 to the Registration
Statement on Form F-1 filed with the Securities and Exchange Commission on
January 28, 1997.


+ Previously submitted.


<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)
                               2003 ANNUAL REPORT
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

                     2003 CONSOLIDATED FINANCIAL STATEMENTS

                                TABLE OF CONTENTS
                                -----------------

                                                                          PAGE
                                                                          ----

REPORT OF INDEPENDENT AUDITORS                                             F-1
CONSOLIDATED FINANCIAL STATEMENTS:
      Balance Sheets                                                       F-2
      Statements of Operations                                             F-3
      Statements of Changes in Shareholders' Equity                        F-4
      Statements of Cash Flows                                             F-5
      Notes to Financial Statements                                        F-7

                   THE AMOUNTS ARE STATED IN U.S. DOLLARS ($).

                             ----------------------
                                  -------------
                                     ------
<PAGE>

                          INDEPENDENT AUDITORS' REPORT
                             TO THE SHAREHOLDERS OF
                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)

We have audited the accompanying consolidated balance sheets of BluePhoenix
Solutions Ltd. (formerly: Crystal Systems Solutions Ltd.) (the "Company") and
its subsidiaries as of December 31, 2003 and 2002 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, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company and its subsidiaries as of December 31, 2003 and 2002, and the related
consolidated results of its operations and cash flows for each of the three
years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States.

As discussed in Note 1 to the consolidated financial statements, effective
January 1, 2002, the Company adopted Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets."

As discussed more fully in Note 11, there were public reports in early 2004 that
Microsoft source code was leaked to the Internet, with source traces coming from
the Company's subsidiary. While the Company's subsidiary believes its
relationship with Microsoft will continue on terms acceptable to the Company's
subsidiary, a change in the relationship could materially adversely affect the
Company's subsidiary's business, result of operations, and financial condition.

Tel-Aviv, Israel
May 27, 2004


                                        /s/ ZIV HAFT
                                        ----------------------------------------
                                        Ziv Haft
                                        Certified Public Accountants (Isr.)
                                        BDO Member Firm


                                      F-1
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)
                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                           DECEMBER 31,
                                                                                     ----------------------
                                                                                       2003          2002
                                                                                     --------      --------
                                                                                         (IN THOUSANDS)
                                                                                     ----------------------
<S>                                                                                  <C>           <C>
ASSETS

CURRENT ASSETS (NOTE 13):
    Cash and cash equivalents                                                        $ 11,105      $ 15,306
    Marketable securities                                                                 406           640
    Trade accounts receivable (Note 15A1)                                              12,617        10,811
    Other current assets (Note 15A2)                                                    1,899         2,924
                                                                                     --------      --------
              Total current assets                                                     26,027        29,681
                                                                                     --------      --------

INVESTMENTS IN AFFILIATES AND OTHER COMPANIES (NOTE 3)                                  3,794         3,475
                                                                                     --------      --------

FIXED ASSETS (NOTE 4, 15A3):
    Cost                                                                                8,920        11,173
    Less - accumulated depreciation                                                     6,121         7,601
                                                                                     --------      --------
                                                                                        2,799         3,572
                                                                                     --------      --------

GOODWILL (NOTE 5)                                                                      36,807        41,822
                                                                                     --------      --------

CAPITALIZED SOFTWARE DEVELOPMENT COSTS AND OTHER (NOTE 6)                              11,393         8,931
                                                                                     --------      --------

Total assets                                                                         $ 80,820      $ 87,481
                                                                                     ========      ========

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES (NOTE 13):
    Short-term bank credit (Note 7)                                                  $  8,342      $  7,473
    Accounts payable and accruals:
       Trade                                                                            3,425         3,738
       Deferred revenue                                                                 3,034         3,094
       Other (Note 15A3)                                                               10,980        13,884
       Restructuring accrual                                                               --           182
                                                                                     --------      --------
              Total current liabilities                                                25,781        28,371
                                                                                     --------      --------

LONG-TERM LIABILITIES:
    Accrued severance pay, net (Note 8)                                                   915           931
    Provision for losses in formerly-consolidated subsidiary (Note 9)                   1,971         2,512
    Loans from banks (Note 10)                                                          2,065         2,652
                                                                                     --------      --------
              Total long-term liabilities                                               4,951         6,095
                                                                                     --------      --------

MINORITY INTEREST                                                                       4,690         6,294
                                                                                     --------      --------
COMMITMENTS AND CONTINGENCIES (NOTE 11)

SHAREHOLDERS' EQUITY (NOTE 12):

Share capital - ordinary shares of NIS 0.01 par value (authorized - December 31,
   2003 and 2002 - 30,000,000 shares; issued: December 31, 2003 - 15,354,841
   shares; December 31, 2002 - 15,319,574 shares)                                          30            30
   Capital surplus                                                                     54,412        54,329
   Accumulated other comprehensive income (loss)                                       (1,476)        1,781
   Retained earnings                                                                    7,140         5,289
                                                                                     --------      --------
                                                                                       60,106        61,429
                                                                                     --------      --------
   Cost of 1,870,565 Company shares held by subsidiaries                              (14,708)      (14,708)
                                                                                     --------      --------

              Total shareholders' equity                                               45,398        46,721
                                                                                     --------      --------
Total liabilities and shareholders' equity                                           $ 80,820      $ 87,481
                                                                                     ========      ========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.


                                      F-2
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)
                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                     YEAR ENDED DECEMBER 31,
                                                               ------------------------------------
                                                                 2003          2002          2001
                                                               --------      --------      --------
                                                             (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                                               ------------------------------------
<S>                                                            <C>           <C>           <C>
Revenues (Note 15D1)                                           $ 54,340      $ 36,668      $ 38,438
Cost of revenues                                                 24,115        15,220        17,722
                                                               --------      --------      --------
         Gross profit                                            30,225        21,448        20,716
Software development costs, net                                   8,138         7,387         8,868
Selling, general and administrative expenses                     20,140        13,245        19,794
Goodwill impairment, restructuring costs and non-recurring
   expenses (Note 15B1)                                              --           472         4,467
                                                               --------      --------      --------

         Operating income (loss)                                  1,947           344       (12,413)
Financial income (expenses), net (Note 15B3)                        165          (195)          (62)
Gain on realization of shareholdings (Note 15B4)                    376            --           693
Other income (expenses), net (Note 15B5)                            567        (1,581)       (2,649)
                                                               --------      --------      --------

         Income (loss) before taxes on income                     3,055        (1,432)      (14,431)
Income tax expense (Note 14)                                        152           160           115
                                                               --------      --------      --------

                                                                  2,903        (1,592)      (14,546)
Equity in losses of affiliated companies, net                      (898)       (1,336)       (1,304)
Minority interest                                                  (154)         (702)          863
                                                               --------      --------      --------

         Net income (loss)                                     $  1,851      $ (3,630)     $(14,987)
                                                               ========      ========      ========

EARNINGS (LOSS) PER SHARE (NOTE 15C):
         Basic                                                 $   0.14      $  (0.35)     $  (1.52)
                                                               ========      ========      ========

         Diluted                                               $   0.14      $  (0.35)     $  (1.52)
                                                               ========      ========      ========

WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (NOTE 15C):
         Basic                                                   13,451        10,517         9,872
                                                               ========      ========      ========

         Diluted                                                 13,644        10,517         9,872
                                                               ========      ========      ========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.


                                      F-3
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)
           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                       SHARE CAPITAL
                                                              -----------------------------

                                                                                                             ACCUMULATED OTHER
                                                               NUMBER OF                         CAPITAL      COMPREHENSIVE
                                                                SHARES            AMOUNT         SURPLUS          INCOME
                                                              -----------      -----------     -----------      -----------
                                                                                  (IN THOUSANDS, EXCEPT SHARES)
                                                              ------------------------------------------------------------------
<S>                                                            <C>             <C>             <C>             <C>

BALANCE AT JANUARY 1, 2001                                     10,009,100      $        23     $    40,632              --

CHANGES DURING 2001:
   Net loss                                                            --               --              --              --
   Exercise of employee share options                             181,850               --             499              --
   Purchase of treasury stock                                    (206,100)              --              --              --
                                                              -----------      -----------     -----------     -----------
BALANCE AT DECEMBER 31, 2001                                    9,984,850               23          41,131              --
CHANGES DURING 2002:
   Components of comprehensive income:
      Net loss                                                         --               --              --              --
      Currency translation adjustments                                 --               --              --           1,781

       Total comprehensive loss

   Repayment of loans granted against exercise of options              --               --              --              --
   Exercise of employee share options                              90,000               --             321              --
   Purchase of treasury stock                                    (104,465)              --              --              --
   Issuance of shares (Note 2E)                                 3,478,624                7          12,877              --
                                                              -----------      -----------     -----------     -----------
BALANCE AT DECEMBER 31, 2002                                   13,449,009               30          54,329           1,781
CHANGES DURING 2003:
   Components of comprehensive income:
      Net income                                                       --               --              --              --
      Currency translation adjustments                                 --               --              --          (3,257)

       Total comprehensive loss

   Exercise of employee share options                              35,267               --              83              --
                                                              -----------      -----------     -----------     -----------
BALANCE AT DECEMBER 31, 2003                                   13,484,276      $        30     $    54,412     $    (1,476)
                                                              ===========      ===========     ===========     ===========
<CAPTION>
                                                                                 LOANS           COST OF
                                                                                AGAINST       COMPANY SHARES
                                                               RETAINED       EXERCISE OF        HELD BY
                                                               EARNINGS         OPTIONS        SUBSIDIARIES        TOTAL
                                                             -----------      -----------      ------------     -----------
                                                                            (IN THOUSANDS, EXCEPT SHARES)
                                                            ---------------------------------------------------------------
<S>                                                          <C>              <C>              <C>              <C>

BALANCE AT JANUARY 1, 2001                                   $    23,906               --      $   (13,152)     $    51,409

CHANGES DURING 2001:
   Net loss                                                      (14,987)              --               --          (14,987)
   Exercise of employee share options                                 --             (346)              --              153
   Purchase of treasury stock                                         --               --           (1,318)          (1,318)
                                                             -----------      -----------      -----------      -----------
BALANCE AT DECEMBER 31, 2001                                       8,919             (346)         (14,470)          35,257
CHANGES DURING 2002:
   Components of comprehensive income:
      Net loss                                                    (3,630)              --               --           (3,630)
      Currency translation adjustments                                --               --               --            1,781
                                                                                                                -----------
       Total comprehensive loss                                                                                      (1,849)
                                                                                                                -----------
   Repayment of loans granted against exercise of options             --              346               --              346
   Exercise of employee share options                                 --               --               --              321
   Purchase of treasury stock                                         --               --             (238)            (238)
   Issuance of shares (Note 2E)                                       --               --               --           12,884
                                                             -----------      -----------      -----------      -----------
BALANCE AT DECEMBER 31, 2002                                       5,289               --          (14,708)          46,721
CHANGES DURING 2003:
   Components of comprehensive income:
      Net income                                                   1,851               --               --            1,851
      Currency translation adjustments                                --               --               --           (3,257)
                                                                                                                -----------
       Total comprehensive loss                                                                                      (1,406)
                                                                                                                -----------
   Exercise of employee share options                                 --               --               --               83
                                                             -----------      -----------      -----------      -----------
BALANCE AT DECEMBER 31, 2003                                 $     7,140      $        --      $   (14,708)     $    45,398
                                                             ===========      ===========      ===========      ===========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.


                                      F-4
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                  YEAR ENDED DECEMBER 31,
                                                                            ------------------------------------
                                                                              2003          2002          2001
                                                                            --------      --------      --------
                                                                                       (IN THOUSANDS)
                                                                            ------------------------------------
<S>                                                                         <C>           <C>           <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income (loss)                                                        $  1,851      $ (3,630)     $(14,987)
   Adjustments to reconcile net income (loss) to net cash
      provided by operating activities:
   Minority interest in earnings (losses) of consolidated subsidiaries           154           702          (863)
   Equity in losses of affiliated companies, net                                 898         1,481         1,080
   Depreciation and amortization                                               3,910         2,774         6,029
   Increase (decrease) in accrued severance pay, net                              96          (214)         (116)
   Loss from sale of fixed assets                                                 31            37           149
   Gain on realization of shareholdings and expiration of options               (451)          (84)         (693)
   Write-down of loans to an investee                                            350            --         2,500
   Write-down of shareholdings in an investee                                    100         1,800            --
   Change in value of long term-loans and liabilities                            (92)          (92)           (4)
   Decrease of provision for losses in formerly consolidated subsidiary         (541)           --            --
   Deferred taxes                                                                513            50          (340)
   Changes in operating assets and liabilities:
      Decrease in marketable securities                                          234            60         4,500
      Decrease (increase) in trade receivables                                (2,022)        3,965         8,313
      Decrease  in other current assets                                          647         1,205         1,409
      Increase (decrease) in trade payables                                     (193)       (3,422)        1,341
      Decrease in other accounts payable                                      (3,027)       (1,830)       (1,203)
                                                                            --------      --------      --------

         Net cash provided by operating activities                             2,458         2,802         7,115
                                                                            --------      --------      --------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchase of fixed assets                                                     (867)         (823)         (878)
   Proceeds from sale of fixed assets                                            157           278           231
   Investment in and loans to affiliated and other companies                  (1,140)       (2,999)       (4,714)
   Repayment of loans to affiliated and other companies                           --            --           933
   Proceeds from sale of investments                                             376            --         1,960
   Capitalization of software development and other costs                     (3,159)       (2,442)       (3,203)
   Purchase of minority interest in subsidiaries                              (2,730)       (1,124)       (5,120)
   Investment in newly-consolidated subsidiaries (Appendix A)                     --         2,605            --
   Realization of investment in previously-consolidated subsidiaries
      (Appendix B)                                                              (152)           --            --
                                                                            --------      --------      --------

         Net cash used in investing activities                                (7,515)       (4,505)      (10,791)
                                                                            --------      --------      --------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Short-term bank credit, net                                                   495         5,165         1,257
   Repayment of long-term loans                                                   --            --           (28)
   Receipt of long-term loans                                                     --         1,375           287
   Issuance in a subsidiary to minority shareholders                             313            --           613
   Purchase of Company shares by subsidiaries                                     --          (238)       (1,318)
   Repayment of loans granted against exercise of options                         --           346            --
   Exercise of employee share options                                             83           321           153
                                                                            --------      --------      --------

         Net cash provided by (used in) financing activities                     891         6,969           964
                                                                            --------      --------      --------

EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH                                  (35)          666            --
                                                                            --------      --------      --------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                          (4,201)        5,932        (2,712)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                                15,306         9,374        12,086
                                                                            --------      --------      --------

         CASH AND CASH EQUIVALENTS AT END OF YEAR                           $ 11,105      $ 15,306      $  9,374
                                                                            ========      ========      ========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.


