Edgar Filing: MAGIC SOFTWARE ENTERPRISES LTD

20-F


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

[_]  REGISTRATION STATEMENT PURSUANT TO SECTION 12(B) OR (G) OF THE SECURITIES
     EXCHANGE ACT OF 1934

                                       OR

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
     ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006

                                       OR

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

             FOR THE TRANSITION PERIOD FROM __________ TO __________

[_]  SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
     EXCHANGE ACT OF 1934

       Date of event requiring this shell company report .................

                         COMMISSION FILE NUMBER: 0-19415

                         MAGIC SOFTWARE ENTERPRISES LTD.
              (Exact Name of Registrant as specified in its charter
               and translation of Registrant's name into English)

                                     ISRAEL
                 (JURISDICTION OF INCORPORATION OR ORGANIZATION)

                    5 HAPLADA STREET, OR YEHUDA 60218, ISRAEL
                    (Address of principal executive offices)

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

        Title of each class            Name of each exchange on which registered
 ORDINARY SHARES, NIS 0.1 PAR VALUE              NASDAQ GLOBAL MARKET

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

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

Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the period covered by the annual
report:

     ORDINARY SHARES, PAR VALUE NIS 0.01 PER SHARE...............31,323,845
                            (as of December 31, 2006)

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

                               Yes [_]     No [X]

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

                               Yes [_]     No [X]

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


                               Yes [X]     No [_]


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

   Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [X]

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

                           Item 17 [_]     Item 18 [X]

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

                               Yes [_]     No [X]

This annual report on Form 20-F is incorporated by reference into the
registrant's Registration Statements on Form S-8, Registration Nos. 333-13270,
333-11220, 333-1946, 333-10794, 333-113552 and 333-132221.



                                  INTRODUCTION

     Magic Software Enterprises Ltd. develops, markets and supports composite
application development and deployment platforms with a service-oriented
architecture, or SOA, including application integration and business process
management, or BPM, with existing and legacy systems. Our products and services
are available through a global network of subsidiaries, distributors and
software solution providers in approximately 100 countries. As used in this
annual report, the terms "we," "us," "our," and Magic mean Magic Software
Enterprises Ltd. and its subsidiaries, unless otherwise indicated.

     Over the last twenty-four years we have developed an application
development and deployment technology, which is a metadata driven, rule based
platform and development framework. During that period, a broad community of
independent software vendors, or ISVs, and customers worldwide, have been using
our rapid application development and deployment technology and products. In
2002, we recognized that the software application market was changing.
Organizations had built up a wide array of systems that needed to communicate
with each other more efficiently in order to streamline business processes,
improve productivity and ultimately reduce costs and increase business revenues.
The demand for technology enablement was no longer coming exclusively from the
information technology, or IT, department, but from businesses charged with
improving operations. In order to address the needs of both developers and
business users, we added to our eDeveloper two additional layers, orchestration
and graphical process design, as well as an activity monitoring service, and
created iBOLT a single, unified and highly scalable development and business
integration suite. iBOLT allows our customers to implement application
integration layers, create service oriented architectures and manage end-to-end
processes.

     We have obtained trademark registrations for Magic(R) in the United States
as well as in Canada, Israel, the Netherlands (Benelux), Switzerland, Thailand
and the United Kingdom. All other trademarks and trade names appearing in this
annual report are owned by their respective holders.

     Our consolidated financial statements appearing in this annual report are
prepared in U.S. dollars and in accordance with generally accepted accounting
principles in the United States, or U.S. GAAP. All references in this annual
report to "dollars" or "$" are to U.S. dollars and all references in this annual
report to "NIS" are to New Israeli Shekels.

     Statements made in this annual report concerning the contents of any
contract, agreement or other document are summaries of such contracts,
agreements or documents and are not complete descriptions of all of their terms.
If we filed any of these documents as an exhibit to this annual report or to any
previous filling with the Securities and Exchange Commission, you may read the
document itself for a complete recitation of its terms.

     This annual report on Form 20-F contains various "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and
the Private Securities Litigation Reform Act of 1995, as amended, with respect
to our business, financial condition and results of operations. Such
forward-looking statements reflect our current view with respect to future
events and financial results. Statements which use the terms "anticipate,"
"believe," "expect," "plan," "intend," "estimate," "anticipate" and similar
expressions are intended to identify forward looking statements. We remind
readers that forward-looking statements are merely predictions and therefore
inherently subject to uncertainties and other factors and involve known and
unknown risks that could cause the actual results, performance, levels of
activity, or our achievements, or industry results, to be materially different
from any future results, performance, levels of activity, or our achievements
expressed or implied by such forward-looking statements. Readers are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of the date hereof. Except as required by applicable law, including the
securities laws of the United States, we undertake no obligation to publicly
release any update or revision to any forward looking statements to reflect new
information, future events or circumstances, or otherwise after the date hereof.
We have attempted to identify significant uncertainties and other factors
affecting forward-looking statements in the Risk Factors section that appears in
Item 3D. "Key Information - Risk Factors"


                                       1

TABLE OF CONTENTS

PART I 4

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 4
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 4
ITEM 3. KEY INFORMATION 4
A. SELECTED FINANCIAL DATA 4
B. CAPITALIZATION AND INDEBTEDNESS 5
C. REASONS FOR THE OFFER AND USE OF PROCEEDS 5
D. RISK FACTORS 5
ITEM 4. INFORMATION ON THE COMPANY 14
A. HISTORY AND DEVELOPMENT OF THE COMPANY 14
B. BUSINESS OVERVIEW 16
C. ORGANIZATIONAL STRUCTURE 26
D. PROPERTY, PLANTS AND EQUIPMENT 26
ITEM 4A. UNRESOLVED STAFF COMMENTS 27
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 27
A. RESULTS OF OPERATIONS 27
B. LIQUIDITY AND CAPITAL RESOURCES 42
C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES 44
D. TREND INFORMATION 45
E. OFF-BALANCE SHEET ARRANGEMENTS 45
F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS 45
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 45
A DIRECTORS AND SENIOR MANAGEMENT 45
B. COMPENSATION 48
C. BOARD PRACTICES 49
D. EMPLOYEES 56
E. SHARE OWNERSHIP 57
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 60
A. MAJOR SHAREHOLDERS 60
B. RELATED PARTY TRANSACTIONS 61
C. INTERESTS OF EXPERTS AND COUNSEL 61
ITEM 8. FINANCIAL INFORMATION 61
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION 61
B. SIGNIFICANT CHANGES 62
ITEM 9. THE OFFER AND LISTING 62
A. OFFER AND LISTING DETAILS 62
B. PLAN OF DISTRIBUTION 63
C. MARKETS 63
D. SELLING SHAREHOLDERS 64
E. DILUTION 64
F. EXPENSE OF THE ISSUE 64
ITEM 10. ADDITIONAL INFORMATION 64
A. SHARE CAPITAL 64
B. MEMORANDUM AND ARTICLES OF ASSOCIATION 64
C. MATERIAL CONTRACTS 66
D. EXCHANGE CONTROLS 66
E. TAXATION 67
F. DIVIDEND AND PAYING AGENTS 76
G. STATEMENT BY EXPERTS 76
H. DOCUMENTS ON DISPLAY 76
I. SUBSIDIARY INFORMATION 76
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS 77
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 77

PART II 77

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 77
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 77
ITEM 15. CONTROLS AND PROCEDURES 77
ITEM 15T. CONTROLS AND PROCEDURES 77
ITEM 16. RESERVED 78
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 78
ITEM 16B. CODE OF ETHICS 78
ITEM 16C. PRINCIPAL ACCOUNTING FEES AND SERVICES 78
ITEM 16D. EXEMPTIONS FROM THE LISTING REQUIREMENTS AND STANDARDS FOR AUDIT COMMITTEE 79
ITEM 16E. PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS 79

PART III 79

ITEM 17. FINANCIAL STATEMENTS 79
ITEM 18. FINANCIAL STATEMENTS 79
ITEM 19. EXHIBITS 79
S I G N A T U R E S 81



                                     PART I

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 table presents selected consolidated financial data as of the
dates and for each of the periods indicated. You should read the selected
consolidated financial data set forth below together with Item 5. "Operating and
Financial Review and Prospects" as well as our consolidated financial statements
and notes thereto appearing elsewhere in this annual report.

     We have derived the following consolidated income statement data for the
years ended December 31, 2004, 2005 and 2006 and the consolidated balance sheet
data as of December 31, 2005 and 2006 from our audited consolidated financial
statements and notes included elsewhere in this annual report. We have derived
the consolidated income statement data for the years ended December 31, 2002 and
2003 and the consolidated balance sheet data as of December 31, 2002, 2003 and
2004 from our audited consolidated financial statements that are not included in
this annual report.

INCOME STATEMENT DATA:

                                                                            YEAR ENDED DECEMBER 31,
                                                    -----------------------------------------------------------------------
                                                      2002            2003            2004           2005            2006
                                                    --------        --------        --------       --------        --------
                                                         (U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Revenues:
   Software                                         $ 15,136        $ 19,712        $ 20,614       $ 16,803        $ 15,853
   Applications                                        7,355           7,277           7,408          8,300           6,483
   Maintenance and technical support                  10,882          10,853          12,555         14,376          14,935
   Consulting services                                26,631          25,548          24,590         21,511          24,454
                                                    --------        --------        --------       --------        --------
     Total revenues                                   60,004          63,390          65,167         60,990          61,725
                                                    --------        --------        --------       --------        --------
Cost of revenues:
   Software                                            3,318           3,943           4,742          4,412           4,014
   Applications                                        2,334           1,162           1,720          4,071           3,002
   Maintenance and technical support                   4,100           2,580           3,199          2,679           3,615
   Consulting services                                19,239          16,454          15,818         15,514          18,087
                                                    --------        --------        --------       --------        --------
     Total cost of revenues                           28,991          24,139          25,479         26,676          28,718
                                                    --------        --------        --------       --------        --------
Gross profit                                          31,013          39,251          39,688         34,314          33,007
                                                    --------        --------        --------       --------        --------
Operating expenses:
   Research and development, net                       5,336           4,775           3,845          3,733           3,942
   Sales, marketing, general and administrative       30,694          30,814          32,541         34,842          32,349
   Restructuring and impairment
     and other non-recurring costs                     1,123               -               -              -           2,157
                                                    --------        --------        --------       --------        --------
Operating income (loss)                               (6,140)          3,662           3,302         (4,261)         (5,441)
Financial income (expense), net                          958             307             912           (811)            410
Other income (expenses)                                    -             (42)              -          1,169             278
                                                    --------        --------        --------       --------        --------
Income (loss) before taxes on income                  (5,182)          3,927           4,214         (3,903)         (4,753)
Income taxes                                            (384)            230             281            491             325
                                                    --------        --------        --------       --------        --------
Income (loss) after taxes on income                   (5,566)          3,697           3,933         (4,394)         (5,078)
Equity in earnings (losses) of affiliates               (108)            (36)             79             19             (15)
Minority interest in losses (earnings)
    of subsidiaries                                       11            (594)             78           (232)            (57)
Net income (loss)                                   $ (5,663)       $  3,067        $  4,090       $ (4,607)       $ (5,006)
                                                    ========        ========        ========       ========        ========
Basic net earnings (loss) per share                 $  (0.19)       $   0.10        $   0.13       $  (0.15)       $  (0.16)
Diluted net earnings (loss) per share               $  (0.19)       $   0.10        $   0.13       $  (0.15)       $  (0.16)
Shares used to compute basic earnings
   (loss) per share                                   29,690          29,624          31,029         31,124          31,184
Shares used to compute diluted earnings
   (loss) per share                                   29,690          29,909          32,426         31,124          31,184


                                       4

BALANCE SHEET DATA:

AT DECEMBER 31,
-----------------------------------------------------------
2002 2003 2004 2005 2006
---- ---- ---- ---- ----
(U.S. DOLLARS IN THOUSANDS)

Working capital $23,200 $16,798 $19,852 $13,471 $ 8,641
Cash, cash equivalents, short term deposits
and marketable securities 24,785 13,581 12,803 13,865 12,880
Total assets 84,522 77,800 80,285 73,723 69,911
Shareholders' equity 61,021 53,924 59,547 52,305 47,644

B. CAPITALIZATION AND INDEBTEDNESS

Not applicable.

C. REASONS FOR THE OFFER AND USE OF PROCEEDS

Not applicable.

D. RISK FACTORS

INVESTING IN OUR ORDINARY SHARES INVOLVES A HIGH DEGREE OF RISK AND
UNCERTAINTY. YOU SHOULD CAREFULLY CONSIDER THE RISKS AND UNCERTAINTIES DESCRIBED
BELOW BEFORE INVESTING IN OUR ORDINARY SHARES. OUR BUSINESS, PROSPECTS,
FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED DUE TO
ANY OF THE FOLLOWING RISKS. IN THAT CASE, THE VALUE OF OUR ORDINARY SHARES COULD
DECLINE, AND YOU COULD LOSE ALL OR PART OF YOUR INVESTMENT.

RISKS RELATED TO OUR BUSINESS AND OUR INDUSTRY

WE HAVE A HISTORY OF LOSSES AND MAY NOT BE ABLE TO ACHIEVE OR SUSTAIN
PROFITABILITY IN THE FUTURE.

In the year ended December 31, 2006, we recorded a net loss of
approximately $5.0 million. We have incurred losses in three out of the last
five years and we may not be able to achieve or sustain profitability in the
future.



WE HAVE A HISTORY OF QUARTERLY FLUCTUATIONS IN OUR RESULTS OF OPERATIONS AND
EXPECT THESE FLUCTUATIONS TO CONTINUE.

     We have experienced and in the future may continue to experience
significant fluctuations in our quarterly results of operations and we expect
these fluctuations to continue. Factors that may contribute to fluctuations in
our quarterly results of operations include:

     o    The size and timing of orders;

     o    The high level of competition that we encounter;

     o    The timing of our product introductions or enhancements or those of
          our competitors or of providers of complementary products;

     o    Market acceptance of our new products, applications and services;

     o    The purchasing patterns and budget cycles of our customers and
          end-users;

     o    Seasonality in our revenues, with the third quarter typically having
          lower levels of revenues due to the summer months in Europe;

     o    The mix of product sales;

     o    Exchange rate fluctuations; and

     o    General economic conditions.

         Our customers ordinarily require the delivery of products promptly
after we accept their orders. With the exception of contracts for services, we
usually do not have a significant backlog of orders for our products.
Consequently, revenues from our products in any quarter depend on orders
received and accepted by the customers in that quarter. The deferral of the
placing and acceptance of any large order from one quarter to another could
materially adversely affect our results of operations for the former quarter.
Our customers sometimes require an acceptance test for services we provide and
as a result, we may have a significant backlog of orders for our services. Our
revenues from services depend on orders received and services provided by us and
accepted by our customers in that quarter. If sales in any quarter do not
increase correspondingly or if we do not reduce our expenses in response to
level or declining revenues in a timely fashion, our financial results for that
quarter would be materially adversely affected. For these reasons,
quarter-to-quarter comparisons of our results of operations are not necessarily
meaningful and you should not rely on the results of our operations in any
particular quarter as an indication of future performance.

CURRENCY EXCHANGE RATE FLUCTUATIONS IN THE WORLD MARKETS IN WHICH WE CONDUCT
BUSINESS COULD HAVE A MATERIAL ADVERSE AFFECT ON OUR BUSINESS, RESULTS OF
OPERATIONS AND FINANCIAL CONDITION.

     Our financial statements are stated in U.S. dollars, our functional
currency. Nevertheless, a substantial portion of our sales and expenses are
incurred in other currencies, particularly Euros, Japanese yen, NIS and the
British pound. We maintain substantial non-U.S. dollar balances of assets,
including cash and accounts receivable, and liabilities, including accounts
payable. Fluctuations in the value of the currencies in which we do business
relative to the U.S. dollar may have a material adverse effect on our business,
results of operations and financial condition, by decreasing the U.S. dollar
value of assets held in other currencies and increasing the U.S. dollar amount
of liabilities payable in other currencies. From time to time we use derivative
or other instruments to hedge against part or all of our exposures.

OUR WIDESPREAD OPERATIONS MAY STRAIN OUR MANAGEMENT, OPERATIONAL AND FINANCIAL
RESOURCES.

     Our widespread operations have significantly strained our management,
operational and financial resources in the past. Any future growth may increase
this strain. To manage future growth effectively, we must:


                                       6



     o    Expand our operational, management, financial, marketing and research
          and development functions;

     o    Train, motivate, manage and retain qualified employees; and

     o    Hire additional personnel.

     We may not succeed in managing future growth.

WE FACE INTENSE COMPETITION IN THE MARKETS FOR OUR APPLICATION DEVELOPMENT AND
INTEGRATION TECHNOLOGIES AND SERVICES, WHICH ARE EVOLVING INTO A NEW UNIFIED
MARKET FOR COMPOSITE APPLICATIONS DEVELOPMENT AND DEPLOYMENT.

     Many companies compete with us in the areas of software development tools,
business integration and business process management, or BPM, tools, and in the
applications and services markets in which we operate. We expect that
competition will increase in the future, both with respect to our technology,
applications and services which we currently offer and applications and services
which we and other vendors are developing. Increased competition, direct and
indirect, could adversely affect our business, financial condition and results
of operations.

     Many of our existing and potential competitors are far larger, have
substantially greater resources including financial, technological, marketing,
skilled human resources and distribution capabilities, and enjoy greater market
recognition than us. We may not be able to differentiate our products from those
of our competitors, offer our products as part of integrated systems or
solutions to the same extent as our competitors, or successfully develop or
introduce new products that are more cost-effective, or offer better performance
than our competitors. Failure to do so could adversely affect our business,
financial condition and results of operations.

WE MAY NOT SUCCEED IN INCREASING OUR MARKET SHARE IN THE BUSINESS INTEGRATION
AND PROCESS MANAGEMENT MARKETS WITH OUR IBOLT PRODUCTS, OR LEVERAGE OUR
EXPERIENCE IN THE COMPOSITE APPLICATIONS FIELD.

     During 2003, we launched the iBOLT Integration Suite, which provides
business integration and process management solutions to mid-size and large
organizations. In 2004, we launched iBOLT Version 2.0, and in 2005 we released
both iBOLT Version 2.5 and iBOLT Special Edition for SAP Business One. We are
currently developing the next release of iBOLT, which we expect to release
during the latter part of 2007.

     The business integration and BPM markets in which we compete are extremely
competitive and subject to rapid changes. Our competitors utilize varying
approaches to the provision of technology to business integration and BPM
markets. We may not have the resources, skills and product variety required to
successfully increase our market share in these markets. We do not have a long
history of selling products in the business integration and process management
markets and we will have to devote substantial resources to educating
prospective customers and the market about our products' benefits. In addition,
even if we succeed in convincing prospective customers and the market that our
products are effective and provide real business benefits, our target customers
may not choose them for technical, cost, support or other reasons.

     To succeed in these markets, we will need to:

     o    Further develop and improve our expertise in marketing and selling
          integration technology;

     o    Recruit, develop and cultivate additional system integrators who will
          serve as market and sales channels of integration projects for
          prospective customers; and

     o    Effectively establish and enhance relationships with technological
          partners and application vendors, which will extend our value
          proposition and assist us in reaching more customers.


                                       7



OUR FUTURE SUCCESS WILL BE LARGELY DEPENDENT ON THE ACCEPTANCE OF FUTURE
RELEASES OF OUR EDEVELOPER APPLICATION DEVELOPMENT AND DEPLOYMENT PRODUCT.

     Our future success will be in great measure dependent on the acceptance of
future releases of our eDeveloper application development and deployment
product. The acceptance of this product relies in part on the continued
acceptance and growth of diverse platforms, systems and databases, where
eDeveloper operates as the bridge for creating composite applications. In the
future, organizations may not implement multiple environments to serve their
computing needs.

CHANGES IN THE RATIO OF OUR REVENUES GENERATED FROM DIFFERENT REVENUE ELEMENTS
MAY ADVERSELY AFFECT OUR GROSS PROFIT MARGINS.

     We derive our revenues from the sale of software licenses, applications,
maintenance and technical support and consulting services. Our gross margin is
affected by the proportion of our revenues generated from the sale of each of
those elements of our revenues. Our revenues from the sale of our software
licenses and maintenance and technical support have higher gross margins than
our revenues from the sale of consulting services. If the relative proportion of
our revenues from the sale of consulting services increases as a percentage of
our total revenues, our gross profit margins will decline. Our software licenses
revenues include the sale of the third party software license sales, which have
a lower gross margin than the sales of our software products. Any increase in
the portion of third party software license sales out of total license sales
will decrease our gross profit margin.

WE DERIVE A SIGNIFICANT PORTION OF OUR REVENUES FROM INDEPENDENT DISTRIBUTORS
WHO ARE UNDER NO OBLIGATION TO PURCHASE OUR PRODUCTS.

     We sell our products through our direct sales representatives, as well as
through third parties that use our technology to develop solutions for their
customers, referred to as Magic solution providers, and independent
distributors. These independent distributors then resell our products to
end-users. We are dependent upon the acceptance of our products by our
independent distributors and their active marketing and sales efforts.
Typically, our arrangements with our independent distributors do not require
them to purchase specified amounts of products or prevent them from selling
non-competitive products. The independent distributors may not continue, or may
not give a high priority to, marketing and supporting our products. Our results
of operations could be materially adversely affected by changes in the financial
condition, business, marketing strategies, local and global economic conditions,
or results of our independent distributors.

WE MAY LOSE INDEPENDENT DISTRIBUTORS ON WHOM WE CURRENTLY DEPEND AND WE MAY NOT
SUCCEED IN DEVELOPING NEW DISTRIBUTION CHANNELS.

     If any of our distribution relationships are terminated, we may not be
successful in replacing them on a timely basis, or at all. In addition, we will
need to develop new sales channels for new products, and we may not succeed in
doing so. Any changes in our distribution and sales channels, particularly the
loss of a major distributor, or our inability to establish effective
distribution and sales channels for new markets, will impact our ability to sell
our products and result in a loss of revenues and profits.

OUR EFFORTS TO INCREASE OUR PRESENCE IN THE UNITED STATES, EUROPE AND ASSIA MAY
NOT BE PROFITABLE.

     Our success in becoming a stronger competitor in the sale of software
development and deployment technology and a leading provider of applications is
dependent upon our ability to increase our sales in the United States, Europe
and Japan. Our efforts to increase our penetration to these markets are subject
to risks inherent to such markets, including the high cost of doing business in
such locations.


                                       8



OUR PRODUCTS HAVE A LENGTHY SALES CYCLE.

     Our customers typically use our technology to develop, deploy and integrate
applications that are critical to their businesses. As a result, the licensing
and implementation of our technology generally involves a significant commitment
of attention and resources by prospective customers. Because of the long
approval process that typically accompanies strategic initiatives or capital
expenditures by companies, our sales process is often delayed, with little or no
control over any delays encountered by us. Our sales cycle can be further
extended for sales made through third party distributors.

RAPID TECHNOLOGICAL CHANGES MAY ADVERSELY AFFECT THE MARKET ACCEPTANCE OF OUR
PRODUCTS AND SERVICES.

     We compete in a market that is characterized by rapid technological change.
The introduction of new technologies could render existing products and services
obsolete and unmarketable and could exert price pressures on our products and
services. Our future success will depend upon our ability to address the
increasingly sophisticated needs of our customers by:

     o    Supporting existing and emerging hardware, software, databases and
          networking platforms; and

     o    Developing and introducing new and enhanced software development
          technology and applications that keep pace with such technological
          developments, emerging new markets and changing customer requirements.

     If release dates of any future products or enhancements are delayed or if,
when released, they fail to achieve market acceptance, our business, financial
condition and results of operations would be materially adversely affected.

WE MAY BE UNABLE TO ATTRACT, TRAIN AND RETAIN QUALIFIED ENGINEERING,
ADMINISTRATIVE, OPERATIONAL, SALES AND TECHNICAL SUPPORT PERSONNEL.

     In the event our business grows, we will need to hire additional qualified
engineering, administrative, operational, sales and technical support personnel.
The process of locating, training and successfully integrating qualified
personnel into our operations can be lengthy and expensive. We may not be able
to compete effectively for the personnel we need. Competition for these
employees in the industry in which we operate is intense around the world,
especially in Israel, India and the United States. Any loss of members of senior
management or key technical personnel, or any failure to attract or retain
highly qualified employees as needed, could have a material adverse effect on
our business, financial condition and results of operations.

OUR PRODUCTS MAY CONTAIN DEFECTS THAT MAY BE COSTLY TO CORRECT, DELAY MARKET
ACCEPTANCE OF OUR PRODUCTS AND EXPOSE US TO DIFFICULTIES IN THE COLLECTION OF
RECEIVABLES AND TO LITIGATION.

     Despite quality assurance testing performed by us, as well as by Magic
solution providers and end-users who participate in our beta-testing programs,
errors may be found in our software products or in applications developed with
our technology. This risk is exacerbated by the fact that a significant
percentage of the applications developed with our technology were and are likely
to continue to be developed by Magic solution providers over whom we exercise no
supervision or control. If defects are discovered, we may not be able to
successfully correct them in a timely manner or at all. Defects and failures in
our products could result in a loss of, or delay in, market acceptance of our
products, as well as difficulties in the collection of receivables and
litigation, and could damage our reputation.

     Our standard license agreement with our customers contains provisions
designed to limit our exposure to potential product liability claims that may
not be effective or enforceable under the laws of some jurisdictions.
Accordingly, we could fail to realize revenues and suffer damage to our
reputation as a result of, or in defense of, a substantial claim.

WE RELY ON THIRD PARTY TECHNOLOGY LICENSES.

     We incorporate software that we license from third parties into our
technology. If we lose, or are unable to maintain any software licenses, we
could suffer harm until equivalent software can be developed, identified,
licensed and integrated. Loss of third party software licensing would materially
adversely affect our business, financial condition and results of operations.


                                       9



OUR PROPRIETARY TECHNOLOGY IS DIFFICULT TO PROTECT AND UNAUTHORIZED USE OF OUR
PROPRIETARY TECHNOLOGY BY THIRD PARTIES MAY IMPAIR OUR ABILITY TO COMPETE
EFFECTIVELY.

     Our success and ability to compete depend in large part upon our ability to
protect our proprietary technology. We rely on a combination of trade secret and
copyright laws and confidentiality, non-disclosure and assignment-of-inventions
agreements to protect our proprietary technology. We do not have any patents.
Our policy is to require employees and consultants to execute confidentiality
agreements upon the commencement of their relationships with us. These measures
may not be adequate to protect our technology from third-party infringement, and
our competitors might independently develop technologies that are substantially
equivalent or superior to ours. Additionally, our products may be sold in
foreign countries that provide less protection for intellectual property rights
than that provided under U.S. or Israeli laws.

THIRD PARTIES MAY CLAIM THAT WE INFRINGE UPON THEIR INTELLECTUAL PROPERTY
RIGHTS.

     Third parties may assert infringement claims against us or claims that we
have violated a patent or infringed upon a copyright, trademark or other
proprietary right belonging to them. Any infringement claim, even one without
merit, could result in the expenditure of significant financial and managerial
resources to defend any such claims.

WE MAY ENCOUNTER DIFFICULTIES WITH OUR INTERNATIONAL OPERATIONS AND SALES.

     While our principal executive offices are located in Israel, 95% of our
sales in 2004 and 93% of our sales in 2005 and 2006 were generated from other
countries. This subjects us to many risks inherent to international business
activities, including:

     o    Limitations and disruptions resulting from the imposition of
          government controls;

     o    Changes in regulatory requirements;

     o    Export license requirements;

     o    Economic or political instability;

     o    Trade restrictions;

     o    Changes in tariffs;

     o    Currency fluctuations;

     o    Difficulties in the collection of receivables;

     o    Greater difficulty in safeguarding intellectual property; and

     o    Difficulties in managing overseas subsidiaries and international
          operations.

     We may encounter significant difficulties in connection with the sale of
our products in international markets as a result of one or more of these
factors.


                                       10



WE ARE CONTROLLED BY FORMULA SYSTEMS (1985) LTD.

     Formula Systems (1985) Ltd., whose shares trade on the NASDAQ Global Market
and the Tel Aviv Stock Exchange, or TASE, directly owns 15,750,989 or 50.10% of
our outstanding ordinary shares. Formula Systems Ltd. is and may continue to be
in a position to exercise control over most matters requiring shareholder
approval, including the election of our directors, approval of significant
corporate transactions and the general ability to direct our affairs. Such
concentration of ownership may have the effect of delaying or preventing a
change in control.

COMPLIANCE WITH CORPORATE GOVERNANCE REGULATIONS COULD INCREASE THE COST OF OUR
OPERATIONS.

     As a result of certain corporate governance scandals and the legislative
and litigation environment resulting from those scandals, the costs of being a
public company in general have increased in recent years. The Sarbanes-Oxley Act
of 2002 requires changes in some of our corporate governance and securities
disclosure or compliance practices. We expect that the on-going implementation
of these regulations will further increase our accounting and legal compliance
costs and will make some activities more time consuming. We are presently
evaluating and monitoring regulatory developments and cannot estimate the
magnitude of additional costs we may incur as a result of such developments.
When we are required to implement Section 404 of the Sarbanes-Oxley Act of 2002,
which governs internal controls and procedures for financial reporting, we will
need to expend significant management time and financial resources to comply
with the applicable requirements. This and other proposed legislation may
increase the fees of our professional advisors and our insurance premiums.