                                      F-5
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                      YEAR ENDED DECEMBER 31,
                                                                -----------------------------------
                                                                  2003         2002          2001
                                                                --------     --------      --------
                                                                          (IN THOUSANDS)
                                                                -----------------------------------
<S>                                                             <C>          <C>           <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

    Cash paid during the year for:
       Income taxes                                             $    415     $    258      $    380
       Interest                                                 $    537     $    321      $    216

APPENDIX A - INVESTMENT IN NEWLY-CONSOLIDATED SUBSIDIARIES:

                                                                       YEAR ENDED DECEMBER 31,
                                                                -----------------------------------
                                                                  2003         2002          2001
                                                                --------     --------      --------
                                                                          (IN THOUSANDS)

Working capital, other than cash                                      --     $ (4,551)           --
Investment in and loans to affiliated company                         --        4,156            --
Fixed assets                                                          --         (968)           --
Minority interest                                                     --        2,144            --
Goodwill                                                              --      (25,232)           --
Capitalized software development costs                                --       (3,763)           --
Non-current liabilities                                               --       17,935            --
The Company shares issued upon acquisition                            --       12,884            --
                                                                --------     --------      --------

      Net cash provided by (used in) acquisition                      --     $  2,605            --
                                                                ========     ========      ========
</TABLE>

APPENDIX B - REALIZATION OF PREVIOUSLY-CONSOLIDATED SUBSIDIARIES:

<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31,
                                                  --------------------------------
                                                   2003         2002        2001
                                                  -------      -------     -------
                                                           (IN THOUSANDS)
                                                  --------------------------------
<S>                                               <C>          <C>         <C>
Working capital, other than cash                  $   226           --          --
Investment in and loans to affiliated company      (2,613)          --          --
Fixed assets other                                    145           --          --
Other assets                                           49
Minority interest                                      21           --          --
Goodwill                                            2,132           --          --
Severance pay                                        (112)          --          --
                                                  -------      -------     -------

      Total                                       $  (152)          --          --
                                                  -------      -------     -------
</TABLE>

APPENDIX C - NON CASH ACTIVITIES:

<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31,
                                                  --------------------------------
                                                   2003         2002        2001
                                                  -------      -------     -------
                                                           (IN THOUSANDS)
                                                  --------------------------------
<S>                                               <C>          <C>         <C>
Purchase of technology from affiliate offset
   against the outstanding loan that was
   given to the affiliate                          $  1,917         --          --
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.


                                      F-6
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

A.    GENERAL:

      The significant accounting policies, applied on a consistent basis, are as
follows:

      1.    The Company:


            a)    BluePhoenix Solutions Ltd. (formerly: Crystal Systems
                  Solutions Ltd.) ("BluePhoenix") (together with its
                  subsidiaries "the Company") is an Israeli corporation, which
                  operates in one business segment - enterprise IT modernization
                  solutions. The Company develops and markets software tools and
                  provides consulting services for efficient modernization of
                  legacy systems and cross-platform migration. The Company
                  manages its business in various international markets through
                  several entities, including its wholly-owned subsidiaries
                  located in: USA, UK, Denmark, Germany, Italy, Netherlands,
                  Cyprus, Romania and Israel. The Company also holds four
                  affiliated companies ("affiliates"). The Company and its
                  affiliates operate in one reportable operating segment. Listed
                  below are details relating to BluePhoenix's major subsidiaries
                  and affiliates:


<TABLE>
<CAPTION>
                                                                                                            STATE OF
                                                                          SHAREHOLDING PERCENTAGE         INCORPORATION
                                                                      --------------------------------- ------------------
                 NAME                                                      2003             2002
                 ----                                                 ---------------- ----------------
                                                                                      %
                                                                      ---------------------------------
                 SUBSIDIARIES:
<S>                                                                   <C>              <C>               <C>
                 BluePhoenix Solutions B.V.  ("BluePhoenix")                 100 *           100 *         Netherlands
                 BluePhoenix Solutions Nordic Aps                            100 *           100 *         Denmark
                 Advanced Systems Europe B.V.                                100 *           100 *         Netherlands
                 Liraz Systems Ltd. ("Liraz")                                100                90         Israel
                 Mainsoft Corporation ("Mainsoft")                            58                58         USA
                 IntraComp Group, Inc. ("IntraComp")                         100                53         USA
                 MSI Multiconn Solutions International
                   (1995) Ltd.**                                              --                60         Israel
                 Multiconn Technologies Ltd.**                                --                60         Israel

                 AFFILIATES:

                 Intercomp Ltd. ("Intercomp")                                 49                49         Israel
                 Tesnet Software Testing Ltd. ("Tesnet")                      19                19         Israel
                 MSI Multiconn Solutions International (1995) Ltd.**          60                60         Israel
                 Multiconn Technologies Ltd.**                                60                60         Israel

                  *Indirectly through Liraz.
                 **See Note 3D.
</TABLE>

            b)    In July 2003 the name of the Company was changed from "Crystal
                  Systems Solutions Ltd." to "BluePhoenix Solutions Ltd.".

      2.    Principal Shareholder:

      Formula Systems (1985) Ltd. ("Formula"), owns 58.5% of the Company's
      shares as of December 31, 2003.


                                      F-7
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.):

A.    GENERAL (CONT.):

      3.    Accounting Principles:

            The consolidated financial statements are prepared in accordance
            with accounting principles generally accepted ("GAAP") in the United
            States.

      4.    Functional Currency:

            The currency of the primary economic environment in which the
            operations of the Company and most of its subsidiaries are conducted
            is the U.S. dollar ("dollar"). Most of the Company's sales are made
            outside of Israel (see Note 15B1 for export sales by geographic
            areas) and are denominated in dollars. In addition, a substantial
            portion of the Company's costs are incurred in dollars. Thus, the
            functional and reporting currency of the Company is considered to be
            the dollar. During the first quarter of 2003 some of the
            subsidiaries changed their functional currency from Euro to U.S.
            dollar which caused a reduction in the goodwill amount of
            approximately $3 million.

            For consolidated companies whose functional currency is the dollar,
            transactions and balances originally denominated in dollars are
            presented at their original amounts. Balances in non-dollar
            currencies are translated into dollars using historical and current
            exchange rates for non-monetary and monetary balances, respectively.
            For non-dollar transactions reflected in the statements of
            operations, the exchange rates at transaction dates are used.
            Amortization and depreciation deriving from non-monetary items are
            based on historical exchange rates. The resulting transaction gains
            or losses are included in the statements of operations.

            For consolidated companies whose functional currency is other than
            the dollar, transactions and balances have been translated to
            dollars under the principles prescribed in Statement of Financial
            Accounting Standards ("SFAS") No. 52 of the Financial Accounting
            Standards Board ("FASB"). Assets and liabilities have been
            translated at period-end exchange rates. Results of operations have
            been translated at appropriately weighted average exchange rates.
            Differences resulting from such translation are presented as a
            separate component of shareholder's equity under the caption
            "Accumulated Other Comprehensive Income".


      5.    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, disclosure of contingent assets and liabilities at the
            dates of the financial statements and the reported amounts of
            revenues and expenses during the reporting periods.

            Actual results could differ from those estimates.


                                      F-8
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.):

B.    PRINCIPLES OF CONSOLIDATION:

      The consolidated financial statements include the accounts of BluePhoenix
      Solutions Ltd. and its subsidiaries in which it has a controlling
      interest. Acquisition of subsidiaries is accounted for under the purchase
      method. All intercompany 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 deposit and
      which are not restricted.

D.    PROVISION FOR DOUBTFUL ACCOUNTS:

      The provision for doubtful accounts was computed on the basis of specific
      receivables the collection of which, in the opinion of Company's
      management, is in doubt.


E.    INVESTMENTS:

      Investments in affiliates over which the Company exercises significant
      influence are accounted for under the equity method. As to goodwill - see
      Note 1H. Investments in other companies are accounted for under the cost
      method. Investments in marketable securities are classified as "trading",
      and unrealized gains or losses therefrom are reported in the statement of
      operations in accordance with the principles set forth in SFAS 115 of the
      FASB. Investments are periodically reviewed to determine whether an
      other-than-temporary impairment in value has occurred, in which case the
      investment is written down to its fair value.

F.    FIXED ASSETS:

      Fixed assets are stated at cost, net of accumulated depreciation.
      Depreciation is calculated by the straight-line method over their
      estimated useful lives. Annual rates of depreciation are as follows:

                                                                   %
                                                          -------------------
      Computers and computer equipment                    20 - 33 (mainly 33)
      Office furniture and equipment                       6 - 15 (mainly 7)
      Leasehold improvements                                       10
      Motor vehicles                                               15


                                      F-9
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.):

G.    IMPAIRMENT OF LONG-LIVED ASSETS:

      The Company's long-lived assets are reviewed for impairment in accordance
      with SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived
      Assets" whenever events or changes in circumstances indicate that the
      carrying amount of an asset may not be recoverable. Recoverability of
      assets to be held and used is measured by a comparison of the carrying
      amount of an asset 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 their fair value.


H.    GOODWILL:

      Goodwill that arose from acquisitions prior to July 1, 2001 was amortized
      until December 31, 2001 on a straight-line basis over 10 years. Prior to
      2002, goodwill was assessed for impairment by comparing undiscounted cash
      flows to the carrying amount of the goodwill. If the carrying amount was
      not recoverable, goodwill was written down to its fair value.

      In July 2001 the FASB issued SFAS 142, "Goodwill and Other Intangible
      Assets" ("SFAS 142"). SFAS 142 requires goodwill to be tested for
      impairment on an annual basis and between annual tests in certain
      circumstances, and written down when impaired, rather than being amortized
      as previous accounting standards required. Furthermore, SFAS 142 requires
      purchased intangible assets other than goodwill to be amortized over their
      useful lives unless these lives are determined to be indefinite.

      SFAS 142 is effective for fiscal years beginning after December 15, 2001.
      The Company adopted SFAS 142 effective January 1, 2002. In accordance with
      SFAS 142, the Company ceased amortizing goodwill totaling $15.1 million as
      of the beginning of 2002. Based on the impairment tests performed, there
      was no impairment of goodwill in 2003 and 2002. There can be no assurance
      that future goodwill impairment tests will not result in a charge to
      earnings.


                                      F-10
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.):


H.    GOODWILL (CONT.):

      The following table presents the impact of SFAS 142 on net income (loss)
      and net income (loss) per share had the accounting standard been in effect
      for 2001 (in thousands, except per-share amounts):

                                                                 YEAR ENDED
                                                                DECEMBER 31,
                                                                ------------
                                                                    2001
                                                                ------------
                                                               (IN THOUSANDS)
                                                                ------------

     Net loss as reported                                        $(14,987)
     Amortization of goodwill                                       1,896
                                                                 --------

              Net loss adjusted                                  $(13,091)
                                                                 ========

     Basic net loss per share as reported                           (1.52)
                                                                 ========

     Basic net loss per share adjusted                              (1.33)
                                                                 ========

     Diluted net loss per share as reported                         (1.52)
                                                                 ========

     Diluted net loss per share adjusted                            (1.33)
                                                                 ========

I.    SOFTWARE DEVELOPMENT COSTS:


      Development costs of software, that is intended for sale, and which were
      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 of the FASB.


      Software development costs incurred before technological feasibility is
      established are charged to the statement of operations as incurred.

      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
      years. During the year ended December 31, 2003, a consolidated subsidiary
      capitalized software development costs aggregating $3.2 million (2002 -
      $2.4 million, 2001 - $3.1 million) and amortized capitalized software
      development costs aggregating $2.7 million (2002 - $1.5 million, 2001
      -$1.2 million).

      In the Company management's estimate, 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.


                                      F-11
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.):

J.    EMPLOYEE SHARE OPTIONS:

      At December 31, 2003, the Company has one stock-based employee
      compensation plan, which is described more fully in Note 12B. The Company
      accounts for this plan under the recognition and measurement principles of
      APB Opinion No. 25, "Accounting for Stock Issued to Employees", and
      related Interpretations. No stock-based employee compensation cost is
      charged to income, as all options granted under this plan had an exercise
      price equal to the market value of the underlying common stock on the date
      of grant. The following table illustrates the effect on net income and
      earnings per share if the Company had applied the fair value recognition
      provisions of SFAS 123 of the FASB, "Accounting for Stock-Based
      Compensation", to stock-based employee compensation.


<TABLE>
<CAPTION>
                                                                                  YEAR ENDED DECEMBER 31,
                                                                        -----------------------------------------
                                                                           2003           2002            2001
                                                                        ----------     ----------      ----------
                                                                         (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                                                        ----------     ----------      ----------
<S>                                                                     <C>            <C>             <C>
Net income (loss) as reported                                           $    1,851     $   (3,630)     $  (14,987)
Deduct:  Total stock-based employee compensation expense determined
    under fair value based method for all awards, net of related
    tax effects                                                               (473)          (681)           (836)
                                                                        ----------     ----------      ----------

         Pro forma net income (loss)                                    $    1,378     $   (4,311)     $  (15,823)
                                                                        ==========     ==========      ==========

Earnings per share:
         Basic - as reported                                            $     0.14     $    (0.35)     $    (1.52)
                                                                        ==========     ==========      ==========
         Basic -pro forma                                               $     0.10     $    (0.41)     $    (1.60)
                                                                        ==========     ==========      ==========

         Diluted -as reported                                           $     0.14     $    (0.35)     $    (1.52)
                                                                        ==========     ==========      ==========
         Diluted -pro forma                                             $     0.10     $    (0.41)     $    (1.60)
                                                                        ==========     ==========      ==========
</TABLE>

K.    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, the license fee is otherwise fixed
      or determinable and persuasive evidence of an arrangement exists.


                                      F-12
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.):

K.    REVENUE RECOGNITION (CONT.):

      The arrangements, which include multiple elements, are usually
      arrangements where the Company sells software products and Post Contract
      Support (PCS). In addition there are certain arrangements where the
      Company sells software and consulting services. Consulting service fees
      are based on time invested. For these multiple elements, SOP 97-2 requires
      that the fair value of each component in a multiple element arrangement
      will be determined based on the vendor's specific objective evidence
      (VSOE) for that element, and revenue is allocated to each component based
      on its fair value. SOP 98-9 requires that revenue be recognized under the
      "residual method" when VSOE does not exist for all the delivered elements,
      VSOE of fair value exists for all undelivered elements, and all other SOP
      97-2 criteria are met. Under the residual method, any discount in the
      arrangement is allocated to the delivered elements. The specific objective
      evidence for the PCS is established by the price charged on separate PCS
      renewal contracts. The VSOE for the consulting services is established by
      the price charged on other time based consulting service contracts where
      no sale of other elements is involved, considering the territory where the
      service is performed, the size of the customer, the quantity of the
      purchased services, the professional expertise of the consultants, etc.
      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 post-contract support (PCS).

      Revenue allocated to the PCS is recognized ratably over the term of the
      PCS.


      When a project involves significant production, modification or
      customization, of software, and for other fixed fee contracts, revenue is
      generally recognized according to the percentage of completion method, in
      accordance with the provisions of SOP 81-1 "Accounting for Performance of
      Construction-Type Contracts". Under this method, estimated revenue is
      generally accrued based on costs incurred to date, as a percentage of
      total updated estimated costs.


      The Company recognizes contract losses, if any, in the period in which
      they first become evident. 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 its
      history with similar arrangements, the customer's involvement in the
      progress, and the existence of other service providers and the payments
      terms.



                                      F-13
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.):

K.    REVENUE RECOGNITION (CONT.):

      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 non-refundable.