RISK FACTORS RELATED TO OUR ORDINARY SHARES

OUR SHARE PRICE HAS BEEN VERY VOLATILE IN THE PAST AND MAY CONTINUE TO BE
SUSCEPTIBLE TO SIGNIFICANT MARKET PRICE AND VOLUME FLUCTUATIONS IN THE FUTURE.

     Our ordinary shares have experienced significant market price and volume
fluctuations in the past and may experience significant market price and volume
fluctuations in the future in response to factors such as the following, some of
which are beyond our control:

     o    Quarterly variations in our operating results;

     o    Operating results that vary from the expectations of securities
          analysts and investors;

     o    Changes in expectations as to our future financial performance,
          including financial estimates by securities analysts and investors;

     o    Announcements of technological innovations or new products by us or
          our competitors;

     o    Announcements by us or our competitors of significant contracts,
          acquisitions, strategic partnerships, joint ventures or capital
          commitments;

     o    Changes in the status of our intellectual property rights;

     o    Announcements by third parties of significant claims or proceedings
          against us;

     o    Additions or departures of key personnel;

     o    Future sales of our ordinary shares;

     o    Stock market price and volume fluctuations; and

     o    General trends of the stock markets.

     Domestic and international stock markets often experience extreme price and
volume fluctuations. Market fluctuations, as well as general political and
economic conditions, such as a recession or interest rate or currency rate
fluctuations or political events or hostilities in or surrounding Israel, could
adversely affect the market price of our ordinary shares.


                                       11



     In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. We may in the future be the targets of similar litigation.
Securities litigation could result in substantial costs and divert management's
attention and resources.

WE DO NOT ANTICIPATE PAYING CASH DIVIDENDS ON OUR ORDINARY SHARES IN THE
FORESEEABLE FUTURE.

     We do not anticipate paying any cash dividends on our ordinary shares in
the foreseeable future under our current financial condition. Future dividend
distributions are subject to the discretion of our board of directors and will
depend on various factors, including our operating results, future earnings,
capital requirements, financial condition, tax implications of dividend
distributions on our income, future prospects and any other factors deemed
relevant by our board of directors. The distribution of dividends also may be
limited by Israeli law, which permits the distribution of dividends only out of
profits (as defined by Israeli law) or otherwise upon the permission of the
court. You should not rely on an investment in our company if you require
dividend income from your investment. The success of your investment will likely
depend entirely upon any future appreciation of the market price of our ordinary
shares, which is uncertain and unpredictable. There is no guarantee that our
ordinary shares will appreciate in value or even maintain the price at which you
purchased your ordinary shares.

OUR ORDINARY SHARES ARE TRADED ON MORE THAN ONE MARKET AND THIS MAY RESULT IN
PRICE VARIATIONS.

     Our ordinary shares are traded primarily on the NASDAQ Global Market and on
the Tel Aviv Stock Exchange. Trading in our ordinary shares on these markets is
made in different currencies (U.S. dollars on the NASDAQ Global Market, and New
Israeli Shekels, or NIS, on the Tel Aviv Stock Exchange), and at different times
(resulting from different time zones, different trading days and different
public holidays in the United States and Israel). Consequently, the trading
prices of our ordinary shares on these two markets may differ. Any decrease in
the trading price of our ordinary shares on one of these markets could cause a
decrease in the trading price of our ordinary shares on the other market.

RISKS RELATING TO OUR LOCATION IN ISRAEL

CONDUCTING BUSINESS IN ISRAEL ENTAILS SPECIAL RISKS.

     We are incorporated under the laws of, and our executive offices and
research and development facilities are located in, the State of Israel.
Although most of our sales are made to customers outside Israel, we are
influenced to a limited extent by the political, economic and military
conditions affecting Israel. Specifically, we could be adversely affected by any
major hostilities involving Israel, or the interruption or curtailment of trade
between Israel and its present trading partners.

     Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors, and a state of
hostility, varying from time to time in intensity and degree, has led to
security and economic problems for Israel. Although Israel has entered into
various agreements with Egypt, Jordan and the Palestinian Authority, there has
been an increase in unrest and terrorist activity in Israel, which began in
September 2000 and which has continued with varying levels of severity through
2006. In July 2006, an armed conflict began between Israel and Hezbollah forces
in Lebanon, which involved rocket attacks on populated areas in the northern
parts of Israel. On August 14, 2006, a cease-fire between Hezbollah and Israel
took effect. This situation has had an adverse effect on Israel's economy,
primarily in the geographical areas directly harmed by this conflict. Any future
armed conflict, political instability or violence in the region may have a
negative effect on those research and development activities that we conduct in
Israel and may adversely affect our share price.

OUR RESULTS OF OPERATIONS MAY BE NEGATIVELY AFFECTED BY THE OBLIGATION OF OUR
PERSONNEL TO PERFORM MILITARY SERVICE.

     Many of our executive officers and employees in Israel are obligated to
perform annual reserve duty in the Israeli Defense Forces and may be called for
active duty under emergency circumstances at any time. If a military conflict or
war arises, these individuals could be required to serve in the military for
extended periods of time. Our operations could be disrupted by the absence for a
significant period of one or more of our executive officers or key employees or
a significant number of other employees due to military service. Any disruption
in our operations could adversely affect our business.


                                       12



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

     A portion of our expenses, primarily labor expenses, is incurred in NIS. As
a result, we are exposed to the risk that the rate of inflation in Israel will
exceed the rate of devaluation of the NIS in relation to the U.S. dollar or that
the timing of this devaluation lags behind inflation in Israel. In 2004 and
2006, the U.S. dollar devaluated against the NIS by 1.6% and 8.2%, respectively,
while in 2005, the U.S. dollar appreciated against the NIS by 6.8%. We may be
materially and adversely affected in the future if the rate of inflation in
Israel exceeds the devaluation of the NIS against the U.S. dollar or if the
timing of this devaluation lags behind increases in inflation in Israel.

WE CURRENTLY BENEFIT FROM GOVERNMENT TAX BENEFITS, WHICH MAY BE DISCONTINUED OR
REDUCED IN THE FUTURE.

     We are currently eligible to receive tax benefits under Government of
Israel programs. In order to maintain our eligibility for these tax benefits, we
must continue to meet specific conditions, including making specified
investments in fixed assets. If we or our subsidiary fail to comply with these
conditions in the future, the tax benefits received could be canceled and we
could also be required to pay significantly increased taxes for prior years and
for the future.

SERVICE AND ENFORCEMENT OF LEGAL PROCESS ON US AND OUR DIRECTORS AND OFFICERS
MAY BE DIFFICULT TO OBTAIN.

     We are incorporated in Israel and some of our directors, executive officers
and the Israeli experts named in this annual report reside outside the United
States. Service of process upon them may be difficult to effect within the
United States. Furthermore, most of our assets and the assets of some of our
executive officers and directors and some of the experts named in this annual
report are located outside the United States. Therefore, a judgment obtained
against us or any of them in the United States, including one based on the civil
liability provisions of the U.S. federal securities laws, may not be collectible
in the United States and may not be enforced by an Israeli court. It also may be
difficult for you to assert U.S. securities law claims in original actions
instituted in Israel. For more information regarding the enforceability of civil
liabilities against us, our directors and executive officers and the Israeli
experts named in this prospectus, including the terms under which certain
judgments may be enforced by an Israeli court, please see "Enforceability of
Civil Liabilities."

PROVISIONS OF ISRAELI LAW MAY DELAY, PREVENT OR MAKE DIFFICULT AN ACQUISITION OF
US, WHICH COULD PREVENT A CHANGE OF CONTROL AND THEREFORE DEPRESS THE PRICE OF
OUR SHARES.

     Israeli corporate law regulates mergers, requires tender offers for
acquisitions of shares above specified thresholds, requires special approvals
for transactions involving directors, officers or significant shareholders and
regulates other matters that may be relevant to these types of transactions.
Furthermore, Israeli tax considerations may make potential transactions
unappealing to us or to some of our shareholders. These provisions of Israeli
corporate and tax law may have the effect of delaying, preventing or
complicating a merger with, or other acquisition of, us. This could cause our
ordinary shares to trade at prices below the price for which third parties might
be willing to pay to gain control of us. Third parties who are otherwise willing
to pay a premium over prevailing market prices to gain control of us may be
unable or unwilling to do so because of these provisions of Israeli law.


                                       13



YOUR RIGHTS AND RESPONSIBILITIES AS A SHAREHOLDER WILL BE GOVERNED BY ISRAELI
LAW AND DIFFER IN SOME RESPECTS FROM THE RIGHTS AND RESPONSIBILITIES OF
SHAREHOLDERS UNDER U.S. LAW.

     We are incorporated under Israeli law. The rights and responsibilities of
holders of our ordinary shares are governed by our memorandum of association,
articles of association and by Israeli law. These rights and responsibilities
differ in some respects from the rights and responsibilities of shareholders in
typical U.S. corporations. In particular, a shareholder of an Israeli company
has a duty to act in good faith in exercising his or her rights and fulfilling
his or her obligations toward the company and other shareholders and to refrain
from abusing his power in the company, including, among other things, in voting
at the general meeting of shareholders on certain matters. Israeli law provides
that these duties are applicable in shareholder votes at the general meeting
with respect to, among other things, amendments to a company's articles of
association, increases in a company's authorized share capital, mergers and
actions and transactions involving interests of officers, directors or other
interested parties which require the shareholders' general meeting's approval.
In addition, a controlling shareholder of an Israeli company or a shareholder
who knows that he or she possesses the power to determine the outcome of a vote
at a meeting of our shareholders, or who has, by virtue of the company's
articles of association, the power to appoint or prevent the appointment of an
office holder in the company, or any other power with respect to the company,
has a duty of fairness toward the company. The Israeli Companies Law does not
establish criteria for determining whether or not a shareholder has acted in
good faith. Moreover, the law is relatively new and there is no case law
available on the duty of a non-controlling shareholder to act in good faith.

AS A FOREIGN PRIVATE ISSUER WHOSE SHARES ARE LISTED ON THE NASDAQ GLOBAL MARKET,
WE MAY FOLLOW CERTAIN HOME COUNTRY CORPORATE GOVERNANCE PRACTICES INSTEAD OF
CERTAIN NASDAQ REQUIREMENTS.

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

ITEM 4. INFORMATION ON THE COMPANY

A.   HISTORY AND DEVELOPMENT OF THE COMPANY

     We were incorporated under the laws of the State of Israel in February 1983
as Mashov Software Export (1983) Ltd. and we changed our name to Magic Software
Enterprises Ltd. in 1991. We are a public limited liability company and operate
under the Israeli Companies Law 1999 and associated legislation. Our registered
offices and principal place of business are located at 5 Haplada Street, Or
Yehuda 60218, Israel, and our telephone number is +972-3-538-9292. Our address
on the Internet is www.magicsoftware.com. The information on our website is not
incorporated by reference into this annual report.

     We develop, market and support composite application development and
deployment platforms with a service-oriented architecture, or SOA, including
application integration and business process management, or BPM, with existing
and legacy systems. These enable enterprises to accelerate the process of
building and deploying applications that can be rapidly customized and
integrated with existing systems.

     Our technology and applications based on our technology are used by
independent software vendors and thousands of enterprises in approximately 100
countries. We refer to these vendors and enterprises as the Magic community. We
also provide maintenance and technical support as well as professional services
to the Magic community.

     We develop, market and support eDeveloper, a software development and
deployment technology, and iBOLT, a technology for business integration and BPM.

                                       14



     eDeveloper enables the rapid development and deployment of business
applications. The eDeveloper technology can be deployed on multiple platforms
operating with interoperability under various information technology, or IT,
architectures and can operate on multiple databases. During 2006, we released
eDeveloper Version 10, which highlights SOA architecture. eDeveloper Version 10
supports enhanced compliance with industry standards, provides improved
functionality in comparison to prior versions and provides a composite
application development environment. In March 2006, we performed a controlled
and limited release of eDeveloper Version 10 Enterprise edition to a selection
of representative customers and we supported them during the porting of their
applications to the new version. eDeveloper Version 10 Enterprise edition became
generally available in the third quarter of 2006. In February 2007, we released
two new editions of eDeveloper Version 10, the Discovery edition and Xpress
edition, which target different developer needs. The Discovery edition is
targeted at students, new developers and those developing basic Windows client
and web applications for personal use. The Xpress edition is designed to meet
the needs of users developing and deploying small- to mid-scale desktop and web
applications that are based on either Pervasive or MySQL tables. eDeveloper
Xpress is affordable for small- and home-office developers.

     iBOLT provides affordable business integration solutions to mid-sized and
large enterprises and system integrators. As a comprehensive suite, iBOLT allows
the seamless integration and interoperability of diverse solutions, including
legacy applications, in a quick and efficient manner. In 2005, we released iBOLT
Version 2.5. In addition, during 2006 we continued to develop the iBOLT channel
and entered into agreements with approximately 100 system integrators,
consultancies and service providers, who acquired iBOLT skills and offer iBOLT
licenses and related services to their customers. During the last two years we
have developed a new version of iBOLT, Version 3, which we expect to release in
the latter part of 2007.

     During 2004, we entered into a partnership with SAP, an international
provider of business software solutions. The agreement focused on providing a
special edition of iBOLT as a collaborative platform for the SAP Business One
product, an integrated business management solution designed specifically for
small and midsize businesses. In January 2005, we launched iBOLT Special Edition
for the SAP Business One product and subsequently expanded and intensified our
joint activities with SAP worldwide. The iBOLT Special Edition was accepted by
the SAP community with enthusiasm, and our company was awarded by SAP the ISV
Partner Leadership in Innovation 2005 award.

     During 2006, our software was recognized by SAP for the best overall
achievement in quality and excellence among SAP Business One software solution
partners with the SAP Software Solution Partner Quality Excellence Award. Our
iBOLT Special Edition partner program was endorsed by over 150 SAP Business One
resellers across the globe who have signed a partnership agreement with us and
became a significant new addition to the Magic partner community. In the
beginning of 2007, we announced a new iBOLT Special Edition for SAP R/3 ERP
software and we received SAP's xAPPS certification.