      At December 31, 2003 approximately $2,846 thousand (December 31,
      2002-$2,414 thousand) of the accounts receivable balance was unbilled due
      to the customers payment terms. The Company believes the amount will be
      collected in one year in accordance with the contract terms.


      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".

L.    ADVERTISING COSTS:

      The Company expenses advertising costs as incurred.

M.    GAIN ON REALIZATION OF SHAREHOLDINGS:


      Gain on realization of shareholdings includes the results of realization
      of the Company's shareholdings in investees arising either from the sale
      of such shareholdings or from issuance of stock by the investees to third
      parties, which is recognized in accordance with the provisions of Staff
      Accounting Bulletin (SAB) No. 51 of the Securities and Exchange
      Commission. The Company charges such results to the statement of
      operations, provided that the conditions stipulated in SAB 51 for such
      recognition have been met.


N.    DEFERRED INCOME TAXES:

      The Company applies the provisions of SFAS 109 "Accounting for Income
      Taxes" of the FASB, see also Note 14E.

O.    EARNINGS (LOSS) PER SHARE:

      Earnings (loss) per share ("EPS") were computed in accordance with the
      provisions of SFAS No. 128 of the FASB ("SFAS 128"). SFAS 128 requires the
      presentation of both basic and diluted EPS. Basic net earnings (loss) per
      share is computed based on the weighted average number of common shares
      outstanding during each year. Diluted earnings (loss) per share is
      computed based on the weighted average number of common shares outstanding
      during each year, plus dilutive potential common shares considered
      outstanding during the year.


                                      F-14
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.):

P.    FINANCIAL INSTRUMENTS:

      A.    MANAGEMENT OF CREDIT RISKS:

            Financial instruments which have the potential to expose the Company
            to credit risks are mainly cash and cash equivalents, marketable
            securities, bank deposit accounts and trade receivables.

            The Company holds cash and cash equivalents, marketable securities
            and deposit accounts at large banks in Israel, the United States and
            in the Netherlands, thereby substantially reducing the risk of loss.


            With respect to trade receivables, the risk is limited due to the
            nature and size of the entities which constitute the Company's
            customer base. The Company assesses the financial position of its
            customers prior to the engagement with them, and has not encountered
            material credit difficulties there with.


      B.    FAIR VALUE OF FINANCIAL INSTRUMENTS:

            The financial instruments of the Company consist mainly of cash and
            cash equivalents, short term investments, current receivables, long
            term loans and other investments, credit from banks, accounts
            payable and long term liabilities to banks.

            In view of their nature, the fair value of the financial instruments
            included in the Company's working capital is usually identical or
            close to their carrying value. The carrying value of equity-method
            investees approximates their fair value.

Q.    COMPREHENSIVE INCOME:


      Until 2002, the Company had no comprehensive income components other than
      net income. Beginning with 2002, comprehensive income presented in
      shareholders' equity includes, in addition to net income (loss),
      translation gains and losses of non-dollar currency financial statements
      of subsidiaries (see also Note 1A4 - in respect to the change in the
      functional currency).


R.    FINANCIAL INSTRUMENTS:

      The application of SFAS 133 - "Accounting for Derivatives and Hedging
      Activities" and related pronouncements and interpretations did not have
      any material impact on the Company's consolidated financial statements.


                                      F-15
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.):

S.    RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS:


      The Financial Accounting Standards Board (FASB) issued Interpretation No.
      46 (FIN 46), "Consolidation of Variable Interest Entities", in January
      2003 and amended the Interpretation in December 2003. FIN 46 requires an
      investor with a majority of the variable interests (primary beneficiary)
      in a variable interest entity (VIE) to consolidate the entity and also
      requires majority and significant variable interest investors to provide
      certain disclosures. A VIE is an entity in which the voting equity
      investors do not have a controlling financial interest, or the equity
      investment at risk is insufficient to finance the entity's activities
      without receiving additional subordinated financial support from the other
      parties. Development-stage entities that have sufficient equity invested
      to finance the activities they are currently engaged in and entities that
      are businesses, as defined in the Interpretation, are not considered
      VIE's. The provisions of FIN 46 were effective immediately for all
      arrangements entered into with new VIE's created after January 31, 2003.
      The disclosure requirements will be applied in the annual financial
      statements as of December 31, 2004. The adoption of FIN 46 is not expected
      to have a material impact on the Company's consolidated financial
      statements.


      In May 2003, the FASB issued SFAS 150, "Accounting For Certain Financial
      Instruments with Characteristics of Both Liabilities and Equity" which
      establishes standards for how an issuer of financial instruments
      classifies and measures certain financial instruments with characteristics
      of both liabilities and equity. It requires that an issuer classify a
      financial instrument that is within its scope as a liability (or an asset
      in some circumstances) if, at inception, the monetary value of the
      obligation is based solely or predominantly on a fixed monetary amount
      known at inception, variations in something other than the fair value of
      the issuer's equity shares or variations inversely related to changes in
      the fair value of the issuer's equity shares. This statement is effective
      for financial instruments entered into or modified after May 31, 2003, and
      otherwise is effective at the beginning of the first interim period
      beginning after June 15, 2003. The adoption of SFAS 150 is not expected to
      have a material impact on the Company's financial position or result of
      operations.

      In November 2002, the Emerging Issues Task Force ("EITF") reached a
      consensus on EITF Issue No. 00-21, "Revenue Arrangements with Multiple
      Deliverables" ("Issue 00-21"). Issue 00-21 provides guidance for
      determining the unit(s) of accounting in arrangements that include
      multiple products, services, and/or rights to use assets. Issue 00-21 is
      effective for revenue arrangements entered into in fiscal periods
      beginning after June 15, 2003. To the extent arrangements contain multiple
      deliverables, the Company performs an analysis of the nature of the



                                      F-16
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.):

S.    RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONT.):


      deliverables to determine to what extent the deliverables of the
      arrangement are governed by any higher level literature (as defined in
      EITF 00-21). EITF 00-21 recognizes arrangements that qualify for treatment
      under SOP 97-2 and certain arrangements that qualify for contract
      accounting (i.e., SOP 81-1) as falling under the definition of "higher
      level literature. "For 2003, all of the Company's contracts with multiple
      deliverables have fallen under higher level accounting literature".

      Although the Company has not been impacted in the current year by the
      adoption of EITF 00-21, it is possible that EITF 00-21 may affect future
      periods given the additional revenue streams the Company has initiated
      (i.e., business process outsourcing), as well as the acquisition
      activities of the Company.


NOTE 2 - CERTAIN TRANSACTIONS:

A.    MAINSOFT:


      Mainsoft's product enables independent software vendors (ISVs) to solve
      their cross-platform development challenges. Since 1999 the Company has
      acquired 57.5% of the outstanding share capital of Mainsoft in a series of
      transactions, for aggregate consideration of approximately $17.2 million.
      This holding includes the exercise of warrants in May 2003 pursuant to
      which the Company purchased 630,000 shares of Mainsoft for an aggregate of
      $378 thousand. Following the exercise, all remaining warrants expired in
      May 2003 (see also note 11A).


B.    INTRACOMP:


      IntraComp Group Inc. ("IntraComp") provides migration and conversion
      services for large scale systems and back-end integration services. During
      2000, the Company acquired a 53% controlling interest in IntraComp for
      aggregate consideration of $3.4 million. IntraComp's results of operations
      were consolidated in the Company's financial statements beginning with the
      second quarter of 2000. In addition during 2000 through 2003, the Company
      lent to IntraComp an aggregate amount of $2.2 million (as of December 31,
      2003).

      Under the loan agreement, IntraComp is required to repay the loan by April
      2006 or when the current ratio of IntraComp exceeds 1.25, whichever is
      earlier.

      During the second quarter of 2003, the Company purchased the remaining
      outstanding share capital of IntraComp from the other shareholders of
      IntraComp. As a result, the Company currently wholly owns IntraComp. Under
      the agreement with IntraComp's selling shareholders, the consideration
      shall be calculated based on IntraComp's cumulative earnings before
      interest and taxes, referred to as EBIT, during the three-year period
      commencing on January 1, 2003, as follows:



                                      F-17
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 2 - CERTAIN TRANSACTIONS (CONT.):

B.    INTRACOMP (CONT.):

      -     If the EBIT exceeds $3 million but is less than or equal to $4
            million, the consideration shall be equal to the sum of $900
            thousands plus 40% of the difference between the EBIT and $3
            million;

      -     If the EBIT exceeds $4 million but is less than or equal to $5
            million, the consideration shall be equal to the sum of $1.3 million
            plus 50% of the difference between the EBIT and $4 million;

      -     If the EBIT exceeds $5 million but is less than or equal to $6
            million, the consideration shall be equal to the sum of $2.5 million
            plus 60% of the difference between the EBIT and $5 million;

      -     If the EBIT exceeds $6 million, the consideration shall be equal to
            the sum of $3.6 million plus 60% of the difference between the EBIT
            and $6 million;

      Goodwill arising upon acquisition was $ 191 thousand.

      Under the agreement with the selling shareholders, an advance payment on
      account of the contingent consideration may be due in August 2004, based
      on the interim EBIT at that time. The Company's current estimation, based
      on the calculated interim EBIT, is that there will be no payment due in
      August 2004.

      The balance is due in February 2006, based on a final report of
      IntraComp's earnings.

      The purchase of the remaining shares of IntraComp Group was accounted for
      under SFAS 141. The contingent consideration will be accounted as an
      additional cost of the acquired entity.


      Following the purchase of the entire interest in IntraComp, the Company
      integrated IntraComp's business completely into its business.

C.    SCH:


      Since 2001, the Company wholly owns SCH- Software Conversion House Ltd., a
      developer and marketer of software conversion tools and services for
      midrange environments. SCH's results of operations were initially
      consolidated in the Company's 1998 financial statements. Following the
      purchase of the entire interest in SCH, the Company assimilated SCH's
      business lines into its business, integrating SCH's entire activity with
      its own.



                                      F-18
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 2 - CERTAIN TRANSACTIONS (CONT.):

D.    ALEXANDRIA:


      During 1999, the Company purchased 19% of the outstanding share capital of
      Alexandria Migration Technologies Ltd., which develops DBMSMigrator
      (formerly known as C-MIDAS). In consideration therefore, the Company
      undertook to extend to Alexandria loans in an aggregate amount of $4.2
      million, which were extended to Alexandria from time to time during 1999,
      2000 and 2001. In 2001, the Company wrote off $2.5 million of these loans,
      due to the uncertainty of repayment of the loans. The purpose of the loans
      was for working capital. As of December 31, 2003, the Company lent to
      Alexandria an aggregate of approximately $3.9 million. In September 2002,
      the Company entered into an agreement to purchase from the other
      shareholder of Alexandria his entire shareholdings in Alexandria,
      constituting 81% of Alexandria's outstanding share capital, for an
      aggregate amount of $585 thousands, which was paid in April 2003. As a
      result, the Company currently wholly owns Alexandria and its entire
      activity was integrated within the Company's business.


E.    LIRAZ:

      In November 2002, the Company purchased, through a share exchange
      transaction, approximately 86% of the outstanding share capital of Liraz
      Systems Ltd., or Liraz, an international software and services company
      then publicly traded on the Tel Aviv Stock Exchange ("TASE"). Liraz,
      through a wholly-owned subsidiary, develops and markets the AppBuilder, a
      software product used for the development of sophisticated and robust
      applications needed by large enterprises.

      As part of the share exchange transaction, the Company issued to Liraz's
      selling shareholders, including Formula, 3,478,624 ordinary shares,
      constituting an aggregate of 26% of the Company's outstanding share
      capital.

      The acquisition of Liraz was recorded in the Company's accounts as
      follows:

      -     With respect to Liraz shares acquired from Formula - at the carrying
            value in Formula's accounts, in the aggregate of $10.0 million.

      -     With respect to Liraz shares acquired from other parties- at the
            market value of the consideration paid, in the aggregate of $2.9
            million.

      The market value of the total consideration paid in this acquisition was
      $8.8 million. The purchase agreement with the Liraz shareholders provided
      for a fixed exchange ratio between Liraz shares and the Company shares.
      The exchange ratio was based on the average ratio of the Company's share
      price to Liraz's share price in the three months, prior to the signing of
      the agreement between the parties, in October 2002.



                                      F-19
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 2 - CERTAIN TRANSACTIONS (CONT.):

E.    LIRAZ:

      Based upon a valuation of tangible and intangible assets acquired, the
      Company has allocated the total cost of the acquisition to Liraz's assets
      and liabilities as follows:


                                                           SEPTEMBER 30, 2002
                                                             (IN THOUSANDS)

                                                                -------
Cash and cash equivalents                                       $ 3,436
Marketable securities                                               126
Trade receivables                                                 3,448
Other accounts receivable                                           928
Other long-term tangible assets                                     317
Fixed assets                                                        782
                                                                -------

   Total tangible assets acquired                                 9,037
Goodwill                                                         22,300
                                                                -------

   Total tangible and intangible assets acquired                 31,337

Accounts payable                                                  1,708
Other accounts payable                                           10,112
Accrued severance pay                                               375
Long-term bank loan                                               1,000
Provision for losses in formerly-consolidated subsidiary          2,600
Minority interest                                                 2,658
                                                                -------

Total liabilities                                                18,453
Contribution of capital due to a common control transaction       4,041
                                                                -------

   Net assets acquired                                          $ 8,843
                                                                =======


                                      F-20
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 2 - CERTAIN TRANSACTIONS (CONT.):

E.    LIRAZ (CONT.):


      Liraz's results of operations have been consolidated in the Company's
financial statements since October 1, 2002. Goodwill arising upon acquisition
amounted to $22.3 million.


      The following unaudited pro forma summary presents information as if the
acquisition of Liraz had occurred as of January 1, 2001. 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.

<TABLE>
<CAPTION>
                                                                  YEAR ENDED                    YEAR ENDED
                                                               DECEMBER 31, 2002            DECEMBER 31, 2001
                                                          ----------------------------  ---------------------------
                                                                (IN THOUSANDS,                (IN THOUSANDS,
                                                            EXCEPT PER SHARE DATA)        EXCEPT PER SHARE DATA)
                                                          ----------------------------  ---------------------------
                                                                                (UNAUDITED)
                                                          ---------------------------------------------------------
<S>                                                         <C>                           <C>
     Revenues *                                                      $53,100                       $64,144
                                                                     -------                       -------
     Net income (loss) *                                              $1,911                      $(37,357)
                                                                     -------                       -------
     Earning (loss) per share - basic                                  0.14                         (2.8)
                                                                     -------                       -------
     Earning (loss) per share - diluted                                0.14                         (2.8)
                                                                     -------                       -------
</TABLE>

      * Revenues and net loss for 2001 include the results of operations of
      Level 8 (see Note 2H), which was sold by Liraz in 2001.


      In two public tender offers published by the Company in December 2002 and
      March 2003, the Company purchased additional shares of Liraz representing
      9.0% of the outstanding share capital of Liraz.

      In March 2003, pursuant to the provisions of the Israeli Companies Law,
      the Company purchased the remaining outstanding share capital of Liraz.
      The total aggregate amount of those purchases was $2.7 million. Following
      these transactions, the Company currently holds the entire outstanding
      share capital of Liraz. The total carrying amount of the investment in
      Liraz following these transactions was $15.6 million. During 2003, the
      Company assimilated and integrated Liraz" infrastructure, management
      personnel and sales and marketing activities within the Company's
      business.

F.    ALPHATECH:

      In December 2002, the Company purchased a 65% controlling interest in
      Alphatech (2000) Srl. ("Alphatech") from Intercomp for aggregate
      consideration of $100 thousand. Alphatech, a company incorporated in
      Romania, provides software development services.



                                      F-21
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 2 - CERTAIN TRANSACTIONS (CONT.):

G.    PURCHASE OF SDC'S ACTIVITY:


      In October 2002, Liraz, through a wholly owned subsidiary, acquired from
      SDC FinansSystems A/S referred to as "SDC", a company incorporated in
      Denmark, its IT development services activities relating to customers in
      the banking sector in Denmark. Pursuant to the purchase agreement, the
      Company hired 100 employees of SDC, of which 30 employees were dismissed
      during the first quarter of 2003. The seller agreed to reimburse the
      Company for any costs associated with such dismissal. Pursuant to the
      purchase agreement, the Company assumed all the obligations in respect of
      the purchased activity and paid an aggregate amount of $800 thousand for
      the purchased goodwill and activities. The purchase price was determined
      in October 2002, based on the estimated fair value of the assets received.
      The purchase was recorded as a business combination.

      The Company acquired SDC for the purpose of complementing its array of
      services.

      Following are the amounts assigned to major components of SDC's balance
      sheet as of the date of purchase (in thousands):

      Current assets             $1,097
      Other assets                 $131
      Current liabilities       $(1,228)

      Goodwill arising upon acquisition was $800 thousand.

      In addition, the Company entered into an agreement with two of the
      seller's shareholders, pursuant to which the shareholders are purchasing
      IT development services from the Company.


H.    CEPOST:


      In January 2004, the Company purchased the entire outstanding share
      capital of CePost Ltd., an Israeli company that develops and markets
      software solutions for electronic document mining, management and
      presentment. Pursuant to the purchase agreement, the Company paid $172,500
      to the shareholders of CePost and issued to them 31,500 of the Company's
      ordinary shares, valued at the fair value of $200 thousands. In addition,
      the Company undertook to pay to the sellers royalties from CePost's
      revenues in an amount ranging between $120 thousand and $1.5 million. At
      its option, the Company may pay the royalties in the form of the Company's
      ordinary shares.

      The Company accounted for the contingent purchase consideration at the
      minimum level of $120 thousand, in accordance with SFAS 141and will be
      accounted as an additional cost of the acquired entity.

      The purchase price will be allocated to the assets acquired and the
      liabilities assumed.



                                      F-22
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 2 - CERTAIN TRANSACTIONS (CONT.):

H.    CEPOST (CONT.):

      The fair value assigned to CePost technologies was $553 thousand and is
      being amortized over 5 years.

      Based upon a valuation of tangible and intangible assets acquired, the
      Company has allocated the total acquisition cost to CePost's assets and
      liabilities as follows:


                                                          DECEMBER 31, 2003
                                                          -----------------
                                                            (IN THOUSANDS)
                                                          -----------------

     Current assets                                             $ 118
     Current liabilities                                         (168)
     Fixed assets                                                  25
     Technology                                                   553
     Other liabilities                                            (36)
                                                                -----

        Net assets acquired                                     $ 492
                                                                =====


I.    OUTLOOK:

      Effective as of January 2004, the Company, through a new wholly-owned
      subsidiary, Outlook & BluePhoenix Ltd., acquired from an Israeli company,
      Outlook Systems Ltd., Outlook System's entire business activities in the
      field of software development services. Pursuant to the purchase
      agreement, the Company hired 31 employees previously employed by Outlook
      Systems and assumed all the obligations in respect of the purchased
      activity. These obligations include the extension of a guarantee to banks
      with respect to loans in an aggregate amount of $720 thousand plus
      interest accrued, to be repaid by the Company by February 15, 2007. In
      addition, under the purchase agreement, the Company undertook to pay to
      the shareholders of Outlook Systems, in the first quarter of 2007, an
      amount equal to between 5 and 7 times the average operating profit of
      Outlook & BluePhoenix Ltd. in the years 2004, 2005 and 2006, less the
      amount of $720 thousand. The value assigned to the customer - related
      intangibles amounted to $454 thousand.



                                      F-23
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 3 - INVESTMENTS IN AFFILIATES AND OTHER COMPANIES:

A. 1. THE INVESTMENTS ARE COMPOSED AND PRESENTED AS FOLLOWS:

                                                              DECEMBER 31,
                                                          --------------------
                                                            2003         2002
                                                          -------      -------
                                                             (IN THOUSANDS)
                                                          --------------------

Cost of shares *                                            6,050      $ 3,000
Less - accumulated amortization of goodwill                  (272)        (238)
Equity in post-acquisition accumulated losses              (5,328)      (2,271)
                                                          -------      -------

                                                              450          491
Loans granted to affiliates (2)                             2,928        2,584
Loans granted to others (3)                                   216          300
Investments in other companies                                200          100
                                                          -------      -------
                                                            3,794        3,475
                                                          =======      =======

* Including goodwill - original amount                    $ 4,756      $   613
                                                          =======      =======

      2.    LOANS GRANTED TO AFFILIATES:

<TABLE>
<CAPTION>
             INTEREST RATE
              DECEMBER 31,        LINKAGE         DECEMBER
                  2003             BASIS            2003                   MATURITY DATES
                  ----             -----          --------                 --------------
                   %                           (IN THOUSANDS)
                  ----                          --------------
<S>                              <C>           <C>                <C>
                Libor + 1          Dollar          $ 1,767         19.2.2007
                    -              Dollar              400         January 2007
                    -              Dollar              761         3 equal payments to begin at
                                                   -------         May  2006  or when the
                                                                   current ratio of the
                                                                   affiliates exceeds 1.25.

                                                   $ 2,928
                                                   =======
</TABLE>


            The purpose of the loans was for working capital.

      3.    The loan is linked to the Israeli consumer price index and bear an
            annual interest at a rate of 4% (see Note 16F).


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

                                                            DECEMBER 31,
                                                       ------------------------
                                                         2003            2002
                                                       --------        --------
                                                             (IN THOUSANDS)
                                                       ------------------------
Total assets                                           $ 15,557        $ 20,747
                                                       ========        ========

Total liabilities                                      $(11,727)       $ (9,677)
                                                       ========        ========

Net loss                                               $ (1,578)       $ (1,001)
                                                       ========        ========


                                      F-24
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 3 - INVESTMENTS IN AFFILIATES AND OTHER COMPANIES (CONT.):

B.    INTERCOMP:


      In 1998, the Company invested in Intercomp Ltd., which has developed a set
      of automated analysis and reengineering tools for legacy COBOL
      applications. During 2002 and 2003 Intercomp focused its efforts on the
      development of software tools that comprise a part of the Company's
      LogicMiner. In the fourth quarter of 2003, the Company exercised an option
      to purchase from Intercomp its tool, known as AnalyzeIT, for an aggregate
      of $1.9 million. In addition, the Company undertook to pay royalties to
      Intercomp in amount equal to 25% of the revenues generated from the
      purchased technology. AnalyzeIT provides an analysis of a legacy
      application and creates a repository and inventory of the application's
      components and the relationship between them.

      The results of the analysis are presented graphically and in reports. They
      include a study of the application's control flow and data flow, which
      enable the user to examine the code and structure of the application down
      to the level of a single variable. The technology will be amortized over a
      5 year period.

      In connection with the purchase of Intercomp's technology, the Company
      assumed the rights and obligations of Intercomp under the distribution
      agreement described below. As of December 31, 2003, the Company lent to
      Intercomp an aggregate of approximately $1.8 million. The purpose of the
      loan was for working capital. These loans must be repaid by Intercomp at
      the end of a 5-year period commencing on February 19, 2002 or earlier (i)
      in the event of liquidation or acquisition of Intercomp by a third party
      or (ii) if the current ratio of Intercomp is equal to or greater than
      1.25. The loans bear interest at rate of LIBOR + 1% per annum. The loan
      principal plus interest accrued are convertible into preferred shares of
      Intercomp at a conversion price of $162.7 per share.

      Effective as of January 2004, the Company entered into an option
      agreement, pursuant to which the Company was granted an option to purchase
      from a former shareholder of Intercomp all of his interest in Intercomp
      consisting of 18.5% of the outstanding share capital of Intercomp. In the
      event the Company exercises its option to purchase from the former
      shareholder of Intercomp, the Company undertook to issue to him as
      consideration for his shares warrants to purchase 5,000 of the Company's
      ordinary shares, at an exercise price of $20 per share. The warrants are
      exercisable until October 25, 2005. Concurrently, the remaining
      shareholder of Intercomp, comprised of several funds acting through their
      general partner Israel Infinity Venture Capital Partners Ltd. referred to
      as "Infinity", and the Company approved the signing of a non-exclusive
      distribution agreement between Intercomp and a distributor partially-owned
      by the former shareholder of Intercomp, pursuant to which Intercomp
      granted rights to the distributor rights to further develop and distribute
      Intercomp's products. In March 2004, the Company exercised the option to
      purchase from a former shareholder its holdings in Intercomp. As part of
      this transaction, certain shareholders of Intercomp, holding 2.1% of
      Intercomp's outstanding share capital, transferred to the Company their
      holding in Intercomp.



                                      F-25
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 3 - INVESTMENTS IN AFFILIATES AND OTHER COMPANIES (CONT.):


B.    INTERCOMP (CONT.):

      In addition, the other shareholder of Intercomp, Infinity, converted
      certain outstanding loans owed to it by Intercomp into 7,236 shares of
      Intercomp at the share price of $162.7. Following these transactions, the
      Company's shareholding in Intercomp increased from 49% to 61.6%. Since the
      end of the first quarter of 2004, the Company's has consolidated
      Intercomp.

      In April 2004, the other shareholder of Intercomp, Infinity, granted the
      Company a call option to purchase its entire holding in Intercomp,
      exercisable until April 1, 2006. If the Company does not exercise such
      option, Infinity will have a put option to cause the Company to purchase
      Infinity's entire holdings in Intercomp, exercisable during a six months
      period of commencing in April 2006 (see Note 12B3).

      The Company granted a creditor of Intercomp - First Israel Mezzanine
      Investors Ltd., known as FIMI, a put option to sell to the Company
      promissory notes issued by Intercomp in an aggregate amount of $3.5
      million plus interest accrued at an annual rate of 5% (see Note 12B2).

C.    TESNET:

      Effective as of January 1999, the Company acquired 32% of the outstanding
      share capital of Tesnet - Software Testing Ltd. ("Tesnet"), a provider of
      testing and software quality assurance services. Tesnet's results of
      operations were consolidated in the Company's financial statements
      beginning with the first quarter of 1999, owing to the Company's control
      of Tesnet's board of directors. During 1999 and 2002, the Company paid
      approximately $2 million for its holding in Tesnet,, as Tesnet met an
      agreed upon earnings target within three years following the acquisition.
      Total goodwill arising from this acquisition was $886 thousand.

      In February 2000, Tesnet consummated a public offering of its shares and
      warrants on the Tel-Aviv Stock Exchange. Net proceeds from the offering
      were $9.5 million. As a result, the Company recorded capital gain of $1
      million and its shareholdings in Tesnet decreased to 22%. Consequently the
      Company ceased controlling Tesnet's board of directors and discontinued
      consolidating the operating results of Tesnet during the first quarter of
      2000.

      Until December 2003, the Company's investment in Tesnet was accounted for
      under the equity method, owing to the fact that the Company exercises
      significant influence over operating and financial policies of Tesnet by
      virtue of its representation on Tesnet's board of directors.

      During 2002 and 2003, $75 thousand and $112 thousand, respectively, were
      recorded as income from an increase in the Company's equity investment in
      Tesnet due to the expiration of the abovementioned warrants.



                                      F-26
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 3 - INVESTMENTS IN AFFILIATES AND OTHER COMPANIES (CONT.):

C.    TESNET (CONT.):

      The market value of the Company's holdings in Tesnet as of December 31,
      2003 was $2.8 million. During 2000, the Company sold a portion of its
      holdings, which constitutes 3% of the outstanding share capital of Tesnet,
      and in the first quarter of 2004, the Company sold its entire remaining
      holdings in Tesnet for aggregate consideration of approximately $3.1
      million. The gain from the sale was immaterial.

D.    M.S.I. MULTICONN SOLUTIONS AND MULTICONN TECHNOLOGIES:

      In 1999, the Company acquired 51% of the outstanding share capital of
      M.S.I. MultiConn Solutions International (1995) Ltd. referred to as
      "M.S.I. MultiConn". M.S.I. MultiConn's results of operations were
      consolidated in the Company's financial statements beginning with the
      third quarter of 1999. In 2000, the Company increased its holding in
      M.S.I. MultiConn to 60%.

      Since the first quarter of 2003, the Company recorded the investment under
      the equity method and did not consolidate the result of operation of
      M.S.I. MultiConn, due to lack of control.

      Effective as of January 2004, the other shareholders of M.S.I. MultiConn
      transferred their entire holdings in M.S.I MultiConn to the Company.
      Following this transaction, the Company assumed control over the daily
      management of M.S.I. MultiConn. The Company currently wholly owns M.S.I.
      MultiConn and finances its activities. Effective as of the first quarter
      of 2004, M.S.I. MultiConn's results are consolidated with the Company
      results.

      In 2000, the Company, together with the other shareholders of M.S.I.
      MultiConn established a new company, named MultiConn Technologies Ltd.,
      and initially owned 19% of its share capital.

      Multiconn Technologies develops and markets eMulticonn and related
      solutions referred to as eXpernato.

      Under the Company agreement with MultiConn Technologies entered into in
      2000, the Company lent $2.1 million to Multiconn Technologies, of which $1
      million was convertible into ordinary shares of MultiConn Technologies.


      In 2002, prior to the consolidation, the Company wrote down $1.8 million
      of the balance of its investment in Multiconn Technologies, due to
      impairment of the investment. The carried investment value, including
      loans, as of December 31, 2003 is $671 thousand.


      In December 2002, the Company converted the $1 million loan into shares of
      Multiconn Technologies and, as a result, the Company's holdings increased
      to 60%. In 2003, the Company wrote down $350 thousand out of $1.1 million
      related to loans granted to MultiConn Technologies since it was probable
      that the Company will be unable to collect all amounts due.



                                      F-27
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 3 - INVESTMENTS IN AFFILIATES AND OTHER COMPANIES (CONT.):

D.    M.S.I. MULTICONN SOLUTIONS AND MULTICONN TECHNOLOGIES (CONT.):

      Since the first quarter of 2003, the Company has recorded the investment
      under the equity method and did not consolidate the result of operation
      Multiconn Technologies, due to lack of control.