     During 2006, we continued to work closely with IBM as an Advanced Partner
of the IBM Partnerworld for Developer business partner program and as a Member
Partner of IBM Partnerworld for Software. IBM has awarded us with its
ServerProven(R) certification for our eDeveloper and iBOLT products following a
rigorous testing and evaluation process. Only those products that are validated
by IBM to install quickly, start up easily and run reliably on IBM servers are
awarded this certification, designed by IBM to assist its customers to easily
identify complete solutions for their business-critical e-business needs. During
2006, we also became part of IBM's System i Tools Innovation Program.

     In July 2006, we and IBM entered into a global distribution and original
equipment manufacturer, or OEM, agreement, under which we will bundle IBM's DB2
Express with our eDeveloper Version 10 Composite Applications platform. In
December 2006, as part of our activities with the IBM System i customers and
business partners, we released our JDE Connect, a fully functional version of
our iBOLT integration technology targeted to users of JD Edwards Enterprise One
Oracle enterprise resource planning, or ERP, software on the IBM System i
platform.

     In March 2007, we qualified for the IBM Business Partner SOA Specialty. For
this specialty, IBM selects business partners who market SOA content, services,
or both that demonstrate compatibility with or complement the IBM SOA Foundation
products, who endorse the IBM SOA strategy, and whose marketing activities IBM
determines to be in agreement with its own. We offer SOA capabilities in the
System i (iSeries / AS/400) market and we qualified for this specialty with
respect to one of our SOA projects that was performed in France during 2006.


                                       15



     In January 2006, we increased our holdings from 83.88% to 100% in our
subsidiary Advanced Answers on Demand Holding Corporation, a Florida corporation
that develops and markets application software targeted at the long-term care
industry.

     In June 2006, we sold our customer relationship management, or CRM,
activity in Israel and abroad to eContact Software Ltd.. Under the agreement,
eContact Software Ltd. undertook to pay $0.2 million for this activity.

     In December 2006, we completed the sale of the assets and liabilities of
our 90.48%-held subsidiary, CarPro System Ltd., including the intellectual
property of the RentPro and LeasePro software that includes functions usually
required by multi-facility car and truck rental companies worldwide and its
customer base, to CarPro Systems International B.V., its distributor in the
Benelux. Under the agreement, the purchaser undertook to pay a total of $1.75
million.

     In January 2007, we sold the intellectual property relating to the
technology known as iBolt Portal to Axcepia Technologies Ltd. Under the
agreement, in consideration for the transfer and assignment of our rights in and
to the technology, the buyer agreed to pay us a commission equal to 50% of the
revenues of the buyer derived from sales to customers who were introduced to the
buyer by us of licenses to use the iBolt Portal technology for a period of five
years as of the date of the agreement. In addition, commencing as of six months
from the date of the agreement, the buyer will pay us a commission equal to 20%
of the revenues of the buyer derived from the maintenance and support services
relating to the iBolt Portal technology provided by the buyer for a period of
five years as of the date of the agreement.

     On May,24, 2007,we sold our 5% shares ownership in e-Money to Mr. Uchil in
consideration of $11,760.

     The activities described above were part of our strategy to focus on our
core products. In the fourth quarter of 2006, we announced a restructuring and
impairment plan designed to increase our profitability by focusing on the
marketing and sale of our flagship products. The restructuring and impairment
included the appointment of three new members to our board of directors in
January 2007 and the appointment of a new chief executive officer who will begin
to serve in such capacity on July 1, 2007.

B.   BUSINESS OVERVIEW

INDUSTRY OVERVIEW

     In recent years the multiplication of enterprise applications has lead to a
level of complexity in enterprises' information system that is actually
obstructing business progress and evolution, reducing business agility and is
often resulting in multiple versions of similar data objects such as customer
records. We believe that one of the main challenges the modern enterprise faces
today is "creating a single view of the truth", which is the better way to make
effective and relevant business decisions. Business integration is employed to
facilitate this. Traditionally, given their cost and complexity, business
integration solutions were targeted at large enterprises. Consequently, business
integration tools are mostly complex, require significant implementation
resources, take a long time to implement and are costly. This constituted a
barrier to small and medium enterprises, who could not afford to embark on such
projects. Yet, given the critical need for business integration across the
demand and supply chain, enterprises of all sizes require such solutions. We
recognized this trend and emerging need when we designed iBOLT, and are one of
the first vendors to provide business integration solutions to small and medium
enterprises.


                                       16



     Another major evolution in enterprises is the trend of reusing information
technology, or IT, assets, such as enterprise applications, driving the move
towards SOA (service-oriented architectures) and "applistructures".
Applistructures are the merger of enterprise-application and infrastructure
technology. Due to the large investments in enterprise applications, such as ERP
(enterprise resource planning) and CRM (customer relationship management), on
the one hand, and the accelerating business change, on the other, organizations
need to find a way to continue to leverage and amortize their IT investments
while increasing their ability to change business processes and support new
ones. The software industry's response is a new breed and paradigm of
application development, service oriented development of applications, or SODA,
and composite applications, based on metadata, which is data that describes data
(similar to a table of content describing a book), rather than traditional
programming. We have developed and enhanced this paradigm over the last twenty
years, and we believe that we have the one of the largest installed base of
products employing such technology.

GENERAL

     We develop, market and support eDeveloper, a software development and
deployment technology, and iBOLT, a technology for business integration and BPM.
Our technology enables enterprises to accelerate the process of building and
deploying business software applications that can be rapidly customized to meet
current and future needs. Our development and integration products empower
customers to dramatically improve their business performance and return on
investment by enabling the affordable and rapid integration of diverse
applications, systems and databases to streamline business processes from within
one comprehensive framework.

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

     We address the critical business needs of companies so that they are able
to quickly respond to changing market forces and demands. Robust business
solutions are created, deployed and maintained with unrivaled productivity and
time-to-market results. Our proprietary development methodology enables
developers to create better solutions in less time and with fewer resources.

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

     o    With the launch of iBOLT, we started a repositioning process from the
          application development field to the business integration and process
          management field, which are, presently converging, from a technology
          perspective, to the composite application field. Products in these
          filed require a service-oriented architecture, application integration
          capabilities, process management, orchestration capabilities, and
          information delivery capabilities. Our technology and products provide
          all of these capabilities.

OUR SOLUTION

     Our eDeveloper and iBOLT technologies offer system integrators, software
developers and end-users of deployed applications the following benefits:

     o    SHORTER TIME TO MARKET. We believe that our technology and products
          allow enterprises to prototype and develop, integrate and deploy
          complex, mission-critical components and applications rapidly and in a
          cost-effective manner. Most program functionality that usually
          requires repetitive, tedious coding is provided by our underlying core
          technology, eDeveloper. In today's dynamic and competitive business
          environment, the development community is under pressure to produce
          and integrate applications faster and with more meaningful business
          processes and information than ever before, while reducing costs. This
          requires organizations to build a service-oriented architecture and
          develop on top of it composite applications. Both eDeveloper and iBOLT
          enable organizations to meet these needs.


                                       17



     o    SCALABILITY AND ADAPTABILITY. Applications developed and integrated
          with eDeveloper and iBOLT can be easily modified as business
          requirements change, computing environments evolve and end-user usage
          and transaction volumes increase. As a result, implementations of our
          technology can be quickly adapted to support increased functionality
          and wider use throughout an organization. Applications developed with
          our products can grow within an enterprise from the departmental level
          to the enterprise level by accommodating additional platforms,
          databases and operating systems and increased usage and application
          complexity. Our technology also enables partitioning of applications
          by allowing application logic to be distributed across a system in
          order to achieve optimal system performance and flexibility. Our
          eDeveloper and iBOLT technologies enable enterprises to respond
          quickly to unanticipated changes in their business requirements to
          protect their investments in software and hardware.

     o    PORTABILITY. We designed our products to enable enterprises to develop
          and integrate applications that can be used with most hardware
          platforms, operating systems and databases. Applications developed
          with our technology for one platform also can be deployed on other
          supported platforms. Simply changing the relevant parameters in an
          application and migrating the metadata accomplish porting an
          application developed with our technology from one platform to
          another. As a result, porting applications can be accomplished without
          the lengthy coding, compiling, linking and testing phases typically
          required with other development methodologies. Applications developed
          with our technology can also be partitioned across multiple platforms.
          Developers can therefore take advantage of the flexibility and
          performance advantages inherent in multi-tiered architectures. The
          portability of applications developed with our software development
          technology enables enterprises to migrate quickly to new computing
          environments without having to rewrite their applications.

     o    DATABASE ACCESS AND TECHNOLOGY INDEPENDENCE. eDeveloper and iBOLT
          allow enterprises to access and manipulate data from multiple
          databases, each based on a different technology, into a single
          integrated application. Developers and end-users can access multiple
          legacy and relational databases across the enterprise from within the
          same application and from within the same data view. Our technology
          can easily move data across platforms and convert the data from one
          database format to another.

     o    COMPREHENSIVENESS. Our technology delivers what enterprises need to
          achieve business integration into a single product stack, including a
          composite application framework, SODA, enterprise service bus (ESB, or
          also referred to as a message broker), enterprise application
          integration, BPM, and service and business activity monitoring. Our
          single product stack provides small and medium enterprises as well as
          large enterprises with top tier power, which is simple to learn and
          fast to deliver value even with small business budgets.

     o    INNOVATION AND EXPERIENCE. We provide a service oriented platform
          which includes application integration, business process management
          and composite applications, to rapidly develop, change and deploy
          solutions integrated with existing and legacy systems. We enable
          enterprises to increase their agility and rapidly adapt to business
          changes, by aligning their IT with their business operations,
          accelerating the evolution to a SOA through application integration
          and BPM. Our customers develop and deploy applications that are
          rapidly customized and integrated with existing and legacy systems.
          Our products are built on twenty years of research and development, as
          well as customer experience.

OUR STRATEGY

     Our goal is to achieve a leadership position in the software development
and business integration and deployment technology markets. We focus on
providing technology, applications and services that enable enterprises to meet
their business needs on time and budget. The key elements of our strategy to
achieve this goal are:

     o    Target midsize enterprises, with focus on organizations that require
          rapid solutions for critical projects at an affordable price;

     o    Focus our sales efforts on our core products iBOLT and eDeveloper;


                                       18



     o    Focus our efforts on building a strong partner base of system
          integrators and resellers of our core technologies;

     o    Increase the number of software houses using eDeveloper to build their
          applications;

     o    Focus on our alliance with SAP. The SAP solutions for small businesses
          (such as the SAP Business One products) and midsize companies (such as
          the SAP R/3 solution and SAP All-In One solution) address a broad
          horizontal market. As a result of our alliance with SAP, our offerings
          and resources (such as sales, marketing and research and development)
          more effectively address the SAP market;

     o    Fortify our alliance with IBM, specifically with the server divisions
          of the System i/iSeries/AS/400 market, where we believe we have a
          strong competitive advantage. We intend to provide significant
          resources to increase our market share in the System i market; and

     o    Focus on recruiting software partners who will incorporate our iBOLT
          integration technology into their product offerings.

OUR PRODUCTS

     The driving principles behind our technology are:

     o    Abstraction - to hide complexity and facilitate change;

     o    Automation of mundane tasks - to accelerate development and
          maintenance and reduce risk; and

     o    Interoperability - to support business logic across multiple hardware
          and software platforms, operating systems and geographies.

     We design our tools for use by system architects, business analysts and
consultants rather than by programmers. Over the years, we have enriched our
technology with emerging features such as messaging, application partitioning,
browser based rich client, graphical design studio for business processes, event
and service provision and consumption, orchestration and many more.

     We offer two complementary products that address the wide spectrum of
composite applications.

     IBOLT BUSINESS INTEGRATION SUITE, is a flow oriented composite applications
toolset, delivering a comprehensive, business-driven integration framework that
empowers enterprises to dramatically improve business performance. iBOLT enables
customers to easily design, develop and deploy automated business processes,
including BPM and business activity monitoring. Increasing the usability and
life span of existing legacy and other IT systems, iBOLT allows fast enterprise
application integration, development and customization of diverse applications,
systems and databases, assuring rapid return on invested capital and
time-to-market, increased profitability, and customer satisfaction.

     EDEVELOPER is an interactive composite applications toolset, delivering an
extremely productive, state-of-the-art technology for developing and deploying
web and client/server applications across and beyond the enterprise. eDeveloper
automates the mundane repetitive tasks of the software development cycle,
drastically shortening the process, reducing project risk and minimizing human
errors.

     During 2006, we released eDeveloper Version 10. In March 2006, we performed
a controlled and limited release of eDeveloper Version 10 Enterprise edition to
a selection of representative customers and we supported them during the porting
of their applications to the new version. eDeveloper Version 10 Enterprise
edition became generally available in the third quarter of 2006. In February
2007, we released two new editions of eDeveloper Version 10, the Discovery
edition and Xpress edition, which target different developer needs. The
Discovery edition is targeted at students, new developers and those developing
basic Windows client and web applications for personal use. The Xpress edition
is designed to meet the needs of users developing and deploying small- to
mid-scale desktop and web applications that are based on either Pervasive or
MySQL tables. eDeveloper Xpress is affordable for small- and home-office
developers.


                                       19



     eDeveloper Version 10 highlights SOA architecture, supports enhanced
compliance with industry standards, provides improved functionality in
comparison to prior versions and provides a composite application development
environment. eDeveloper Version 10 further enhances our position as provider of
service oriented development of applications (SODA) technology and the feature
set provided by our iBOLT and eDeveloper product lines fully complies with the
prevailing industry requirements of a comprehensive composite applications and
SOA platform. Gartner, a leading global information technology industry research
and analyst firm, defines an integrated services environment, or ISE, as an
integrated development platform or framework that is focused on developing
applications using a composite (assemble-first) metaphor based on SOA and
process centricity through a lightweight BPM. According to Gartner, ISEs should
have a productivity layer that makes developers more productive through hiding
complexity (such as frameworks or prepackaged functions), automation (or
code-generation or parameterization), and simplification (such as visual
modeling), and forms the basic value proposition of an ISE. Gartner further
describes ISE as intended to be used by developers and business analysts alike
together, but is targeted at process-centric developers. Through these products,
the focus of the user shifts from writing code to assembling and managing
business processes. Through these processes, flexible business solutions can be
assembled or composed. In the beginning of 2006, Gartner recognized us as a
visionary ISE vendor.

     Our technology, comprised of both iBOLT and eDeveloper, is a comprehensive
and proven ISE in the market. It can be applied to the full range of software
development market, from the implementation of micro-vertical solutions, through
tactical application renovation and process automation solutions, to enterprise
spanning SOA migrations and composite applications initiatives. Unlike most
competing ISEs, we offer a coherent and unified toolset stemming from the same
proven metadata driven and rules based declarative technology, resulting in
unprecedented cost savings through fast and easy implementation and reduced
project risk.