      Following a transaction entered into between the Company and the other
      shareholders of MultiConn Technologies in 2004, the other shareholders of
      MultiConn Technologies increased their holdings in MultiConn Technologies
      to 58.2% in the aggregate, through the issuance of shares by MultiConn
      Technologies. As a result, the Company currently holds approximately 40%
      of the outstanding share capital of MultiConn Technologies. The Company
      has an option to increase its holdings in MultiConn Technologies to 60% of
      its outstanding share capital for an exercise price of $50 thousand.

      In May 2004, the Company provided a guarantee on behalf of MultiConn
      Technologies in the amount of $300 thousand, which expires in May 2005. In
      accordance with FIN 45 "Guarantor's Accounting and Disclosure Requirements
      for Guarantees, Including Indirect Guarantees of Others", the Company
      recorded a liability for the aforementioned guarantee in the amount of
      approximately $60 thousand, which was determined to be the fair value of
      the guarantee at its inception. In 2004, the Company included in its
      equity in affiliated companies 100% of the losses of MultiConn
      Technologies up to the guaranteed amount.

      In 2004 the Company did not recognize any gain in the abovementioned
      transaction.



E.    LEVEL 8:

      The Company holds shares and several capital instruments, including
      warrants and rights to receive warrants exercisable into shares of Level 8
      Systems Inc. If the Company exercises these capital instruments in full,
      its shareholdings in Level 8 would reach 4%. During 2003 and in the first
      quarter of 2004, the Company sold substantially all of the preferred stock
      of Level 8 then held by the Company, for $624 thousand. In 2003, the
      Company purchased 444,444 ordinary shares of Level 8 for $200 thousand.
      Liraz consolidated Level 8 until June 30, 2001. Since then Liraz recorded
      equity losses in Level 8 up to the amount of its guarantee approximately
      $2 million in the aggregate (as of December 31, 2003).



                                      F-28
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 3 - INVESTMENTS IN AFFILIATES AND OTHER COMPANIES (CONT.):

E.    LEVEL 8 (CONT.):

      In addition, in November 2003, the Company agreed to extend the term of
      its guarantee to Level 8 to November 2004. As consideration for the
      extension of such guarantees to November 2004, the Company was issued an
      aggregate of 300,000 Level 8 ordinary shares in November 2003 and May
      2004. The shares would be accounted under SFAS 115. The income from the
      issuance of additional shares would be recognized over the extension
      period of the guarantee. The amount of the guarantee outstanding was
      unchanged since the amount remained the same and the shares were issued
      only in connection with the extension of the term of the guarantee.


NOTE 4 - FIXED ASSETS:

      Composition of assets, grouped by major classifications:

                                                               DECEMBER 31,
                                                          ----------------------
                                                            2003          2002
                                                          --------      --------
                                                              (IN THOUSANDS)

     COST:
         Computers and computer equipment                 $  6,544      $  8,004
         Office furniture and equipment                      1,071         1,574
         Leasehold improvements                                442           469
         Motor vehicles                                        863         1,126
                                                          --------      --------

                                                             8,920        11,173
                                                          ========      ========

     ACCUMULATED DEPRECIATION:
         Computers and computer equipment                    5,064         6,136
         Office furniture and equipment                        492           852
         Leasehold improvements                                206           179
         Motor vehicles                                        359           434
                                                          --------      --------
                                                             6,121         7,601
                                                          --------      --------
     Undepreciated balance                                $  2,799      $  3,572
                                                          ========      ========

NOTE 5 - GOODWILL:

                                                               DECEMBER 31,
                                                          ----------------------
                                                            2003          2002
                                                          --------      --------
                                                              (IN THOUSANDS)
                                                          ----------------------
Carrying amounts at beginning of year                     $ 41,822      $ 14,737
Acquired                                                       171        27,085
Realization of previously - consolidated subsidiaries       (2,132)           --
Foreign currency translation adjustments                    (3,054)           --
                                                          --------      --------
      Carrying amount at end of year                      $ 36,807      $ 41,822
                                                          ========      ========


                                      F-29
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 6 - CAPITALIZED SOFTWARE DEVELOPMENT COST AND OTHER:


COMPRISED AS FOLLOWS:

                                                               DECEMBER 31,
                                                           ---------------------
                                                            2003          2002
                                                           -------       -------
                                                              (IN THOUSANDS)
                                                           ---------------------

Capitalized software development costs (*)                 $11,150       $ 8,141
Deferred insurance expenses                                     30            38
Rent deposit                                                   170           189
Deferred tax asset                                              43           563
                                                           -------       -------

                                                           $11,393       $ 8,931
                                                           =======       =======

(*) Original amount (see Note 3B - in respect
      to purchase of technology)                            16,604       $10,944
    Less - accumulated amortization                          5,454         2,803
                                                           -------       -------

                                                           $11,150       $ 8,141
                                                           =======       =======


NOTE 7 - SHORT-TERM BANK CREDIT:

COMPOSITION:

<TABLE>
<CAPTION>
                           INTEREST RATE
                           -------------                      DECEMBER 31,
                            DECEMBER 31,                      ------------
                                2003           LINKAGE     2003          2002
                           --------------     --------   ---------     ---------
                                 %              BASIS        (IN THOUSANDS)
                           --------------     --------   -----------------------
<S>                        <C>                <C>          <C>          <C>
Bank overdraft                8.95-10.5       Unlinked     $1,003        $2,553
Short-term bank loan          4.32-8.5           CPI          448           298
Short-term bank loan          3.05-3.55         Dollar      3,225         2,797
Short-term bank loan          4.18-4.4           Euro       3,666         1,825
                                                           ------        ------

                                                           $8,342        $7,473
                                                           ======        ======
</TABLE>


                                      F-30
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 8 - ACCRUED SEVERANCE PAY, NET:


A.    The Company's liability for severance pay to its employees pursuant to
      applicable local laws prevailing in the respective countries of employment
      and employment agreements for Israeli employees is partly covered by
      managers' insurance policies under the name of the employee, for which the
      Company makes monthly payments. 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.


      The amounts accrued and the amounts funded with managers' insurance
      policies are as follows:

                                                               DECEMBER 31,
                                                         -----------------------
                                                           2003             2002
                                                         ------           ------
                                                              (IN THOUSANDS)
                                                         -----------------------
      Accrued severance pay                              $3,575           $3,189
      Less - amount funded                                2,660            2,258
                                                         ------           ------
                                                         $  915           $  931
                                                         ======           ======

      The Company may make withdrawals from the managers' insurance policies
only for the purpose of paying severance pay.

B.    The expenses in respect of severance pay for the years ended December 31,
      2003, 2002 and 2001 were $720,000, $461,000 and $642,000, respectively.

NOTE 9 - PROVISION FOR LOSSES IN FORMERLY-CONSOLIDATED SUBSIDIARY:


Liraz is liable for losses in a subsidiary it had consolidated (see Note 3E)
until the second quarter of 2001. The provision for such liability at December
31, 2003, was accounted for under SFAS 5 and amounted to $2 million (December
31, 2002 - $2.5 million), representing the maximum potential amount Liraz has
guaranteed to secure a bank loan of the said subsidiary. Under its terms, such
guarantee may be reduced to the extent that the subsidiary raises additional
share capital. The guarantee will be outstanding until November 2004. In the
fourth quarter of 2003, $541 thousand was recorded as gain due to a repayment of
the loan by the formerly-consolidated subsidiary, which resulted in a decrease
by the bank of the guaranteed amount.


                                                              DECEMBER 31,
                                                        ------------------------
                                                          2003             2002
                                                        -------          -------
                                                            (IN THOUSANDS)
                                                        ------------------------
Carrying amount of beginning of year                    $ 2,512          $    --
                                                        -------          -------
Consolidation of new subsidiary                              --            2,512
Realization                                                (541)              --
                                                        -------          -------

      Carrying amount at end of year                    $ 1,971          $ 2,512
                                                        =======          =======


                                      F-31
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 10 - LOANS FROM BANKS:

A.    COMPOSITION:

<TABLE>
<CAPTION>
                                                                            TOTAL LONG-TERM          TOTAL LONG-TERM
                                           LONG-TERM       CURRENT         LIABILITIES NET OF       LIABILITIES NET OF
        INTEREST RATE                     LIABILITIES     MATURITIES       CURRENT MATURITIES       CURRENT MATURITIES
       -----------------                 --------------  -------------   -----------------------  -----------------------
         DECEMBER 31,       LINKAGE                        DECEMBER 31, 2003                        DECEMBER 31, 2002
             2003
       -----------------                 -------------------------------------------------------  -----------------------
              %              BASIS                           (IN THOUSANDS)                           (IN THOUSANDS)
       -----------------  -------------  -------------------------------------------------------  -----------------------
<S>                       <C>            <C>               <C>                   <C>                     <C>
          LIBOR+1.75         Dollar          $ 2,389          $467                $ 1,922                   $ 2,400
          4.32-7.66           CPI                148            63                     85                       126
             6.63            Dollar              101            43                     58                       126
                                             -------          ----                -------                   -------

                                             $ 2,638          $573                $ 2,065                   $ 2,652
                                             =======          ====                =======                   =======
</TABLE>

B.    MATURITY DATES:

                                                                DECEMBER 31,
                                                           ---------------------
                                                            2003           2002
                                                           ------         ------
                                                              (IN THOUSANDS)
                                                           ---------------------

     First year (current maturities)                       $  573         $   75
     Second year                                            1,329            562
     Third year                                               736          1,329
     Fourth year                                               --            761
                                                           ------         ------

         TOTAL                                             $2,638         $2,727
                                                           ======         ======

NOTE 11 - COMMITMENTS AND CONTINGENCIES:

COMMITMENTS:

Significant Agreements:


A.    In August 1998, the Company's subsidiary, Mainsoft Corporation, entered
      into a Windows secure-code licensing agreement. Pursuant to this agreement
      and the amendments thereto, Microsoft granted Mainsoft access to specified
      Microsoft source code, including new versions, service packs, and upgrade
      releases for Windows. Microsoft also granted Mainsoft distribution rights
      to the Windows object code licensed as a component in Mainsoft's products.


      The Agreement provides for the payment of royalties to Microsoft that are
      based upon Mainsoft's licensing of its products which include the Licensed
      Software. The Agreement has a perpetual term although: 1) Microsoft may
      terminate the Agreement upon any one of certain events regarding change of
      control of Mainsoft (the "Change of Control Events") and 2) either party
      may terminate the Agreement if the other fails to comply with the terms of
      the Agreement or files for bankruptcy.


                                      F-32
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 11 - COMMITMENTS AND CONTINGENCIES (CONT.):

COMMITMENTS (CONT.):

Significant Agreements (cont.):

A.    (CONT.):

      Change of Control Events include any third party attempt to acquire (a) a
      seat on Mainsoft's board of directors (b) specified percentages of
      Mainsoft's voting common stock or (c) part ownership or all rights to
      Mainsoft's products. Mainsoft must notify Microsoft in the event of a
      Change of Control Event. Upon receipt of such notice, Microsoft may elect
      to (a) acquire any percentage of Mainsoft at the proposed price per share
      or (b) acquire Mainsoft's products at the proposed price. In the event
      Mainsoft ceases the active distribution or licensing of its products for
      more than one year, Mainsoft will be deemed to have granted to Microsoft a
      worldwide exclusive perpetual irrevocable royalty-free license to its
      products.

      The Agreement provides for a procedure under which Mainsoft may request a
      waiver of the payment of certain royalties to Microsoft on a specified
      customer basis. Upon recording revenue from a customer, Mainsoft accrues
      the royalties due to Microsoft in product cost of revenues and often
      applies for a waiver. Mainsoft recognizes a reduction in product cost of
      revenues when a waiver is approved by Microsoft.


      In December 2003, Mainsoft entered into an Independent Contractor
      Agreement with Microsoft. As a result of this agreement, Microsoft agreed
      to offset the value of the Mainsoft's services performed under the
      Independent Contractor Agreement from the accrued royalties, up to $1,605
      thousand. During the year ended December 31, 2003, Mainsoft accrued
      royalties due to Microsoft of $2,782 thousand and recognized credits
      (reductions to expense) related to waivers and to services performed of
      $2,466 thousand and $999 thousand, respectively. The excess credits over
      the royalties amount is related to previous year royalties.


      On February 13, 2004 there were public reports that a leak of Microsoft
      source code had occurred on the Internet. These reports indicated that the
      source code contained trace references to the Mainsoft servers and
      personnel. Mainsoft's management team immediately adopted a policy of full
      cooperation with local authorities, the FBI, and Microsoft in their
      respective investigation. Mainsoft, through an internal investigation into
      the leak, confirmed that the code had come from one of their servers but
      was most likely extracted some time in 2001. All parties conducting
      investigations have found no trace of a security breach after that date.
      According to the FBI, the investigation is still active and they are
      proceeding with the investigation to date. While Mainsoft believes its
      relationship with Microsoft will continue on terms acceptable to Mainsoft,
      a change in the relationship could materially adversely affect Mainsoft`s
      business, results of operation, and financial condition.


                                      F-33
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 11 - COMMITMENTS AND CONTINGENCIES (CONT.):

COMMITMENTS (CONT.):

Significant Agreements (cont.):


B.    The Company is obligated to pay management fees to Formula in an annual
      amount equal to 3% of revenues, but not more than the Israeli currency
      equivalent of $180 thousand.

C.    The Company is committed under operating leases for rental of office
      facilities for the years 2004-2006. Annual rental fees under current
      leases are approximately $1.7 million for 2004 and $1.8 million for 2005,
      and are expected to remain at this level for each of the next five years.
      In connection with such leases, the Company has issued bank guarantees of
      $113 thousand in favor of the leasing companies, for the term of the
      leases.

D.    Through December 31, 2003, Mainsoft entered into a grant agreement with
      the Office of the Chief Scientist, or the OCS, for the development of
      Visual MainWin for J2EE.

      Royalties of 3% are payable to the OCS on sales of Visual MainWin for J2EE
      up to 100% of the dollar - linked grant received in respect of the funded
      product.

      The balance of the contingent liability relating to the above royalties at
      December 31, 2003 amounted to approximately $570 thousands. Mainsoft has
      submitted an application to the OCS for approval of research and
      development grants for 2004.

E.    As of January 1, 2004 the subsidiary CePost entered into a grant agreement
      with the Office of the Chief Scientist, or the OCS, for the development of
      PowerText. Royalties of 3% are payable to the OCS on sales of PowerText up
      to 100% of the dollar-linked grant received in respect of the funded
      product. The balance of the contingent liability relating to the above
      royalties at January 1, 2004 amounted to approximately $250 thousand.


F.    The Company has guaranteed short-term bank credit of affiliated companies
      in favor of lending banks. As of December 31, 2003, such guarantees
      amounted to approximately $1 million. The guarantees are for one-year
      terms, and may optionally be extended for further periods of one year
      each.


G.    The Company has granted a creditor of Intercomp an option - See Note 3B,
      12B(2).


H.    As to a tax assessment issued to the Company - see Note 14K.

I.    As to a guarantee of debt by Liraz - see Note 9.


                                      F-34
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 11 - COMMITMENTS AND CONTINGENCIES (CONT.):

COMMITMENTS (CONT.):

Significant Agreements (cont.):


J.    Under an agreement entered into in 2000, regarding the sale of its
      integrated IT systems activities and outsourcing business in Israel, Liraz
      is obligated to reimburse the buyer for claims related to the activities
      during the period prior to the sale.


K.    Liraz has a fixed charge in favor of a bank, on certain of its assets, as
      well as a floating charge on its entire assets, securing Liraz's bank
      credit line. This credit facility also covers guarantees of $2 million in
      the aggregate that the Company extended to banks relating to the credit
      line of Level 8 (see note 9).


L.    In the first quarter of 2004, the Singapore-Israel Industrial Research and
      Development Foundation agreed to provide financing to CePost together with
      a company incorporated in Singapore, for the development of Report-IT.
      Accordingly, the foundation agreed to award CePost up to $100 thousand
      repayable according to an agreed upon schedule. CePost is required to pay
      that amount in payments based on sales of the Report-IT up to the amount
      of the grant.


M.    As to a guarantee to banks with respect to a loan of Outlook - see Note
      2J.


N.    In connection with the credit line extended to the Company by Bank Leumi
      Le'Israel Ltd., the Company committed to certain covenants related to its
      operation such as:

      1)    maintaining a minimum level of shareholders' equity of no less than
            40% of the Company's total assets and no less than $40 million;

      2)    maintaining a level of operating income before depreciation and
            amortization of no less than $1 million; and

      3)    maintaining the ratio of the Company bank liabilities to current
            assets, excluding other current assets, not to exceed 55%.


No liability was recorded in the Company's financial statements in respect of
the guarantees mentioned above, except for the guarantee by Liraz - see Note 9.


                                      F-35
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 11 - COMMITMENTS AND CONTINGENCIES (CONT.):

CONTINGENCIES:

A.    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 the
      Company, as a class action. The claim relates to the acquisition of Liraz
      shares which the Company completed in March 2003. The shareholder alleges
      that the share price that the Company paid to Liraz' 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. Under Israeli law, the
      court's approval is required for the plaintiff to represent all of the
      shareholders of Liraz who sold their shareholdings to the Company pursuant
      to the tender offer and the mandatory acquisition. The plaintiff has
      applied for such approval in the lawsuit. A preliminary hearing is
      scheduled for October 2004. The Company believes that the allegations
      against the Company in this proceed are without merit.

B.    Sogeti Nederland B.V. ("Sogeti"), a Dutch company, has notified the
      Company of the termination of a migration project which was performed
      jointly by Sogeti and one of the Company's wholly-owned subsidiaries, ASE
      B.V., for a Dutch customer, NV Interpolis BTL, due to an alleged breach on
      the Company's part. The project was performed by Sogeti as prime
      contractor and by ASE as subcontractor. BluePhoenix acted as subcontractor
      of ASE. In March 2004, Sogeti was granted leave by the district court in
      Amsterdam to put a lien on a bank account of ASE pursuant to an ex parte
      application. In the application, Sogeti claims that it has to make, or has
      made, a refund to Interpolis of 2.2 million Euro and that it may suffer
      losses of at least 150,000 Euro. For purposes of the lien application,
      Sogeti estimates the aggregate amount of the claim at 3 million Euro.
      Sogeti has to file against ASE B.V. by the end of June 2004. The Company
      believes that the alleged claim of Sogeti as described in the application
      for the lien is without merit.



                                      F-36
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 12 - SHAREHOLDERS' EQUITY:

A.    SHARE CAPITAL:

      1.    On January 31, 1997, 3,120,000 ordinary shares of the Company were
            offered in an initial public offering (the "IPO") at a price of $7.5
            per share. Since the above transaction, the Company's shares have
            been traded in the United States on the NASDAQ National Market.
            Their current symbol is "BPHX".

      2.    On July 22, 1997, 1,200,000 ordinary shares of the Company were
            offered in a second public offering, at a price of $27 per share, of
            which 600,000 ordinary shares were issued by the Company and 600,000
            ordinary shares were sold by existing shareholders.

      3.    During the years 1998 through 2002, two subsidiaries of the Company
            purchased a total of 1,870,565 the Company's shares for a total
            consideration of $14.7 million. All of the Company's ordinary shares
            have equal voting rights. However, under applicable Israeli law, the
            shares held by the Company's subsidiaries have no voting rights and,
            therefore, are excluded from the number of its outstanding shares.

      4.    In January 2001 the Company's ordinary shares were listed for
            trading on the Tel Aviv Stock Exchange under the "Dual Listing"
            arrangement.

      5.    In November 2002 the Company issued to Liraz' selling shareholders,
            including Formula, 3,478,624 ordinary shares, constituting an
            aggregate of 26% of the Company's outstanding share capital - see
            Note 2E.

B.    SHARE OPTIONS:

      1.    EMPLOYEE SHARE OPTION PLANS:

            A)    THE 1996 SHARE OPTION PLAN:


                  In 1996, the Company adopted two option plans. One of theses
                  option plans was terminated after all options granted under it
                  were exercised. Pursuant to the other 1996 option plan, as
                  amended, the Company reserved 3,200,000 ordinary shares for
                  issuance to directors, officers, consultants and employees of
                  the Company and its subsidiaries. The exercise price of the
                  options granted under the 1996 option plan ranges from $2.25
                  to $10.50.


                  Under the 1996 option plan, unless determined otherwise by the
                  Board, options vest over a three-year period from the date of
                  grant and expire 10 years after grant date. Unvested options
                  are forfeited upon termination of employment.


                                      F-37
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 12 - SHAREHOLDERS' EQUITY (CONT.):

B.    SHARE OPTIONS (CONT.):

      1.    EMPLOYEE SHARE OPTION PLANS (CONT.):

            B.    OPTIONS GRANTED TO EMPLOYEES OF A SUBSIDIARY:

                  In August 2000, in connection with the purchase of a
                  controlling interest in IntraComp Group Incorporated, the
                  Company granted options to certain employees of IntraComp to
                  purchase an aggregate of 125,000 ordinary shares of which
                  55,000 were cancelled. The exercise price of the options is
                  $9.625 per Company share. All of these options are currently
                  exercisable. The options shall expire in August 2010. Data in
                  respect of the share option plan as of December 31, 2003, 2002
                  and 2001 and changes during the years ended on those dates are
                  as follows:


<TABLE>
<CAPTION>
                                                   2003                         2002                         2001
                                        ---------------------------- ---------------------------- ----------------------------
                                                         WEIGHTED                     WEIGHTED                     WEIGHTED
                                                         AVERAGE                      AVERAGE                      AVERAGE
                                         NUMBER OF       EXERCISE     NUMBER OF       EXERCISE     NUMBER OF       EXERCISE
                                          OPTIONS         PRICE        OPTIONS         PRICE        OPTIONS         PRICE
                                        ------------  -------------- ------------  -------------- ------------  --------------
                                                            $                            $                            $
                                                      --------------               --------------               --------------
<S>                                     <C>           <C>             <C>          <C>             <C>          <C>
         Options outstanding
            at beginning of year          1,347,260        6.56       1,193,650         7.55       1,150,650         8.21
         Changes during the year:
             Granted                        923,000        3.03         353,560         3.00         340,600         3.23
             Exercised                      (35,267)       2.33         (90,000)        3.57        (181,850)        2.74
             Forfeited                      (75,000)       9.46        (109,950)        8.90        (115,750)        8.75
                                        ------------                 ------------                 ------------

               Options outstanding
                  at end of year          2,159,993        4.99       1,347,260         6.56       1,193,650         7.55
                                        ============                 ============                 ============

         Options exercisable at
            year-end                      1,233,575        6.04         888,333         7.63         852,966         6.99
                                        ============                 ============                 ============

         Weighted-average fair value
            of options granted during
            the year*                          0.54                         1.09                         1.40
                                        ============                 ============                 ============
</TABLE>

      *     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: 2003 - 66% 2002 - 67%, 2001 - 61%,
            risk-free interest rate: 2003 - 1.75%, 2002 - 1.75%, 2001 - 3%, and
            expected life: 2003, 2002 and 2001-3 years.


                                      F-38
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 12 - SHAREHOLDERS' EQUITY (CONT.):

B.    SHARE OPTIONS (CONT.):

      1.    EMPLOYEE SHARE OPTION PLANS (CONT.):

            The following table summarizes information about fixed share options
            outstanding at December 31, 2003:

<TABLE>
<CAPTION>
                                               OPTIONS OUTSTANDING                                OPTIONS EXERCISABLE
                           -------------------------------------------------------------  -------------------------------------
                               NUMBER                                                         NUMBER
              RANGE OF     OUTSTANDING AT     WEIGHTED AVERAGE                            EXERCISABLE AT
              EXERCISE      DECEMBER 31,          REMAINING          WEIGHTED AVERAGE      DECEMBER 31,     WEIGHTED AVERAGE
               PRICES           2003          CONTRACTUAL LIFE        EXERCISE PRICE           2003          EXERCISE PRICE
           --------------- ---------------- ---------------------- ---------------------  ---------------- --------------------
                 $                                  YEARS                   $                                       $
           ---------------                  ---------------------- ---------------------                   --------------------
                <S>               <C>               <C>                  <C>                  <C>              <C>
                 2.25            416,000              9.25                   2.25               41,000           2.25
                 3.00            116,000              9.50                   3.00               62,667           3.00
                 3.00            255,660              8.50                   3.00               85,220           3.00
                 3.00             80,000              8.09                   3.00               80,000           3.00
                 3.50             70,000              9.50                   3.50               70,000           3.50
                 3.50             47,000              9.75                   3.50               19,000           3.50
                 4.00            200,000              9.83                   4.00                -               4.00
                 4.50             68,333              7.50                   4.50               45,555           4.50
                 4.50             10,000              9.25                   4.50               10,000           4.50
                 5.20            139,500              2.75                   5.20              139,500           5.20
                 5.50             13,000              6.83                   5.50               13,000           5.50
                 6.00             28,000             10.00                   6.00               28,000           6.00
                 6.50            311,900              2.21                   6.50              311,900           6.50
                 6.50              2,000             10.00                   6.50                2,000           6.50
                 8.00             92,000              5.50                   8.00               92,000           8.00
                 9.00             10,000              5.75                   9.00               10,000           9.00
                 9.63             70,000              6.25                   9.63               70,000           9.63
                10.50            230,600              7.25                  10.50              153,733          10.50
                               ---------                                                     ---------

                               2,159,993                                                     1,233,575
                               =========                                                     =========
</TABLE>

      2.    OPTIONS GRANTED TO FIMI:


            In January 2001, the Company granted to the creditors of an
            affiliate, Intercomp, represented by First Israel Mezzanine
            Investors Ltd., known as FIMI, a put option to sell promissory notes
            issued by Intercomp to the Company in an aggregate amount of $3.5
            million plus interest accrued since January 2001 at an annual rate
            of 5%, which could be paid, subject to FIMI's approval, in the form
            of the Company's ordinary shares. The total outstanding amount of
            the principal and accrued interest as of December 31, 2003 was $4.01
            million. The number of ordinary shares subject to the option will be
            calculated based on the average market price of the shares during
            the 14 trading days prior to the exercise of the option. In August
            2003, the terms of FIMI's option were amended, allowing FIMI to
            exercise its option in three installments during June 2004, June
            2005 and June 2006. At the Company's option, it may pay FIMI the
            consideration, in the form of the Company's ordinary shares.



                                      F-39
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 12 - SHAREHOLDERS' EQUITY (CONT.):

B.    SHARE OPTIONS (CONT.):

      2.    OPTIONS GRANTED TO FIMI (CONT.):


            However, within 7 business days following the Company's notice to
            FIMI of the Company's election to pay the consideration in the form
            of the Company's ordinary shares, FIMI may notify to the Company
            that it refuses to receive the shares and requires instead a payment
            in cash. In such an event, the Company shall have to pay FIMI the
            corresponding cash amount, but shall be entitled to defer such
            payment until September 30, 2006. In addition, for each of the three
            installments of the put option to be exercised by FIMI, the Company
            is obliged to issue warrants to FIMI to purchase ordinary shares at
            an exercise price of $4.00 per share. If the Company pays an
            installment with the Company's ordinary shares, the Company shall
            issue warrants to FIMI to purchase 133,000 ordinary shares. If the
            Company pays an installment in cash, the Company shall issue
            warrants to FIMI to purchase 70,000 ordinary shares. The warrants
            are exercisable until June 30, 2007. Under certain circumstances,
            the Company is obliged to register for resale the shares underlying
            FIMI's warrants. FIMI submitted a notice to exercise the June 2004
            installment for cash, thus postponing the payment of the respective
            portion of the consideration to September 30, 2006.


      3.    OPTION GRANTED TO INFINITY:


            In April 2004, a shareholder of Intercomp, Israel Infinity Venture
            Capital Partners Ltd., referred to as "Infinity", granted the
            Company a call option to purchase its entire holdings in Intercomp,
            exercisable until April 1, 2006. If the Company does not exercise
            such option, Infinity will have a put option to cause the Company to
            purchase Infinity's entire holdings in Intercomp, exercisable during
            a six months period commencing on April 1, 2006. If either of the
            options is exercised, the Company shall be obliged to issue to
            Infinity, as consideration for the Intercomp's shares, 100,000 of
            the Company's ordinary shares and an additional amount of shares to
            be calculated based on revenues generated from the sale of licenses
            to use Intercomp's products generated during a 3 year period
            commencing April 1, 2003. The shares will be subject to a lock up
            period until April 1, 2006. The Company undertook, upon Infinity's
            request, to use their best efforts to effect registration of the
            shares, within 8 months of the end of the lock-up period or within
            90 days of such date, if the Company filed its annual report on From
            20-F during such 90 days period, whichever is earlier. The Company
            may, at the Company's opinion, pay to Infinity the cash equivalent
            of such shares which will be calculated according to the average
            closing price of the Company's shares during the 20 trading days
            prior to the exercise of any of the options.



                                      F-40
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 12 - SHAREHOLDERS' EQUITY (CONT.):

B.    SHARE OPTIONS (CONT.):

      3.    OPTION GRANTED TO INFINITY (CONT.):

            The put and call options with Infinity were accounted for as
            combined instruments under the guidance of EITF 02-02, " When,
            Certain Contracts That Meet the Definition of Financial Instruments
            Should Be Combined for Accounting Purpose". The combined instruments
            (synthetic forwards) will be accounted in accordance with EITF 00-6
            "Accounting for Freestanding Derivative Financial Instruments
            Indexed to, and Potentially Settled in, the Stock of a consolidated
            Subidiary" and SAFS 150 "Accounting for Certain Financial
            Instruments with Characteristics of Both Liabilities and Equity".

      4.    CONVERTIBLE DEBENTURES AND WARRANTS:

            Pursuant to a securities purchase agreement dated March 30, 2004,
            the Company issued to Omicron Master Trust, Smithfield Fiduciary
            LLC, Cranshire Capital LP and Iroquois Capital L.P., referred to as
            institutional investors, $5 million aggregate principal amount of 2%
            convertible debentures due November 30, 2006 and warrants to
            purchase 438,596 of the Company's ordinary shares.

            The net proceeds from the exercise of the warrants, if exercised,
            will be used for working capital and general corporate purposes.