     In December 2006, Forrester Research, a leading technology and market
research company, named our software as a "Strong Performer" in its published
report "Integration-Centric Business Process Management Suites." In all, 35
vendors were interviewed for the report, 13 qualified for review, and only five,
including us, were rated as "Strong Performers." The report stated that our
company's mid-market focus and pricing make it an appealing alternative and that
our comprehensive coverage makes us a good fit for midsize companies looking for
an all-in-one solution for their integration, BPM, and service-oriented
architecture (SOA) needs. The report also noted our surprising number of
strategic alliances for a vendor of that size and strong product roadmap

VERTICAL SOLUTIONS

     Some of our subsidiaries develop, market, and support vertical
applications, including for long-term care, banking and cargo handling
solutions.

     ADVANCED ANSWERS ON DEMAND HOLDING CORPORATION, our wholly-owned
subsidiary, develops and markets application software targeted at the long-term
care industry. Its comprehensive solution is designed to meet the management
information needs of retirement homes, nursing homes, assisted living
facilities, continuing care retirement communities, and home health and
rehabilitation agencies.

     NEXTSTEP INFOTECH PVT. LTD., in which we have a 40% interest, develops and
markets Cheq Mate(TM), a banking application that provides most of the
functionality required to run a retail bank branch, including support for
various deposit types, advances, time deposits, bank guarantees, letters of
credit and portfolio management.

     CORETECH CONSULTING GROUP LLC, our wholly-owned subsidiary, is an
information technology consulting firm offering flexible and creative solutions
in the areas of infrastructure design and delivery, application development,
technology planning and implementation services, as well as supplemental
staffing services.

     HERMES LOGISTICS TECHNOLOGIES LTD., (FORMERLY MAGIC ECARGO), our
wholly-owned subsidiary, develops and markets a comprehensive solution for cargo
handling and inventory control that is designed to increase productivity,
improve efficiency, and reduce costs. Hermes handles many aspects of a cargo
operation including inventory control, automated build-up of
flights/manifesting, messaging to CARGO-IMP standards, customs clearance, weight
and balance departure control systems, interfacing, scanning and verification of
cargo, secured tracking and a comprehensive financial package for all aspects of
billing and collecting fees.


                                       20



SERVICES

     PROFESSIONAL SERVICES. We provide a broad range of consulting and software
development project management services to customers developing, deploying and
integrating distributed applications. We believe that the availability of
effective consulting services is an important factor in achieving widespread
market acceptance.

     We offer fee-based consulting services in connection with installation
assurance, application audits and performance enhancement, application migration
and application prototyping and design. Consulting services are aimed at both
generating additional revenues and ensuring successful implementation of
eDeveloper and iBOLT projects through knowledge transfer. As part of our
restructuring and impairment plan to focus on license sales, our goal is to
provide such activities as a complementary service to our customers and
partners.

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

     MAINTENANCE. We offer our customers annual maintenance contracts providing
for upgrades and new versions of our products for an annual fee.

     TECHNICAL SUPPORT. We believe that a high level of customer support is
important to the successful marketing and sale of our products. Our in-house
technical support group provides training and post-sale support. We believe that
effective technical support during product evaluation as well as after the sale
has substantially contributed to product acceptance and customer satisfaction
and will continue to do so in the future.

     We offer an online support system for the Magic community, which provides
members of the Magic community with the ability to instantaneously enter,
confirm and track support requests via the Internet. It provides support to
Magic solution providers and end-users worldwide.

     TRAINING. We conduct formal and organized training on our development tools
through the Magic University International. We develop courses, pertaining to
our principal products, eDeveloper and iBOLT and provide trainer and student
guidebooks. Course materials are available both in traditional, classroom
courses and as web-based training modules, which can be downloaded and studied
at the student's own pace and location. The courses and course materials are
designed to accelerate the learning process, using an intensive technical
curriculum in an atmosphere conducive to productive training

CUSTOMERS, END-USERS AND MARKETS

     We market and sell our products and services in more than 100 countries
worldwide. The following table presents our revenues by revenue type and
geographical market for the periods indicated:

                                              YEAR ENDED DECEMBER 31,
                                        -----------------------------------
                                         2004          2005          2006
                                        -------       -------       -------
                                                  (In thousands)

Software sales                          $28,022       $25,103       $22,336
Maintenance and technical support        12,555        14,376        14,935
Consulting services                      24,590        21,511        24,454
                                        -------       -------       -------
    Total revenues                      $65,167       $60,990       $61,725
                                        =======       =======       =======


                                       21



                                YEAR ENDED DECEMBER 31,
                         -----------------------------------
                          2004           2005         2006
                         -------       -------       -------
                                    (In thousands)

Israel                   $ 3,354       $ 4,013       $ 4,212
Europe                    25,698        23,186        21,887
United States             21,090        20,435        23,236
Japan                     11,450        10,107        10,223
Other                      3,575         3,249         2,167
                         -------       -------       -------
    Total revenues       $65,167       $60,990       $61,725
                         =======       =======       =======

     Industries that are significantly represented in our Magic community base
include finance, government, health care, logistics, manufacturing media, retail
and telecommunications. Our eDeveloper and iBOLT technologies are used by a wide
variety of developers, integrators and solution providers who can be generally
divided into two segments: in the first segment are those performing in-house
development (corporate IT departments) and in the second segment are Magic
solution providers, including large system integrators and smaller independent
developers, and value added resellers, or VARs, that use our technology to
develop or provide solutions to their customers. Magic solution providers who
are packaged software publishers use our technology to write standard packaged
software products that are sold to multiple clients, typically within a vertical
industry segment or a horizontal business function.

     Among the thousands of end-users running their business systems with our
technology are the following: Adidas-Solomon, Allstate, Athlon Group, Burger
King, Club Med, Compass Group PLC, Danish Ministry of Economic, Deka Bank,
Euroclear, Financial Times, FMRP, Fraport AG, GAP, Hitachi, Johnson & Johnson,
John Menzies, Kodak, Marconi Mobile, Merrill Lynch, Matsushita, Minolta, NEC,
Nestle Nespresso, Nintendo, Philip Morris, TEVA, the State of Washington,
Vodafone, the United Nations, UPS and Victorinox.

SALES, MARKETING AND DISTRIBUTION

     We market and support our products through our own direct sales force in
Europe, India, Israel, Japan and the United States and through a network of
distributors, Magic solution providers and system integrators in those countries
and various other countries in Asia, Europe, Africa and Latin America. We sell
and support our products directly through our subsidiaries in Israel, France,
Germany, Hungary, India, Japan, the Netherlands, the United Kingdom and the
United States, and through local distributors elsewhere.

     DIRECT SALES. We maintain a direct sales force that pursues local accounts
and software solution providers. Our sales personnel carry out strategic sales
with a direct approach to decision makers, managing a constantly monitored
consultative type of sales cycle. At March 31, 2007, we had approximately 60
sales personnel and also a team of ten sales engineers who provide pre-sale
technical support, presentations and demonstrations in order to support our
sales force. Sales efforts are targeted at large enterprises performing internal
application development and Magic solution providers who use our technology to
develop solutions for their customers. We also employ an in-house and external
telesales staff to sell to prospect accounts and to generate and qualify leads.

     INDIRECT SALES. We maintain an indirect sales channel for iBOLT, through
system integrators, consultancies and service providers. In 2006, we dedicated
five indirect sales personnel to develop this channel and by the end of the year
we entered into agreements with approximately 150 entities.

     Some larger Magic solution providers may also resell development systems
when selling applications requiring on-site development, maintenance, and
diagnostics. We carry out marketing activities with our Magic solution providers
and indirect channels, such as publishing solutions directories and newsletters.
We have a marketing program that supports Magic solution providers and supports
iBOLT general partners, and special partner program for those that are also SAP
and IBM reseller/partners by providing a wide range of features and advantages
in the areas of sales and marketing and technical knowledge transfer.


                                       22



     DISTRIBUTORS. In general, we distribute our products through local
distributors in those countries where we do not have a sales subsidiary. A local
distributor is typically a software marketing organization with the capability
to add value with consulting, training, and support. Distributors are generally
responsible for the localization of our software development technology and
applications into their native language. The distributors also translate our
marketing literature and technical documentation. Distributors must undergo our
program of sales and technical training. Marketing, sales, training, consulting,
product and client support are provided by the local distributor. We are
available for backup support for the distributor and for end-users. In
coordination with the local subsidiaries and distributors, we also provide sales
support for large and multinational accounts. We have approximately 25
distributors in Europe, Latin America and Asia, many of whom also act as Magic
solution providers.

     MARKETING ACTIVITIES. We carry out a wide range of marketing activities
aimed at generating awareness of our products and sales leads, including an
extensive program of Internet-based webcasts, exhibitions, advertising and
public relations, attendance at trade shows, fairs and exhibitions, direct mail,
response mail, telemarketing campaigns and user and distributor conferences and
seminars. We also devote substantial efforts to marketing our products on the
Internet. We regularly advertise our products in prominent trade publications.
These activities are intended both to maintain the general public awareness of
our products and to generate sales leads. We conduct distributor and user
conferences to update our worldwide affiliates and user base concerning our new
releases, marketing strategies, pricing, technical information and the like.
These events are conducted approximately once a year.

     In order to foster improved relationships with our iBOLT channel partners,
we periodically sponsor local events and other marketing programs and
activities. On our corporate Internet website, we host an online solutions
directory, which highlights applications developed by our Magic solution
providers, and an information sharing section, which enables our Magic solution
providers to participate alongside our representatives at trade shows and
conferences.

STRATEGIC ALLIANCES

     The important strategic alliances formed by us to date include:

     SAP. During 2004, we entered into a partnership with SAP that focused on
providing a special edition of iBOLT as a collaboration platform for the SAP
Business One product, an integrated business management solution designed
specifically for small and midsize businesses. In January 2005, we launched
iBOLT Special Edition for the SAP Business One product and subsequently expanded
and intensified our joint activities with SAP worldwide. The iBOLT Special
Edition was accepted by the SAP community with enthusiasm, and our company was
awarded by SAP the ISV Partner Leadership in Innovation 2005 award. During 2006,
our software was recognized by SAP for the best overall achievement in quality
and excellence among SAP Business One software solution partners with the SAP
Software Solution Partner Quality Excellence Award. Our iBOLT Special Edition
partner program was endorsed by over 150 SAP Business One resellers across the
globe who have signed a partnership agreement with us and became a significant
new addition to the Magic partner community. In the beginning of 2007, we
announced a new iBOLT Special Edition for SAP R/3 ERP software and we received
SAP's xAPPS certification.

     In addition to the direct economic impact of iBOLT sales, we are
experiencing the following benefits that arise from our partnership with SAP:
(i) recognition and validation of our technology as a mainstream player in the
business integration and composite application development domains; (ii)
privileged access to a pre-qualified partner community that can also employ
iBOLT in non-SAP related projects; and (iii) revitalization of our Magic
solution providers community, by offering them access to the SAP Partner Program
and branding of their existing applications.

     IBM. During 2006, we continued to work closely with IBM as an Advanced
Partner of the IBM Partnerworld for Developer business partner program and as a
Member Partner of IBM Partnerworld for Software. In the past, we have received
the highest approval rating from IBM Alliance Shareholder/400 technical teams in
Rochester for our adherence to IBM's e-business framework. The "Level Four"
certification granted to us from IBM signifies that we are able to demonstrate
our support for several different servers using standards established by IBM.
This accomplishment helps foster our continued business relationship with IBM
throughout the world. IBM has also awarded us with its ServerProven(R)
certification for our eDeveloper and iBOLT products following a rigorous testing
and evaluation process. Only those products that are validated by IBM to install
quickly, start up easily and run reliably on IBM servers are awarded this
certification, designed by IBM to help its customers easily identify complete
solutions for their business-critical e-business needs. During 2006 we also
became part of IBM's System i Tools Innovation Program.


                                       23



     In July 2006, we and IBM entered into a global distribution and original
equipment manufacturer, or OEM, agreement, under which we will bundle IBM's DB2
Express with our eDeveloper Version 10 Composite Applications platform. In
December 2006, as part of our activities with the IBM System i customers and
business partners, we released our JDE Connect, a fully functional version of
our iBOLT integration technology targeted to users of JD Edwards Enterprise One
Oracle enterprise resource planning, or ERP, software on the IBM System i
platform.

     In March 2007, we qualified for the IBM Business Partner SOA Specialty. For
this specialty, IBM selects business partners who market SOA content, services,
or both that demonstrate compatibility with or complement the IBM SOA Foundation
products, who endorse the IBM SOA strategy, and whose marketing activities IBM
determines to be in agreement with its own. We offer SOA capabilities in the
System i (iSeries / AS/400) market] and we qualified for this specialty with
respect to one of our SOA projects that was performed in France during 2006.

     In the third quarter of 2006, we signed a global OEM (original equipment
manufacturer) agreement with Software Route, an IBM PartnerWorld member, for the
sale of IBM's DB2 Express worldwide, in conjunction with our release of
eDeveloper Version 10, which we designed to comply with IBM's DB2 Express data
base. The combination of eDeveloper and DB2 Express data base presents Magic
solution providers with the opportunity to strengthen their technology
offerings.

     W4. In 2005, we entered into agreements with W4, a leading European
provider of BPM software for human resources related processes. W4's BPM
technology has over nine years of proven use by hundreds of customers. W4 has
embedded iBOLT into its BPM platform, W4 BPMSuite V6, which was launched in
December 2005. We have added the W4 BPM engine to our extensive list of
components, which enables iBOLT developers to seamlessly integrate human
resources related activities as a component of any composite applications
developed with the iBOLT Integration Suite.

     PERVASIVE SOFTWARE. We have an OEM agreement with Pervasive Software to
develop and market a bundled product comprised of Pervasive's Scalable SQL
(structured query language) database engines and our eDeveloper technology. The
alliance provides for joint technical development and product integration
channel development programs.

     IWAY SOFTWARE. During 2003, we initiated a partnership with iWay Software
to provide intelligent, prepackaged adapters for the iBOLT Integration Suite.
iWay Software is an information builder company and a leading adapter vendor,
engaged in acceleration of business integration. The availability of over 250
iWay Software adapters to the iBOLT Integration Suite enables organizations to
connect to virtually any packaged application, mainframe and legacy system,
traditional database, and to external data sources. iWay Software adapters
interface seamlessly into the iBOLT environment without requiring complex coding
or application modifications.

COMPETITION

     The markets for our eDeveloper and iBOLT technologies and applications are
characterized by rapidly changing technology, evolving industry standards,
frequent new product introductions and rapidly changing customer requirements.
These markets are therefore highly competitive and we expect competition to
intensify in the future. We may not be able to compete effectively in these
markets and may lose market share to our competitors.


                                       24



     With the introduction of eDeveloper Version 10 in mid 2006, we further
shifted our activities from the integrated development environment market, in
which we were competing with eDeveloper in the past, towards the service
oriented architecture market, which we entered into with iBOLT. Our current
competitors include Above All, Agentis, Appian, BEA, Bowstreet, Broadvision,
ClearNova, Computer Associates, Cordys, FileNet, GT Software, IBM, Microsoft,
OutSystems, Oracle, Pegasytems, Progress, SAP, Skyway, Sun (SeeBeyond), TIBCO,
Ultimus, Unify, and webMethods. Additional competitors may enter each of our
markets at any time. Moreover, our customers may seek to develop internally the
products that we currently sell to them and thereafter compete with us.

     Most of our competitors have greater financial, personnel and other
resources than we do, which may limit our ability to compete effectively with
them. Those competitors may be able to respond more quickly to new or emerging
technologies or changes in customer requirements. Those competitors may also
benefit from greater economies of scale, offer more aggressive pricing, devote
greater resources to the promotion of their products or bundle their products
into existing products in a manner that renders our technology partially or
fully obsolete, thereby discouraging customers from purchasing our technology or
applications.

     We believe that the principal competitive factors affecting the market for
our products include developer productivity, rapid results, product
functionality, performance, reliability, portability, interoperability,
ease-of-use, demonstrable economic benefits for developers and users relative to
cost, quality of customer support and documentation, ease of installation,
vendor reputation and experience, financial stability and, to a lesser degree,
price.

INTELLECTUAL PROPERTY

     We do not hold any patents and rely upon a combination of copyright,
trademark, trade secret laws and contractual restrictions to protect our rights
in our software products. Our policy has been to pursue copyright protection for
our software and related documentation and trademark registration of our product
names. Also, our key employees and independent contractors and distributors are
required to sign non-disclosure and secrecy agreements.

     We provide our products to customers under a non-exclusive,
non-transferable license. Usually, we have not required end-users of our
products to sign license agreements. However, in some accounts license
agreements are required to be signed by the end-users. Generally, a "shrink
wrap" license agreement is included in the product packaging, which explains
that by opening the package seal, the user is agreeing to the terms contained
therein. It is uncertain whether license agreements of this type are legally
enforceable in all of the countries in which the software is marketed.

     Our trademark rights include rights associated with our use of our
trademarks, and rights obtained by registration of our trademarks. We have
obtained trademark registrations in South Africa, Canada, Chile, China, Israel,
the Netherlands (Benelux), Switzerland, Thailand, the United Kingdom and the
United States. The initial terms of the registration of our trademarks range
from 10 to 20 years and are renewable thereafter. Our use and registration of
our trademarks do not ensure that we have superior rights to others that may
have registered or used identical or related marks on related goods or services.
We do not believe that patent laws are a significant source of protection for
our products. We have registered a copyright for our software in the United
States and Japan. Also, we have registered copyrights for some of our manuals in
the United States and have acquired an International Standard Book Number (ISBN)
for some of our manuals. Our copyrights expire 70 years from date of first
publication.

     Since the software industry is characterized by rapid technological
changes, the policing of the unauthorized use of software is a difficult task
and software piracy is expected to continue to be a persistent problem for the
packaged software industry. As there can be no assurance that the
above-mentioned means of legal protection will be effective against piracy of
our products, and since policing unauthorized use of software is difficult,
software piracy can be expected to be a persistent potential problem.

     We believe that because of the rapid pace of technological change in the
software industry, the legal protections for our products are less significant
factors in our success than the knowledge, ability and experience of our
employees, the frequency of product enhancements and the timeliness and quality
of our support services.


                                       25




C.   ORGANIZATIONAL STRUCTURE

     We are a member of the Formula Systems (1985) Ltd. (NASDAQ: FORTY), or
Formula Systems, group. Formula Systems is an international IT company
principally engaged, through its subsidiaries and affiliates, in providing
software consulting services, developing proprietary software products and
producing computer-based solutions. In addition, Formula Systems manages a
venture capital fund, which invests in early stage companies that develop
software products for the international market. Formula Systems, an Israeli
corporation, beneficially owns a 50.10% equity interest in our ordinary shares.

     The following table sets forth the legal name, location and country of
incorporation and percentage ownership of each of our subsidiaries and
affiliates:

                                                      Country of        Ownership
Subsidiary/Affiliate Name                           Incorporation       Percentage
-------------------------                           -------------       ----------

Magic Software Enterprises Inc.                      United States        100%
CoreTech Consulting Group, LLC                       United States        100%
CoreTech Consulting Group, Inc.                      United States        100%
MSE Holdings, Inc.                                   United States        100%
Magic Software Enterprises (UK) Ltd.                 United Kingdom       100%
Hermes Logistics Technologies Limited                United Kingdom       100%
Magic Beheer B.V                                     Netherlands          100%
Magic Software Enterprises Netherlands B.V           Netherlands          100%
Magic Software Enterprises Spain Ltd.                Spain                100%
Magic Software Enterprises GmbH                      Germany              100%
Magic Software Enterprises France                    France               100%
Magic Benelux B.V                                    Netherlands          100%
Magic Software Enterprises (Israel) Ltd.             Israel               100%
Magic Software Enterprises Italy S.r.l               Italy                100%
Magic Software Japan K.K                             Japan                100%
Magic Software Enterprises India Pvt. Ltd.           India                100%
Onyx Magyarorszag Szsoftverhaz                       Hungary              100%
CarPro Systems Ltd.                                  Israel              90.48%
Advanced Answers on Demand Holding Corporation       United States        100%
Nextstep Infotech Prt. Ltd.                          India                 40%

D. PROPERTY, PLANTS AND EQUIPMENT

FACILITIES

     Our headquarters and principal administrative, finance, sales, marketing
and research and development operations are located in an office building of
approximately 39,321 square feet that we own in Or Yehuda, Israel, a suburb of
Tel Aviv. The building was constructed on a parcel of land leased from the
Israel Land Authority. The lease expires in 2040 and can be renewed for an
additional period of 49 years.

     Our Hungarian subsidiary owns a 4,850 square foot office in Budapest,
Hungary.

     Our U.S. subsidiaries lease approximately 20,328 square feet of office
space in Laguna Hills, California; King of Prussia, Pennsylvania; and Fort
Lauderdale, Florida. In addition, our subsidiaries also lease office spaces in
Paris, France; Munich, Germany; Pune, India; Bangalore, India; Tokyo, Japan;
Houten, the Netherlands; and Bracknell, United Kingdom. The aggregate annual
cost for such facilities was $1,585 in the year ended December 31, 2006.

     In the year ended December 31, 2006, we invested approximately $1.0 million
in capital assets, mainly in computers and peripheral equipment.


                                       26




ITEM 4A. UNRESOLVED STAFF COMMENTS

     Not applicable.

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

A.   RESULTS OF OPERATIONS

     THE FOLLOWING DISCUSSION OF OUR RESULTS OF OPERATIONS SHOULD BE READ
TOGETHER WITH OUR CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES, WHICH
APPEAR ELSEWHERE IN THIS ANNUAL REPORT. THE FOLLOWING DISCUSSION CONTAINS
FORWARD-LOOKING STATEMENTS THAT REFLECT OUR CURRENT PLANS, ESTIMATES AND BELIEFS
AND INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THOSE DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE
OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED BELOW AND ELSEWHERE IN
THIS ANNUAL REPORT.

BACKGROUND

     We develop, market and support software development, deployment and
integration technologies and business solutions that enable enterprises to
accelerate the process of building and deploying applications that can be
rapidly customized and integrated with existing systems. We were incorporated
under the laws of Israel in February 1983. We have 18 wholly owned subsidiaries
and one controlled subsidiary, incorporated in the United States, Europe, Asia
and Israel. Our subsidiaries are engaged in developing, marketing and supporting
vertical applications, as well as in selling and supporting our products. One of
our subsidiaries provides software consulting services. Our ordinary shares are
traded on the NASDAQ Global Market under the symbol "MGIC" and on the Tel Aviv
Stock Exchange.

OVERVIEW

     We develop, market and support our software development and deployment
technology called eDeveloper, and technology for business integration and
process management called iBOLT. Our technology enables enterprises to
accelerate the process of building, deploying and integrating business software
applications that can be rapidly customized to meet current and future needs.
Our technology and applications based on our technology are used by software
solution providers and thousands of enterprises in approximately 100 countries.
We refer to these vendors and enterprises as the Magic community. We also
provide maintenance and technical support as well as professional services to
the Magic community.

     We began operations in 1986 and completed an initial public offering of our
ordinary shares in the United States in August 1991. In the first quarter of
2000, we completed a follow-on offering of 4,000,000 of our ordinary shares in
the United States at $25.00 per share. Of these shares, 3,500,000 ordinary
shares were offered by us and 500,000 ordinary shares were offered by our major
shareholder, Formula Group (1985) Ltd. Our net proceeds from the offering, after
deducting the underwriting discount and expenses, were $79.6 million. We paid a
one-time cash dividend of $11,844,713 in February 2003.

GENERAL

     Our consolidated financial statements appearing in this annual report are
prepared in U.S. dollars and in accordance with generally accepted accounting
principles in the United States, or U.S. GAAP. All references in this annual
report to "dollars" or "$" are to U.S. dollars and all references in this annual
report to "NIS" are to New Israeli Shekels. Transactions and balances originally
denominated in dollars are presented at their original amounts. Transactions and
balances in other currencies are remeasured into dollars in accordance with the
principles set forth in Financial Accounting Standards Board Statement No. 52.
The majority of our sales are made outside Israel and a substantial part of them
are in dollars. In addition, substantial portions of our costs are incurred in
dollars. Since the dollar is the primary currency of the economic environment in
which we and certain of our subsidiaries operate, the dollar is our functional
and reporting currency and, accordingly, monetary accounts maintained in
currencies other than the dollar are remeasured using the foreign exchange rate
at the balance sheet date. Operational accounts and non monetary balance sheet
accounts are measured and recorded at the exchange rate in effect at the date of
the transaction. All balance sheet accounts have been translated using the
exchange rates in effect at the balance sheet date. Statement of operations
amounts have been translated using the average exchange rate for the period. The
resulting translation adjustments are reported as a component of shareholders'
equity in accumulated other comprehensive income (loss).


                                       27



DISCUSSION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATIONS

     We have identified the policies below as critical to the understanding of
our financial statements. The preparation of our consolidated financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions in certain
circumstances that affect the amounts reported in the accompanying financial
statements and the related footnotes. Actual results may differ from these
estimates. To facilitate the understanding of our business activities, certain
of our accounting policies that we believe are the most important to the
portrayal of our financial condition and results of operations and that require
management's subjective judgments are described below. We base our judgments on
our experience and various assumptions that we believe are reasonable.

REVENUE RECOGNITION

     To date, we have derived our revenues from licensing the rights to use our
software, maintenance and technical support and providing professional services.
We sell our products primarily through our direct sales force and indirectly
through distributors.

     We account for software sales in accordance with Statement of Position, or
SOP, No. 97-2, "Software Revenue Recognition," as amended by Statement of
Position 98-9, "Modifications of SOP 97-2, Software Revenue Recognition with
Respect to Certain Transactions," or SOP No. 97-2. Revenue is recognized when
the following four criteria are met: (i) persuasive evidence of an arrangement
exists; (ii) delivery has occurred; (iii) the fee is fixed or determinable; and
(iv) collectibility is probable.

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

     Revenue from license fees is recognized when persuasive evidence of an
agreement exists, delivery of the product has occurred, no significant
obligations with regard to implementation remain, the fee is fixed or
determinable, and collectibility is probable. We do not generally grant a right
of return to our customers. When a right of return exists, we defer revenue
until the right of return expires, at which time revenue is recognized provided
that all other revenue recognition criteria are met.

     Maintenance and technical support revenue is deferred and recognized on a
straight-line basis over the term of the maintenance and support agreement.
Revenue from consulting services consists of billable hours for services
provided, and is recognized as the services are rendered.

     Arrangements that include consulting services are evaluated to determine
whether those services are essential to the functionality of other elements of
the arrangement. When services are considered essential, revenue under the
arrangement is recognized using contract accounting based on Statement of
Position No. 81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts," or SOP 81-1, on a percentage of completion method
based on input measures. Provisions for estimated losses on uncompleted
contracts are made in the period in which such losses are first determined, in
the amount of the estimated loss for the entire contract. As of December 31,
2006, no such estimated losses were identified.


                                       28



     When consulting services are not considered essential, the revenue
allocable to the consulting services is recognized as the services are
performed. In most cases to date, we have determined that the services are not
considered essential to the functionality of other elements of the arrangement.

     Deferred revenue includes unearned amounts received under maintenance and
support contracts, and amounts received from customers but not yet recognized as
revenues.

OTHER INTANGIBLE ASSETS

     Intangible assets are comprised of distribution rights, acquired technology
and customer relations, and are amortized over their useful life using a method
of amortization that reflects the pattern in which the economic benefits of the
intangible assets are consumed or otherwise used up. Distribution rights,
acquired technology and customer relations are amortized on a straight line
basis over a period of five years.

CAPITALIZATION OF SOFTWARE DEVELOPMENT COSTS

     Certain software development costs are capitalized subsequent to the
establishment of technological feasibility in accordance with Financial
Accounting Standards Board, or FASB, Statement of Financial Accounting Standard,
or SFAS, No. 86 "Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed." Based on our product development process and that
of our subsidiaries, technological feasibility is established upon completion of
a detailed program design and a working model.

     Research and development costs incurred in the process of developing
product improvements or new products, are generally charged to expenses as
incurred.

     Significant costs incurred by us and our subsidiaries between completion of
the detailed program design and the point at which the product is ready for
general release, have been capitalized.

     Capitalized software costs are amortized by the greater of the amount
computed using the: (i) ratio that current gross revenues from sales of the
software to the total of current and anticipated future gross revenues from
sales of that software, or (ii) the straight-line method over the estimated
useful life of the product (three to five years). We assess the recoverability
of this intangible asset on a regular basis by determining whether the
amortization of the asset over its remaining life can be recovered through
undiscounted future operating cash flows from the specific software product
sold. As of December 31, 2006, no impairment losses have been identified.

GOODWILL

     Goodwill and intangible assets with an identifiable useful life are no
longer amortized but are subject to annual impairment tests based on estimated
fair value in accordance with SFAS No. 142 "Goodwill and Other Intangible
Assets," or SFAS No. 142. We conduct our annual test of impairment for goodwill
in December of each year. In addition we test for impairment periodically
whenever events or circumstances occur subsequent to our annual impairment tests
that indicate that the asset might be impaired. Indicators we consider important
which could trigger an impairment include, but are not limited to, significant
underperformance relative to historical or projected future operating results,
significant changes in the manner of use of acquired assets or the strategy for
our overall business, significant negative industry or economic trends, a
significant decline in our stock price for a sustained period and our market
capitalization relative to net book value.