            The debentures are convertible at the investors' option into the
            Company's ordinary shares, at a conversion price of $5.70 per
            ordinary share. Interest on the debentures is paid quarterly in cash
            or in the form of the Company's ordinary shares, at the Company's
            discretion. The conversion rate with respect to payments of interest
            on the debentures is equal to 90% of the volume-weighted average
            price of the Company's ordinary shares on the Nasdaq during the 20
            trading days preceding the date of interest payment. In the event
            that the volume weighted average price per share for any 20
            consecutive trading days exceeds $7.125, then the Company may force
            the holders of the debentures to convert any or all of the principal
            amount of the debentures held by them as of such date, subject to,
            among other things, having an effective registration statement at
            such time for the resale of the ordinary shares underlying the
            debentures.

            As part of the transaction, the institutional investors were issued
            warrants to purchase up to 438,596 of the Company's ordinary shares
            at an exercise price of $ 6.50 per share. The warrants are
            exercisable during a 5 years period commencing on September 2004.

            If the debentures issued to institutional investors are fully
            converted and the warrants are fully exercised, the Company would be
            required to issue to the investors up to 1,708,411 ordinary shares,
            subject to adjustments.



                                      F-41
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 12 - SHAREHOLDERS' EQUITY (CONT.):

B.    SHARE OPTIONS (CONT.):

      4.    CONVERTIBLE DEBENTURES AND WARRANTS (CONT.):

            If, during a period of 180 days after the date in which the
            registration statement with respect to the underlying debentures'
            shares is declared effective, the volume weighted average price per
            share of the Company's ordinary shares equals or exceeds the market
            price per share of the Company' shares on March 30, 2004, the
            institutional investors may purchase additional debentures from the
            Company for an aggregate purchase price of up to $3 million and
            receive warrants on the same terms as the initial warrants,
            exercisable into such number of the Company's ordinary shares equal
            to 50% of the ordinary shares into which the debentures are
            convertible.

            If, during such period mentioned above, the volume weighted average
            price per share of the Company's ordinary shares during any 10
            consecutive trading days exceeds $12.825, the Company may require
            the institutional investors to purchase additional debentures for an
            aggregate purchase price of up to $3 million and warrants under the
            same terms as the initial warrants, exercisable into such number of
            the Company ordinary shares equal to 50% of the ordinary shares into
            which the debentures are convertible. If these additional debentures
            are fully converted and the additional warrants are exercised in
            full, the Company would be required to issue to the investors up to
            an additional 1,025,047 ordinary shares.

            In connection with the private placement, the Company agreed to file
            a registration statement for the resale of the ordinary shares
            underlying the convertible debentures and the ordinary shares to be
            issued as interest thereon and the ordinary shares underlying the
            warrants.

            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 Rations", and EITF 00-27,
            "Application of Issue No. 98-5 to Certain Convertible Instruments"
            ("EITF 00-27"), a portion of the proceeds of the convertible
            debenture issued with detachable warrants is allocated to the
            warrants, based on the relative fair values of the securities at
            time of issuance. Amounts allocated to 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", and SFAS No. 150, "Accounting for
            Certain Financial Instruments with Characteristics of Both
            Liabilities and Equity" and are measured, based on the fair values
            of the underlying shares, each reporting date, against financial
            expenses (income).

            A beneficial conversion feature was recorded on the debentures,
            because the effective conversion price of the debentures was higher
            than the fair value of the common shares on the commitment date.



                                      F-42
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 12 - SHAREHOLDERS' EQUITY (CONT.):

B.    SHARE OPTIONS (CONT.):

      4.    CONVERTIBLE DEBENTURES AND WARRANTS (CONT.):

            The deemed discount of the debentures is deducted from the liability
            and the issuance expenses, which are recorded as an asset, are
            amortized using the interest method over a period of 32 months, the
            term of the debentures.


      5.    EMPLOYEE OPTION PLANS IN SUBSIDIARY:


            A subsidiary granted options to its employees to purchase the
            subsidiary's shares. The options are exercisable in 3 years after
            the date of grant. A summary of the status of the option plans as of
            December 31, 2003 and 2002 and changes during the years then ended
            is given below:


<TABLE>
<CAPTION>
                                                                      2003                           2002
                                                           ---------------------------- --------------------------------
                                                                            WEIGHTED                       WEIGHTED
                                                                            AVERAGE                        AVERAGE
                                                            NUMBER OF       EXERCISE      NUMBER OF        EXERCISE
                                                             OPTIONS         PRICE         OPTIONS          PRICE
                                                           ------------- -------------- -------------- -----------------
                                                                               $                              $
                                                                         --------------                -----------------
<S>                                                        <C>          <C>              <C>            <C>
           Options outstanding at beginning of year          3,751,250        0.75         3,537,813         1.36
           Changes during the year:
               Granted                                         548,303        0.65         2,841,448         0.65
               Exercised                                        -              -             (10,000)        0.25
               Forfeited                                      (605,316)       0.75        (2,618,011)        1.64
                                                             ---------                     ---------
                 Options outstanding at end of year          3,694,237        0.74         3,751,250         0.75
                                                             =========                     =========

           Options exercisable at year-end                   2,203,370        0.76         1,211,637         1.09
                                                             =========                     =========

           Weighted-average fair value of options granted
              during the year *                                   0.07                          0.09
                                                             =========                     =========
</TABLE>

      *     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: 2003 - 0.1% 2002 - 0.1%, risk-free
            interest rate: 2003 - 3.00%, 2002 - 4.00%, and expected life: 2003,
            2002 -4 years.


                                      F-43
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 12 - SHAREHOLDERS' EQUITY (CONT.):

B.    SHARE OPTIONS (CONT.):

      5.    EMPLOYEE OPTION PLANS IN SUBSIDIARY (CONT.):


            The following table summarizes information about fixed share options
            outstanding at December 31, 2003:

<TABLE>
<CAPTION>
                                              OPTIONS OUTSTANDING                                OPTIONS EXERCISABLE
                          -------------------------------------------------------------  ------------------------------------
                              NUMBER                                                         NUMBER
             RANGE OF      OUTSTANDING       WEIGHTED AVERAGE                             EXERCISABLE
             EXERCISE      AT DECEMBER          REMAINING           WEIGHTED AVERAGE      AT DECEMBER      WEIGHTED AVERAGE
              PRICES         31, 2003        CONTRACTUAL LIFE        EXERCISE PRICE         31, 2003        EXERCISE PRICE
           -------------  ---------------  ---------------------  ---------------------  ---------------  -------------------
                $                                 YEARS                    $                                      $
           -------------                   ---------------------  ---------------------                   -------------------
<S>                       <C>             <C>                     <C>                    <C>             <C>
            0.25-0.50         799,421              12.38                  0.26               799,421             0.26
               0.65         2,672,423               8.89                  0.65             1,195,608             0.65
             0.75-2.5         222,393               9.51                  1.38               208,341             1.38
                            ---------                                                      ---------

                            3,694,237                                                      2,203,370
                            =========                                                      =========
</TABLE>

C.    DIVIDENDS:

      1.    The Company has not paid any cash dividends on its ordinary shares
            in the past and does not expect to pay cash dividends on its
            ordinary shares in the foreseeable future.

      2.    As described in Note 14A, in the event of a distribution of cash
            dividends in the amount of approximately $12.8 million out of
            retained earnings, in respect of which the Company was tax exempt
            due to the "Approved Enterprise" status of its approved operations,
            the Company would have to pay a 25% tax on the said amount.


                                      F-44
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 13 - MONETARY BALANCES IN NON-DOLLAR CURRENCY:

                                                            DECEMBER 31,
                                                        ---------------------
                                                         2003          2002
                                                        -------       -------
                                                           (IN THOUSANDS)
                                                        ---------------------

ASSETS:

   Current assets                                       $12,737       $14,805
   Long-term assets                                          32         -
                                                        -------       -------

                                                         12,769        14,805
                                                        -------       -------

LIABILITIES:
   Current liabilities                                   18,311        19,655
   Long-term liabilities                                    948         1,041
                                                        -------       -------

                                                         19,259        20,696
                                                        -------       -------

      Net monetary liabilities                          $(6,490)      $(5,891)
                                                        =======       =======

NOTE 14 - TAXES ON INCOME:

A.    TAX BENEFITS UNDER THE ISRAELI LAW FOR THE ENCOURAGEMENT OF CAPITAL
      INVESTMENTS, 1959 (HEREAFTER - THE "LAW"):

      Some operations of BluePhoenix and certain subsidiaries ("BluePhoenix and
      the Subsidiaries") have been granted "Approved Enterprise" status under
      the Law. Since BluePhoenix and 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 BluePhoenix or the Subsidiaries
      during the year, in relation to the revenue in the year preceding the
      first year of their having the abovementioned 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%.


      Since January 31, 1997, the percentage of BluePhoenix share capital held
      by foreign shareholders has exceeded 25%. Therefore BluePhoenix 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 BluePhoenix or the Subsidiaries have
      taxable income and 14 years elapse since the Approved Enterprise was
      granted and 12 years since the commencing of the Approved Enterprise.



                                      F-45
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 14 - TAXES ON INCOME (CONT.):

A.    TAX BENEFITS UNDER THE ISRAELI LAW FOR THE ENCOURAGEMENT OF CAPITAL
      INVESTMENTS, 1959 (HEREAFTER - THE "LAW") (CONT.):

      The entitlement to the above benefits is subject to final ratification by
      the Investment Center in the Ministry of Industry and Trade, such
      ratification being conditional upon fulfillment of all terms of the
      approved program.

      In the event of distribution of a cash dividend out of retained earnings
      which were tax exempt due to the above benefits, BluePhoenix would have to
      pay approximately $4.3 million tax in respect of the amount distributed,
      (see Note 12 C.2). 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 BluePhoenix or the Subsidiaries fail to comply with the
      approved program terms, the tax benefits may be canceled and BluePhoenix
      or 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.

B.    MEASUREMENT OF RESULTS FOR TAX PURPOSES UNDER THE INCOME TAX (INFLATIONARY
      ADJUSTMENTS) LAW, 1985 (HEREAFTER - THE "INFLATIONARY ADJUSTMENTS LAW"):

      Under this law, results for tax purposes are adjusted based on the changes
      in the exchange rate of the U.S. dollar.

C.    TAX BENEFITS UNDER THE LAW FOR THE ENCOURAGEMENT OF INDUSTRY (TAXATION),
      1969:

      The Company currently qualifies as an "Industrial Company" as defined by
      this law, and as such is entitled to certain tax benefits including, inter
      alia, depreciation at increased rates as stipulated by regulations
      published under the Inflationary Adjustments Law and the right to deduct
      for tax purposes, over a period of 3 years, expenses relating to public
      issue of shares. If realized, any tax benefit relating to issuance
      expenses is credited to capital surplus.

D.    TAX RATES APPLICABLE TO INCOME FROM OTHER SOURCES IN ISRAEL:

      Income not eligible for "Approved Enterprise" benefits mentioned in A.
      above is taxed at the regular corporate tax rate of 36%.


                                      F-46
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 14 - TAXES ON INCOME (CONT.):

E.    DEFERRED INCOME TAXES:

      Deferred tax assets are comprised as follows:

<TABLE>
<CAPTION>
                                                                                    DECEMBER 31,
                                                                        ------------------------------------
                                                                            2003          2002          2001
                                                                        --------      --------      --------
                                                                                    (IN THOUSANDS)
                                                                        ------------------------------------
<S>                                                                     <C>           <C>           <C>
     Net operating losses carry forwards                                $ 13,421      $ 11,954      $ 10,215
     Software development costs                                            1,028         1,027         2,113
     Provisions for employee rights and other temporary differences          853         1,128           760
                                                                        --------      --------      --------
                                                                          15,302        14,109        13,088
     Valuation allowance                                                 (15,148)      (13,393)      (12,312)
                                                                        --------      --------      --------

                                                                        $    154      $    716      $    776
                                                                        ========      ========      ========
</TABLE>

      For the year ended December 31, 2003, the valuation allowance increased by
      $1,755 thousand.

      The Company's management cannot determine that it is more likely than not
      that the deferred tax asset relating to net operating losses will be
      realized.

F.    NON ISRAELI SUBSIDIARIES:

      Non-Israeli subsidiaries are taxed based upon tax laws in the country of
      domicile of the respective subsidiary.

G.    INCOME (LOSS) BEFORE TAXES ON INCOME IS COMPOSED AS FOLLOWS:

<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31,
                                                ------------------------------------
                                                  2003          2002          2001
                                                --------      --------      --------
                                                            (IN THOUSANDS)
                                                ------------------------------------
<S>                                             <C>           <C>           <C>
     The Company and subsidiaries in Israel     $ (4,665)     $ (5,008)     $(13,659)
     Subsidiaries outside of Israel                7,720         3,576          (772)
                                                --------      --------      --------

                                                $  3,055      $ (1,432)     $(14,431)
                                                ========      ========      ========
</TABLE>


                                      F-47
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 14 - TAXES ON INCOME (CONT.):

H.    TAXES ON INCOME INCLUDED IN THE STATEMENTS OF INCOME:

                                                      YEAR ENDED DECEMBER 31,
                                                    ---------------------------
                                                    2003       2002       2001
                                                    -----      -----      -----
                                                           (IN THOUSANDS)
                                                    ---------------------------

     For the reported year - current:
         In Israel                                  $   8      $  (3)     $  14
         Out of Israel                                411        204        263
                                                    -----      -----      -----

                                                      419        201        277
     Taxes in respect of prior years                 (780)         9        178
     Deferred taxes, net                              513        (50)      (340)
                                                    -----      -----      -----

                                                    $ 152      $ 160      $ 115
                                                    =====      =====      =====

I.    A RECONCILIATION OF THE THEORETICAL TAX EXPENSE (BENEFIT), ASSUMING ALL
      INCOME IS TAXED AT THE REGULAR RATES, AND THE ACTUAL TAX EXPENSE IS AS
      FOLLOWS:

<TABLE>
<CAPTION>
                                                                                           DECEMBER 31,
                                                                              --------------------------------------
                                                                                  2003           2002           2001
                                                                              --------       --------       --------
                                                                                           (IN THOUSANDS)
                                                                              --------------------------------------
<S>                                                                           <C>            <C>            <C>
     Income (loss) before taxes on income, per consolidated statements of
         income                                                               $  3,055       $ (1,432)      $(14,431)
                                                                              --------       --------       --------

     Theoretical tax expense (income)                                            1,100           (516)        (5,195)
     Tax benefit arising from exempt tax rate as an "Approved Enterprise"           --            231            616
                                                                              --------       --------       --------

                                                                                 1,100           (285)        (4,579)
     Increase (decrease) in taxes resulting from permanent differences:
         State income tax, net of Federal benefit                                   12             91            (50)
         Tax exempt income                                                        (222)        (1,167)          (104)
         Non-deductible expenses                                                   270            379          1,348
         Effect of different tax rates in foreign subsidiaries                      --             49             --
         Taxes in respect of previous years                                       (780)             9            178
     Temporary differences for which deferred taxes were not recorded             (296)         1,431          3,272
        Other                                                                       68           (347)            50
                                                                              --------       --------       --------

     Taxes on income in the consolidated statements of income -for the
         reported year                                                        $    152       $    160       $    115
                                                                              ========       ========       ========

     Effective tax rate                                                              5%            11%             1%
                                                                              ========       ========       ========
</TABLE>


                                      F-48
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 14 - TAXES ON INCOME (CONT.):

J.    TAX LOSSES:


      1.    A U.S. subsidiary has net operating losses ("NOL") carry forwards
            for federal tax purposes as of December 31, 2003 totaling $23
            million, all of which will expire through 2022.