     We have three reporting units. Goodwill attributable to each of the
reporting unit is measured separately. The first step of the goodwill impairment
test compares the carrying value of each reporting unit with its fair value on
that date. Since the fair value of the reporting units exceeded their carrying
amount, no impairment was identified in 2006.


                                       29



IMPAIRMENT OF LONG-LIVED ASSETS

     We review our long-lived assets for impairment in accordance with SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets," or SFAS
No. 144, whenever a sale event or change in circumstances indicate that the
carrying value of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying value 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 value of the assets exceeds the
fair value of the assets. In the year ended December 31, 2006, our Board of
Directors determined that the technology relating to iBolt Portal had been
impaired and its carrying value in the amount of approximately $0.3 million was
written-off.

MARKETABLE SECURITIES

     We account for investments in marketable securities in accordance with SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities," or
SFAS No. 115. Our management determines the appropriate classification of its
investments in marketable debt securities at the time of purchase and
reevaluates such determinations at each balance sheet date. Debt securities are
classified as available for sale and reported at fair value.

     Debt securities that are designated as available-for-sale are stated at
fair value, with unrealized gains and losses reported in accumulated other
comprehensive income (loss), a separate component of shareholders' equity.
Realized gains and losses on sales of investments, as determined on a specific
identification basis, are included in financial income, net. As of December 31,
2006, the unrealized losses in our investments in available-for-sale marketable
securities were caused by interest rate increases. We believe that we have the
ability to hold our current marketable securities until they recover. We expect
that our marketable securities will not be exercised at a price less than the
amortized cost of our investment. Based on our intent and ability to hold our
marketable securities until they recover and the partial recovery of the
securities' market since the beginning of 2006, no impairment has been
identified as of December 31, 2006.

STOCK-BASED COMPENSATION

     FASB SFAS No. 123 (revised 2004), "SHARE-BASED PAYMENT," or SFAS 123(R),
requires companies to estimate the fair value of equity-based payment awards on
the date of grant using an option-pricing model. The value of the portion of the
award that is ultimately expected to vest is recognized as an expense over the
requisite service periods in our consolidated income statement. Prior to the
adoption of SFAS 123(R), we accounted for equity-based awards to employees and
directors using the intrinsic value method in accordance with Accounting
Principles Board No. 25, or APB 25, as allowed under SFAS No. 123, "ACCOUNTING
FOR STOCK-BASED COMPENSATION."

     We adopted SFAS 123(R) using the modified prospective transition method,
which requires the application of the accounting standard starting from January
1, 2006, the first day of our fiscal year 2006. Under the transition method,
since all the unvested options had been accelerated prior to the adoption of
SFAS 123(R) (see Note 12 to the consolidated financial statements), compensation
cost recognized in the year ended December 31, 2006 includes compensation cost
for all share-based payments granted subsequent to January 1, 2006, based on the
grant-date fair value estimated in accordance with the provisions of SFAS
123(R). Results for prior periods have not been restated.

     We recognize compensation expenses for the value of our awards, which have
graded vesting based on the straight line method over the requisite service
period of each of the awards, net of estimated forfeitures. Estimated
forfeitures are based on actual historical pre-vesting forfeitures.

     As a result of adopting SFAS 123(R) on January 1, 2006, our income before
income taxes and net income for the year ended December 31, 2006, is $27,000
lower than if we had continued to account for stock-based compensation under APB
25.


                                       30



     Prior to January 1, 2006, we applied the intrinsic value method of
accounting for stock options as prescribed by APB 25, whereby compensation
expense is equal to the excess, if any, of the quoted market price of the stock
over the exercise price at the grant date of the award.

SIGNIFICANT EXPENSES

     COST OF REVENUES. Cost of revenues for software sales consist primarily of
software production costs royalties and licenses payable to third parties, as
well as amortization of capitalized software. Cost of revenues for maintenance
and technical support and professional services consists primarily of personnel
expenses and other related costs.

     RESEARCH AND DEVELOPMENT EXPENSES, NET. Research and development costs
consist primarily of salaries of employees engaged in on-going research and
development activities and other related expenses. The capitalization of
software development costs is applied as reductions to gross research and
development costs to calculate net research and development expenses.

     The following table sets forth the gross research and development costs,
capitalized software development costs, and the net research and development
expenses for the periods indicated:

                                                                   YEAR ENDED DECEMBER 31
                                                           --------------------------------------
                                                             2004          2005           2006
                                                           -------        -------        -------
                                                                (U.S. dollars in thousands)

Gross research and development costs                       $ 7,317        $ 7,642        $ 7,477
   Less capitalization of software development costs        (3,472)        (3,909)        (3,535)
                                                           -------        -------        -------
Research and development expenses, net                     $ 3,845        $ 3,733        $ 3,942
                                                           =======        =======        =======

     SELLING AND MARKETING EXPENSES. Selling and marketing expenses consist
primarily of compensation and related expenses for sales and marketing
personnel, sales commissions, marketing programs, web site related expenses,
public relations, promotional materials, travel expenses and trade show exhibit
expenses.

     GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of salaries and related expenses for executive, accounting,
human resources and administrative personnel, professional fees, provisions for
doubtful accounts, and other general corporate expenses.

     The following table presents selected consolidated statement of operations
data for the periods indicated:

                                                                       YEAR ENDED DECEMBER 31
                                                               ---------------------------------------
                                                                 2004           2005            2006
                                                               --------       --------        --------
                                                              (U.S. dollars in thousands, except share and
                                                                            per share data)

Revenues:
   Software                                                    $ 20,614       $ 16,803        $ 15,853
   Applications                                                   7,408          8,300           6,483
   Maintenance and technical support                             12,555         14,376          14,935
   Consulting services                                           24,590         21,511          24,454
                                                               --------       --------        --------
     Total revenues                                              65,167         60,990          61,725
                                                               --------       --------        --------
Cost of revenues:
   Software                                                       4,742          4,412           4,014
   Applications                                                   1,720          4,071           3,002
   Maintenance and technical support                              3,199          2,679           3,615
   Consulting services                                           15,818         15,514          18,087
                                                               --------       --------        --------
     Total cost of revenues                                      25,479         26,676          28,718
                                                               --------       --------        --------
Gross profit                                                     39,688         34,314          33,007
                                                               --------       --------        --------
Operating expenses:
   Research and development, net                                  3,845          3,733           3,942
   Sales and marketing, net                                      17,157         18,510          16,777
   General and administrative                                    15,384         16,332          15,572
   Restructuring and impairment expenses                              -              -           2,157
                                                               --------       --------        --------
   Total operating expenses                                      36,386         38,575          38,685
                                                               --------       --------        --------
Operating income (loss)                                           3,302         (4,261)         (5,441)
Financial  income (expenses), net                                   912           (811)            410
Other income (expenses)                                               -          1,169             278
                                                               --------       --------        --------
Income (loss) before taxes on income                              4,214         (3,903)         (4,753)
Income taxes                                                        281            491             325
                                                               --------       --------        --------
Income (loss) after taxes on income                               3,933         (4,394)         (5,078)
Equity in earnings (losses) of affiliates                            79             19             (15)

Minority interest in losses (earnings) of
   consolidated subsidiaries                                         78           (232)            (57)
                                                               --------       --------        --------
Net income (loss)                                              $  4,090       $ (4,607)       $ (5,006)
                                                               ========       ========        ========
  Basic earnings (loss) per share                              $   0.13       $  (0.15)       $  (0.16)
                                                               ========       ========        ========
  Diluted earnings (loss) per share                            $   0.13       $  (0.15)       $  (0.16)
                                                               ========       ========        ========
Shares used to compute basic earnings (loss) per share           31,029         31,124          31,184
                                                               ========       ========        ========
Shares used to compute diluted earnings (loss) per share         32,426         31,124          31,184
                                                               ========       ========        ========


                                       31



     The following table presents selected consolidated statement of operations
data for the periods indicated as a percentage of total revenues:

                                                          YEAR ENDED DECEMBER 31,
                                                    ---------------------------------
                                                    2004          2005           2006
                                                    -----         -----         -----
Revenues:
   Software                                          31.6%         27.5%         25.7%
   Applications                                      11.4          13.6          10.5
   Maintenance and technical support                 19.3          23.6          24.2
   Consulting services                               37.7          35.3          39.6
                                                    -----         -----         -----
     Total revenues                                 100.0%        100.0%        100.0%
Cost of revenues:
   Software                                           7.3           7.2           6.5
   Applications                                       2.6           6.7           4.9
   Maintenance and technical support                  4.9           4.4           5.9
   Consulting services                               24.3          25.4          29.3
                                                    -----         -----         -----
     Total cost of revenues                          39.1          43.7          46.6
                                                    -----         -----         -----
Gross profit                                         60.9          56.3          53.4
                                                    -----         -----         -----
Operating expenses:
   Research and development, net                      5.9           6.1           6.4
   Selling and marketing, net                        26.3          30.3          27.2
   General and administrative                        23.6          26.8          25.2
                                                    -----         -----         -----
   Restructuring and impairment  expenses               -             -           3.5
                                                    -----         -----         -----
     Total operating expenses                        55.8          63.2          62.3
                                                    -----         -----         -----
Operating income (loss)                               5.1          (7.0)         (8.9)
                                                    -----         -----         -----
Other income (expenses)                                 -           1.9           0.5
                                                    -----         -----         -----
Financial  income (expenses), net                    (1.4)         (1.3)          0.7
                                                    -----         -----         -----
Income (loss) before taxes on income                  6.5          (6.4)         (7.7)
Income taxes                                          0.4           0.8           0.5
Equity in earnings (losses) of affiliates             0.1           0.0          (0.0)
Minority interest in (earnings) losses of
  consolidated subsidiaries                           0.1          (0.4)         (0.1)
                                                    -----         -----         -----
Net income (loss)                                     6.3%         (7.6)%        (8.1)%
                                                    =====         =====         =====


                                       32



YEAR ENDED DECEMBER 31, 2006 COMPARED WITH YEAR ENDED DECEMBER 31, 2005

     REVENUES. Total revenues increased by 1% to $61.7 million in 2006 from
$61.0 million in the year ended December 31, 2005. License revenues decreased by
5% to $15.9 million in the year ended December 31, 2006 from $16.8 million in
the year ended December 31, 2005 due to a decrease in sales, primarily in
Europe. Application revenues decreased by 22% to $6.5 million in the year ended
December 31, 2006 from $8.3 million in the year ended December 31, 2005
primarily due to the decrease in sales of applications by certain of our
subsidiaries. Revenues from maintenance and technical support increased by 3% to
$14.9 million in the year ended December 31, 2006 from $14.4 million in the year
ended December 31, 2005, as a result of our entering into maintenance and
support contracts with more customers in 2006. Revenues from consulting and
other services increased by 13% to $24.4 million in the year ended December 31,
2006 from $21.5 million in the year ended December 31, 2005, as a result of
growth in demand for consulting and other services. We expect that our total
revenues will moderately increase in 2007.

     COST OF REVENUES. Cost of revenues increased by 7% to $28.7 million in the
year ended December 31, 2006 from $26.7 million in the year ended December 31,
2005. Cost of revenues for licenses decreased by 9% to $4.0 million in the year
ended December 31, 2006 from $4.4 million in the year ended December 31, 2005
primarily as a result of the decrease in third party sales . Cost of revenues
for applications decreased by 27% to $3.0 million in the year ended December 31,
2006 from $4.1 million in the year ended December 31, 2005, consistent with the
decrease in application license sales. Cost of revenues for maintenance and
technical support increased by 35% to $3.6 million in the year ended December
31, 2006 from $2.7 million in the year ended December 31, 2005 consistent with
the increase in revenues .Cost of revenues for consulting and other services
increased by 17% to $18.1 million in the year ended December 31, 2006 from $15.5
million in the year ended December 31, 2005, primarily due to the increase in
our revenues from consulting and other services. We expect that our cost of
revenues will slightly decrease in 2007, as a result of the change in the
revenues mix of revenues.

     GROSS PROFIT. As a result of the forgoing, gross profit decreased by 4% to
$33.0 in the year ended December 31, 2006 from $34.3 million in the year ended
December 31, 2005.

     RESEARCH AND DEVELOPMENT EXPENSES, NET. Total research and development
expenses decreased by 3% to $7.4 million in the year ended December 31, 2006
from $7.6 million in the year ended December 31, 2005. Net research and
development expenses increased by 5% to $3.9 million in the year ended December
31, 2006 from $3.7 million in the year ended December 31, 2005. In 2006, we
capitalized $3.5 million of software development costs, as compared to $3.9
million capitalized in 2005. The increase in total research and development
expenses in 2006 was due to work performed in connection with the expected
release of eDeveloper Version 10 in 2006 as well as our new version of iBOLT.
Net research and development expenses as a percentage of revenues increased to
6.4% in the year ended December 31, 2006 from 6.1% in the year ended December
31, 2005. We do not expect a material change in our net research and development
expenses as percentage of our revenues in 2007.

     SELLING AND MARKETING EXPENSES, NET. Selling and marketing expenses
decreased by 9% to $16.8 million in the year ended December 31, 2006 from $18.5
million in the year ended December 31, 2005 reflecting the reduction of our
marketing activities for both our eDeveloper and iBOLT products and the effect
of the sales force reduction. Selling and marketing expenses as a percentage of
revenues decreased to 27.2% in the year ended December 31, 2006 from 30.3% in
the year ended December 31, 2005, due to decreased marketing activities for both
our eDeveloper and iBolt products and the effect of the sales force reduction.
As part of the implementation of our restructuring and impairment plan, we
expect that our selling and marketing expenses will decrease in 2007.


                                       33



     GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased by 4% to $15.6 million in the year ended December 31, 2006 from $16.3
million in the year ended December 31, 2005. Of such general and administrative
expenses, $0.6 million was attributable to bad debt expenses in the year ended
December 31, 2006 compared to $1.2 million of bad debt expenses in the year
ended December 31, 2005.

     RESTRUCTURING AND IMPAIRMENT EXPENSES. In the third quarter of 2006, we
announced a restructuring and impairment plan primarily to reduce our costs and
improve profitability. Total restructuring and impairment costs in the year
ended December 31, 2006 were $2.2 million, a significant portion of which was
attributable to severance payments.

     OTHER INCOME. We recorded other income of approximately $0.3 million in the
year ended December 31, 2006 relating to the sale of CarPro System Ltd.'s IP and
related assets. We recorded other income of approximately $1.2 million in the
year ended December 31, 2005 relating to life insurance that we received
following the death of Mr. Barry Scutillo, the former chief executive officer of
our subsidiary Advanced Answers On Demand Holding Corporation in June 2004.