            That subsidiary has net operating losses carry forwards for state
            tax purposes of $4 million, which expire through 2007. In addition,
            that subsidiary has tax credits carry forwards totaling $446
            thousand, which expire through 2021.


      2.    The Company and its subsidiaries in Israel have NOL carry forwards
            for income tax purposes as of December 31, 2003 totaling NIS 66.1
            million ($15.1 million).

K.    TAX ASSESSMENTS:


      The Company received a revised tax assessment for the 1997-2001 tax years
      at a total amount of approximately $1.2 million. As agreed with the tax
      authorities, the Company should pay a down payment of approximately $800
      thousand payable in 24 monthly installments until December 2005. The
      Company is acting to obtain documentation in order to cancel the balance
      of approximately $400 thousand. This tax expense is fully offset against
      previously existing tax reserves (the tax reserve is included in accounts
      payable and accrual - other).


L.    TAX REFORM:

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


                                      F-49
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 15 - SUPPLEMENTARY FINANCIAL STATEMENT INFORMATION:

A.    BALANCE SHEETS:

      1.    TRADE RECEIVABLES:

                                                              DECEMBER 31,
                                                        -----------------------
                                                          2003           2002
                                                        --------       --------
                                                             (IN THOUSANDS)
                                                        -----------------------

          Trade accounts receivable                     $ 13,693       $ 11,819
          Less provision for doubtful accounts            (1,076)        (1,008)
                                                        --------       --------

                                                        $ 12,617       $ 10,811
                                                        ========       ========

      2.    OTHER CURRENT ASSETS:

                                                                 DECEMBER 31,
                                                             -------------------
                                                              2003         2002
                                                             ------       ------
                                                                (IN THOUSANDS)
                                                             -------------------

          Government departments and agencies                $  618       $1,134
          Advances to suppliers and others                       21           48
          Employees                                              80          201
          Prepaid expenses                                      178          829
          Related parties                                       477          121
          Deferred taxes                                        111          153
          Short-term deposits                                   251           --
          Interest income receivable                            163          438
                                                             ------       ------

                                                             $1,899       $2,924
                                                             ======       ======

      3.    ACCOUNTS PAYABLE AND ACCRUALS - OTHER:

                                                                 DECEMBER 31,
                                                             -------------------
                                                               2003        2002
                                                             -------     -------
                                                                (IN THOUSANDS)
                                                             -------------------
          Government departments and agencies                $ 2,809     $ 3,997
          Employees and wage-related liabilities               4,867       5,708
          Related parties                                        215          --
          Accrued expenses and other current liabilities       3,089       4,179
                                                             -------     -------

                                                             $10,980     $13,884
                                                             =======     =======


                                      F-50
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 15 - SUPPLEMENTARY FINANCIAL STATEMENT INFORMATION (CONT.):

B.    STATEMENTS OF OPERATIONS:

      1.    GOODWILL IMPAIRMENT, RESTRUCTURING COSTS AND NON-RECURRING EXPENSES:


                                                      YEAR ENDED DECEMBER 31,
                                                    ----------------------------
                                                     2003       2002       2001
                                                    ------     ------     ------
                                                           (IN THOUSANDS)
                                                    ----------------------------
          Goodwill impairment (1)                   $   --     $   --     $1,657
          Restructuring costs (2)                       --        472      2,660
          Non-recurring expenses                        --         --        150
                                                    ------     ------     ------
                                                    $   --     $  472     $4,467
                                                    ======     ======     ======

-----------------
(1)   Relates to the entire balance of goodwill in SCH as of December 31, 2001,
      which, in the estimation of the Company's management, is not recoverable.

(2)   Restructuring costs include 2002 - $322,000 (2001- $2.3 million) in
      respect of employee termination benefits and 2002 - $150,000 (2001-
      $363,000) in respect of other exit costs. Restructuring costs include an
      accrual of 2002 - $182,000 (2001- $734,000). Under the Company's
      restructuring plan, at the end of 2002 5 employees were terminated out of
      the following employee groups: research and development, marketing and
      management.


      2.    PRINCIPAL CUSTOMERS:

      One customer accounted for 14% of the Company's revenues and 8.7% of the
      Company's trade receivable in 2003.

      In the period 2002-2001 the Company did not have revenues from any single
      customer in excess of 10% of total revenues in the respective period.

      3.    FINANCIAL INCOME (EXPENSES), NET:


<TABLE>
<CAPTION>
                                                                      YEAR ENDED DECEMBER 31,
                                                                     ---------------------------
                                                                     2003       2002       2001
                                                                     -----      -----      -----
                                                                            (IN THOUSANDS)
                                                                     ---------------------------
<S>                                                                  <C>        <C>        <C>
          Interest income                                            $ 109      $ 648      $ 372
          Foreign currency translation adjustments (see Note A4)       614        (64)      (238)
          Gain (loss) on sale of marketable securities                 105         24        (46)
          Interest expenses                                           (663)      (803)      (150)
                                                                     -----      -----      -----
                                                                     $ 165      $(195)     $ (62)
                                                                     =====      =====      =====
</TABLE>


                                      F-51
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 15 - SUPPLEMENTARY FINANCIAL STATEMENT INFORMATION (CONT.):

B.    STATEMENTS OF OPERATIONS (CONT.):

      4.    GAIN ON REALIZATION OF SHAREHOLDINGS:

                                                       YEAR ENDED DECEMBER 31,
                                                     ---------------------------
                                                     2003       2002       2001
                                                     -----       ----       ----
                                                           (IN THOUSANDS)
                                                     ---------------------------

          Level 8                                    $ 376       $ --       $ --
          Polyglot                                      --         --        693

                                                     $ 376       $ --       $693

      5.    OTHER INCOME (EXPENSES), NET:

<TABLE>
<CAPTION>
                                                                                    YEAR ENDED DECEMBER 31,
                                                                              ---------------------------------
                                                                               2003         2002         2001
                                                                              -------      -------      -------
                                                                                       (IN THOUSANDS)
                                                                              ---------------------------------
<S>                                                                           <C>          <C>          <C>
          Write-down of loans to Alexandria (Note 2D)                         $    --      $    --      $(2,500)
          Loss from disposal of fixed assets                                      (31)         (37)        (149)
          Expiration of warrants in Tesnet (Note 3C)                               75          112           --
          Write-down of shareholdings in MultiConn Technologies (Note 3D)          --       (1,800)          --
          Write-down of shareholdings in Transale (1)                            (100)          --           --
          Write-down of loan to MultiConn Technologies
             (Note 3D)                                                           (350)          --           --
          Decrease of provision for losses in formerly-consolidated
             subsidiary (Note 9)                                                  541           --           --
          Other                                                                   432          144           --
                                                                              -------      -------      -------

                                                                              $   567      $(1,581)     $(2,649)
                                                                              =======      =======      =======
</TABLE>


----------------
(1)   In 2003, the Company wrote down its entire investment in Transale Ltd, a
      company accounted for under the cost method. The write-down was due to
      uncertainty regarding its value, since it ran out of funds and could not
      continue the development of its products.

C.    EARNINGS (LOSS) PER SHARE:

      Basic earnings per share ("EPS") was computed based on the average number
      of shares outstanding during each year, after giving retroactive effect to
      stock dividends and stock splits. In computing diluted EPS, effect was
      given to share options outstanding in each period, using the treasury
      stock method, provided that such effect is not anti-dilutive.



                                      F-52
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 15 - SUPPLEMENTARY FINANCIAL STATEMENT INFORMATION (CONT.):

C.    EARNINGS (LOSS) PER SHARE (CONT.):

      The following table sets forth the computation of basic and diluted net
      earnings (loss) per share.

<TABLE>
<CAPTION>
                                                                                            YEAR ENDED DECEMBER 31,
                                                                               -----------------------------------------------
                                                                                   2003             2002              2001
                                                                               ------------     ------------      ------------
                                                                                               (IN THOUSANDS)
                                                                               -----------------------------------------------
<S>                                                                            <C>              <C>               <C>
      A.   NUMERATOR:

           Net income (loss) to holders of Ordinary shares                     $      1,851     $     (3,630)     $    (14,987)
                                                                               ============     ============      ============

           Numerator for basic and diluted net earnings (loss) per share -
            income (loss) available to holders of Ordinary
            shares                                                                    1,851           (3,630)          (14,987)
                                                                               ============     ============      ============

      B.   DENOMINATOR:

           Denominator for basic net earnings (loss) per share -
            weighted average of shares                                           13,451,234       10,517,085         9,872,278
                                                                               ============     ============      ============

           Effect of dilutive securities:
            Employee stock options                                                  193,150              * -               * -
                                                                               ============     ============      ============

           Dilutive potential Ordinary shares                                       193,150               --                --
                                                                               ============     ============      ============

           Denominator for diluted net earnings (loss) per share -
            weighted average shares and assumed exercise of options              13,644,384       10,517,085         9,872,278
                                                                               ============     ============      ============

           Basic net earnings (loss) per share                                 $       0.14     $      (0.35)     $      (1.52)
                                                                               ============     ============      ============

           Diluted net earnings (loss) per share                               $       0.14     $      (0.35)     $      (1.52)
                                                                               ============     ============      ============
</TABLE>

      *     Anti-dilutive.


      Options to purchase 100,000 shares at $28.35 per share were outstanding
      during the entire years of 2002 and 2001, but were not included in the
      computation of diluted EPS because the options' exercise price was greater
      than the average market price of the ordinary shares. Furthermore, options
      to purchase 1,067,000, 1,347,260 and 1,101,000 shares at various prices
      between 5.5 to 10.5 per share and $3.00 to $10.50 per share were
      outstanding during the entire years of 2003, 2002 and 2001, respectively
      but were not included in the computation of diluted EPS because the
      options' exercise price was greater than the average market price of the
      ordinary shares.



                                      F-53
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)


NOTE 15 - SUPPLEMENTARY FINANCIAL STATEMENT INFORMATION (CONT.):

D.    GEOGRAPHIC AREAS INFORMATION:

      1.    SALES - CLASSIFIED BY GEOGRAPHIC AREAS:


                                              YEAR ENDED DECEMBER 31,
                                          -------------------------------
                                           2003        2002        2001
                                          -------     -------     -------
                                                  (IN THOUSANDS)
                                          -------------------------------
          USA                             $18,520     $20,847     $21,428
          Europe (other than Denmark)      19,799       7,785       8,518
          Denmark                           8,997       2,530          --
          Israel                            3,986       4,636       7,482
          Other                             3,038         870       1,010
                                          -------     -------     -------

                                          $54,340     $36,668     $38,438
                                          =======     =======     =======


      Sales by geographic areas are determined based on the customer's location.

      2.    THE COMPANY'S LONG-LIVED ASSETS ARE AS FOLLOWS:

                                                            DECEMBER 31,
                                                       --------------------
                                                        2003         2002
                                                       -------      -------
                                                         (IN THOUSANDS)
                                                       --------------------
          Israel                                       $10,160      $ 6,318
          U.S.A                                          3,543        5,100
          Europe (other than Denmark)                      240          309
          Denmark                                           36           24
                                                       -------      -------

                                                       $13,979      $11,751
                                                       =======      =======


      Long-lived assets information is based on the physical location of the
      assets at the end of each of the fiscal years.

      The Company does not identify or allocate goodwill by geographic areas.



                                      F-54
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 16 - TRANSACTIONS WITH RELATED PARTIES:

<TABLE>
<CAPTION>
                                                                                     YEAR ENDED DECEMBER 31,
                                                                            ---------------------------------------
                                                                              2003            2002            2001
                                                                            -------         -------         -------
                                                                                         (IN THOUSANDS)
                                                                            ---------------------------------------
<S>                                                                         <C>             <C>             <C>
FORMULA, ITS SUBSIDIARIES AND OTHER ASSOCIATED COMPANIES:

A.    Selling, general and administrative expenses:
      Management fees (Note 11B)                                            $   180         $   180         $   180

B.    Revenues from sale of software conversion tool and software
      services to related parties                                           $   225         $ 1,108         $ 3,960

C.    Cost of revenues relating to services from related Parties            $   354         $ 1,811         $ 3,318

D.    Reimbursement with respect to services rendered to affiliated
      and other companies                                                   $   256         $   481         $ 1,516

E.    Sale of investees to Formula Vision Technologies (F.V.T.) Ltd.        $    --         $    --         $ 1,959
</TABLE>


F.    Arie Kilman was nominated as the Company Chief Executive Office in May
      2003. In his former position as Liraz' chairman of the board of directors,
      he was granted in May 2002 a loan of approximately $300 thousand, linked
      to the Israeli consumer price index, and bearing an annual interest at a
      rate of 4%. Under the terms of the loan, the loan should be repaid to
      Liraz in four equal annual installments, but no later than termination of
      Mr. Kilman's employment. Mr. Kilman pledged 200,000 of the Liraz' shares
      he owned in favor of the Company to secure repayment of the loan.
      Following the share exchange transaction between the Company and Liraz'
      shareholders effective as of November 14, 2002, Mr. Kilman replaced the
      pledged shares with 119,760 of the Company' shares. The amount of the
      Company's shares pledged by Mr. Kilman was based on the exchange ratio
      determined in the share exchange agreement, pursuant to which every 1.67
      shares of Liraz were exchanged for one BluePhoenix ordinary share. Except
      for the replacement of the pledged shares, the terms of the loan were not
      amended. As of December 31, 2003, the outstanding balance of this loan was
      $216 thousand.

G.    As to the Company's acquisition of Alphatech from Intercomp - see Note 2F.

H.    As to the Company's acquisition of Liraz from Formula - see Note 2E.

I.    In October 2003, the Company entered into an option agreement with
      Intercomp to purchase Intercomp's technology for an aggregate of $1.9
      million. In addition, the Company undertook to pay royalties to Intercomp
      of 25% of the revenues generated from the purchased technology.



                                      F-55
<PAGE>

                           BLUEPHOENIX SOLUTIONS LTD.
                   (FORMERLY: CRYSTAL SYSTEMS SOLUTIONS LTD.)
                            (AN ISRAELI CORPORATION)

NOTE 17 - SUBSEQUENT EVENTS:


A.    As to the change in the Company name - see not 1A.

B.    As to the acquisition of CePost - see note 2I.

C.    As to the acquisition of Outlook - see note 2J.

D.    As to the sale of the Company's holding in Tesnet - see note 3C.

E.    As to Mainsoft's commitments - see note 11A.

F.    As to grants from the Office of the Chief Scientist - see note 11D and
      11E.

G.    As to the Company's put option in Intercomp - see note 12B2 and 12B3.

H.    As to a private placement - see not 12B4.

I.    As to funding received from the Singapore-Israel Industrial Research and
      Development Foundation - see note 11L.

J.    During 2004, the Company and a customer mutually agreed to terminate a
      contract. As a result, the Company recorded a loss of $ 400 thousand in
      the first quarter of 2004.



                                      F-56