     FINANCIAL INCOME (EXPENSES) NET. We had financial income of $0.4 million in
the year ended December 31, 2006 primarily due to the appreciation of certain
currencies in which we had assets that were denominated or to which assets were
tied, against the U.S. dollar. We had financial expense of $0.8 million in the
year ended December 31, 2005 primarily due to the devaluation of certain
currencies in which we had assets that were denominated or to which assets were
tied, against the U.S. dollar.

     INCOME TAXES. We incurred income taxes of $0.3 million in the year ended
December 31, 2006, compared to $0.5 million in the year ended December 31, 2005.
Those taxes are primarily attributable to taxes accrued in the United States.

     EQUITY IN EARNINGS (LOSSES) OF AFFILIATES. In the year ended December 31,
2006, we recognized equity in losses of affiliates of $15,000, while we
recognized equity in earnings of affiliates of $19,000 in the year ended
December 31, 2005.

     MINORITY INTEREST IN PROFITS (LOSSES) OF CONSOLIDATED SUBSIDIARIES.
Minority interest in the profits of our consolidated subsidiaries represents the
minority shareholders' share of the profits (losses) of some of certain majority
owned subsidiaries. In the year ended December 31, 2006, we recognized an income
of $0.06 million compared to a loss of $0.2 million in the year ended December
31, 2005.

YEAR ENDED DECEMBER 31, 2005 COMPARED WITH YEAR ENDED DECEMBER 31, 2004

     REVENUES. Total revenues decreased by 6% to $61.0 million in 2005 from
$65.2 million in the year ended December 31, 2004. Software sales decreased by
18% to $16.8 million in the year ended December 31, 2005 from $20.6 million in
the year ended December 31, 2004. Application revenues increased by 12% to $8.3
million in the year ended December 31, 2005 from $7.4 million in the year ended
December 31, 2004. Revenues from maintenance and technical support increased by
14% to $14.37 million in the year ended December 31, 2005 from $12.6 million in
the year ended December 31, 2004, as a result of our entering into maintenance
and support contracts with more customers in 2005. Revenues from professional
services decreased by 13% to $21.5 million in the year ended December 31, 2005
from $24.6 million in the year ended December 31, 2004, as a result of our long
term strategy to gradually reduce our revenues from professional services by
using third parties to deliver projects.

     COST OF REVENUES. Cost of revenues increased by 5% to $26.7 million in the
year ended December 31, 2005 from $25.5 million in the year ended December 31,
2004. Cost of revenues for software sales decreased by 6% to $4.4 million in the
year ended December 31, 2005 from $4.7 million in the year ended December 31,
2004. Cost of revenues for applications increased by 141% to $4.1 million in the
year ended December 31, 2005 from $1.7 million in the year ended December 31,
2004, partly as a result of an increase in our application revenues and lower
margins in certain sales made in 2005. Cost of revenues for maintenance and
technical support decreased by 16% to $2.7 million in the year ended December
31, 2005 from $3.2 million in the year ended December 31, 2004. Cost of revenues
for professional services decreased by 2% to $15.5 million in the year ended
December 31, 2005 from $15.8 million in the year ended December 31, 2004,
primarily due to the decrease in our revenues from professional services.


                                       34



     GROSS PROFIT. As a result of the forgoing, Gross profit decreased by 14% to
$34.3 in the year ended December 31, 2005 from $39.7 million in the year ended
December 31, 2004.

     RESEARCH AND DEVELOPMENT EXPENSES, NET. Total research and development
expenses increased by 4% to $7.6 million in the year ended December 31, 2005
from $7.3 million in the year ended December 31, 2004. Net research and
development expenses decreased by 3% to $3.7 million in the year ended December
31, 2005 from $3.8 million in the year ended December 31, 2004. In 2005, we
capitalized $3.9 million of software development costs, as compared to $3.5
million capitalized in 2004. The increase in total research and development
expenses in 2005 was due to work performed in connection with the expected
release of eDeveloper Version 10 in 2006 as well as our new version of iBOLT.
Net research and development expenses as a percentage of revenues increased to
6.1% in the year ended December 31, 2005 from 6% in the year ended December 31,
2004.

     SELLING AND MARKETING EXPENSES, NET. Selling and marketing expenses
increased by 8% to $18.5 million in the year ended December 31, 2005 from $17.2
million in the year ended December 31, 2004 reflecting the growth of our
marketing activities for both our eDeveloper and iBOLT products. Selling and
marketing expenses as a percentage of revenues increased to 30.3% in the year
ended December 31, 2005 from 26.3% in the year ended December 31, 2004, due to
increased marketing activities for both our eDeveloper and iBolt products and a
decrease in revenues in 2005 compared to 2004.

     GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased by 6% to $16.3 million in the year ended December 31, 2005 from $15.4
million in the year ended December 31, 2004.

     RESTRUCTURING AND IMPAIRMENT EXPENSES. We did not have any restructuring
and impairment expenses in 2004 and 2005. We began to implement our
restructuring and impairment plan during 2006 .

     OTHER INCOME. We recorded other income of approximately $1.2 million in
2005 relating to life insurance that we received following the death of Mr.
Barry Scutillo, the former chief executive officer of our subsidiary Advanced
Answers On Demand Holding Corporation in June 2004. We did not have any other
income in 2004.

     FINANCIAL INCOME (EXPENSES) NET. We had financial expenses of $0.8 million
in the year ended December 31, 2005 primarily due to the devaluation of certain
currencies in which we had assets that were denominated or to which assets were
tied, against the U.S. dollar. We had financial income of $0.9 million in the
year ended December 31, 2004 primarily due to the appreciation of certain
currencies in which we had assets that were denominated or to which assets were
tied, against the U.S. dollar.

     INCOME TAXES. We incurred income taxes of $0.5 million in the year ended
December 31, 2005, out of which $0.1 million is attributable to prior years, and
we incurred income taxes of $0.4 million in the year ended December 31, 2004.
These taxes are primarily attributable to taxes accrued in the United States and
Israel.

     EQUITY IN GAINS (LOSSES) OF AFFILIATES. In the year ended December 31,
2005, we recognized equity in earnings of affiliates of $0.02 million, compared
to equity in earnings of affiliates of $0.08 million in the year ended December
31, 2004.

     MINORITY INTEREST IN PROFITS (LOSSES) OF CONSOLIDATED SUBSIDIARIES.
Minority interest in the profits of our consolidated subsidiaries represents the
minority shareholders' share of the profits (losses) of some of certain majority
owned subsidiaries. In the year ended December 31, 2005, we recognized a loss of
$0.2 million as compared to income of $0.08 million in the year ended December
31, 2004.


                                       35



QUARTERLY RESULTS OF OPERATIONS

     The following tables set forth unaudited quarterly results of operations in
U.S. dollars and as a percentage of revenues for each of the eight fiscal
quarters ended December 31, 2006. We have prepared this information on a basis
consistent with our audited consolidated financial statements included in this
annual report and include all necessary adjustments, consisting only of normal
recurring accruals that we consider necessary for a fair presentation of the
information for the periods indicated. The results of operations for any quarter
are not necessarily indicative of results for any future periods.

                                                                                           THREE MONTHS ENDED
                                                ----------------------------------------------------------------------------------------------------------
                                                MAR. 31,      JUNE 30,      SEP. 30,      DEC. 31,      MAR. 31,      JUNE 30,      SEP. 30,      DEC. 31,
                                                  2005          2005          2005          2005          2006          2006          2006          2006
                                                --------      --------      --------      --------      --------      --------      --------      --------
                                                                                       (U.S. dollars in thousands)
Revenues:
  Software                                      $  4,870      $  4,408      $  3,798      $  3,727      $  4,847      $  3,930      $  3,449      $  3,627
  Applications                                     2,207         1,894         2,196         2,003         1,406         1,776         1,484         1,817
  Maintenance and technical support                3,546         3,858         3,607         3,365         3,486         3,848         3,870         3,731
  Consulting services                              4,881         5,542         5,167         5,921         5,527         5,598         6,315         7,014
                                                --------      --------      --------      --------      --------      --------      --------      --------
Total revenues                                    15,504        15,702        14,768        15,016        15,266        15,152        15,118        16,189
                                                --------      --------      --------      --------      --------      --------      --------      --------
Cost of revenues:
Software                                             761         1,273         1,042         1,336           822           988         1,497           707
  Applications                                       747           911         1,145         1,268           876           742           815           569
  Maintenance and technical support                  873           740           585           481           941           969           807           898
  Consulting services                              3,797         3,821         3,729         4,167         4,150         4,379         4,429         5,129
                                                --------      --------      --------      --------      --------      --------      --------      --------
  Total cost of revenues                           6,178         6,745         6,501         7,252         6,789         7,078         7,548         7,303
                                                --------      --------      --------      --------      --------      --------      --------      --------
  Gross profit                                     9,326         8,957         8,267         7,764         8,477         8,074         7,570         8,886
                                                --------      --------      --------      --------      --------      --------      --------      --------
Operating expenses:

  Research and development, net                    1,054           953           826           900           865           911         1,338           828
  Selling and marketing, net                       4,845         4,867         4,188         4,610         4,180         4,621         3,885         4,091
  General and administrative                       3,822         4,142         4,470         3,898         3,595         3,931         4,101         3,945
  Restructuring and impairment
   expenses                                            -             -             -             -             -             -         1,888           269
  Total operating expenses                         9,721         9,962         9,484         9,408         8,640         9,463        11,212         9,133
                                                --------      --------      --------      --------      --------      --------      --------      --------
  Operating income (loss)                           (395)       (1,005)       (1,217)       (1,644)         (163)       (1,389)       (3,642)         (247)
  Financial income (expenses), net.                 (320)          (47)         (252)         (192)          (72)          167           191           124
  Other income                                     1,169             -             -             -             -             -             -           278
                                                --------      --------      --------      --------      --------      --------      --------      --------
  Income (loss) before taxes on income               454        (1,052)       (1,469)       (1,836)         (235)       (1,222)       (3,451)          155
  Income taxes                                       231            54           143            63            47           139            55            84
  Equity in earnings (losses) of affiliates           53            (2)           21           (53)           57            11           (49)           (4)
  Minority interest in earnings (losses)
   of  subsidiaries                                  112            52            29            39            56            12            26           (37)
                                                --------      --------      --------      --------      --------      --------      --------      --------
  Net income (loss)                             $    164      $ (1,160)     $ (1,620)     $ (1,991)     $   (169)     $ (1,338)     $ (3,529)     $     30
                                                ========      ========      ========      ========      ========      ========      ========      ========


                                       36



                                                                         THREE MONTHS ENDED
                                      ------------------------------------------------------------------------------------------
                                     MAR. 31,    JUN. 30,    SEP. 30,    DEC. 31,    MAR. 31,    JUN. 30,     SEP. 30,     DEC. 31,
                                      2005         2005        2005        2005        2006        2006        2006         2006
                                      -----       -----       -----       -----       -----       ------       -----       -----
                                                                  (As percentage of total revenues)
Revenues:
Software                               31.4%       28.1%       25.7%       24.8%       31.7%        25.9%       22.8%       22.4%
Applications                           14.2%       12.1%       14.9%       13.3%        9.2%        11.7%        9.8%       11.2%
Maintenance and technical support      22.9%       24.5%       24.4%       22.4%       22.8%        25.4%       25.6%       23.0%
Consulting services                    31.5%       35.3%       35.0%       39.5%       36.3%        37.0%       41.8%       43.4%
                                      -----       -----       -----       -----       -----       ------       -----       -----
Total revenues                        100.0%      100.0%      100.0%      100.0%      100.0%       100.0%      100.0%      100.0%
                                      -----       -----       -----       -----       -----       ------       -----       -----
Cost of revenues:
Software                                4.9%        8.2%        7.1%        8.9%        5.4%         6.5%        9.9%        4.4%
Applications                            4.8%        5.8%        7.8%        8.4%        5.7%         4.9%        5.4%        3.5%
Maintenance and technical
   support                              5.6%        4.7%        4.0%        3.2%        6.2%         6.4%        5.3%        5.5%
Consulting services                    24.5%       24.3%       25.3%       27.8%       27.2%        28.9%       29.3%       31.7%
                                      -----       -----       -----       -----       -----       ------       -----       -----
Total cost of revenues                 39.8%       43.0%       44.0%       48.3%       44.5%        46.7%       50.0%       45.1%
                                      -----       -----       -----       -----       -----       ------       -----       -----
Gross profit                           60.2%       57.0%       56.0%       51.7%       55.5%        53.3%       50.0%       54.9%
                                      -----       -----       -----       -----       -----       ------       -----       -----
Operating expenses:
Research and development,
   net                                  6.8%        6.1%        5.6%        6.0%        5.7%         6.0%        8.9%        5.1%
Selling and marketing, net..           31.3%       31.0%       28.4%       30.7%       27.4%        30.5%       25.7%       25.3%
General and administrative..           24.7%       26.4%       30.3%       26.0%       23.5%        25.9%       27.1%       24.4%
Restructuring and impairment
   expenses                               -           -           -           -           -            -        12.4%        1.7%
Total operating expenses               62.7%       63.4%       64.2%       62.7%       56.6%        62.5%       74.1%       56.4%
                                      -----       -----       -----       -----       -----       ------       -----       -----
Operating income (loss)                (2.5)%      (6.4)%      (8.2)%     (10.9)%      (1.1)%       (9.2)%     (24.1)%      (1.5)%
Financial income (expenses), net       (2.1)%      (0.3)%      (1.7)%      (1.3)%      (0.5)%        1.1%        1.3%        0.8%
                                      -----       -----       -----       -----       -----       ------       -----       -----
Other income                            7.5%          -           -           -           -            -           -         1.7%
                                      -----       -----       -----       -----       -----       ------       -----       -----
Income (loss) before taxes on
   income                               2.9%       (6.7)%     (10.0)%     (12.2)%      (1.5)%       (8.1)%     (22.8)%       1.0%
Income taxes                            1.5%        0.3%        1.0%        0.4%        0.3%         0.9%        0.4%        0.5%
Equity in earnings (losses) of
   affiliates                           0.3%        0.0%        0.1%       (0.4)%       0.4%        0.01%       (0.3)%      (0.0)%
Minority interest in losses
   (earnings)
   of subsidiaries                      0.7%        0.3%        0.2%        0.3%        0.4%        0.01%        0.2%       (0.2)%
                                      -----       -----       -----       -----       -----       ------       -----       -----
Net income (loss)                       1.1%       (7.4)%     (11.0)%     (13.3)%      (1.1)%       (8.8)%     (23.3)%       0.2%
                                      =====       =====       =====       =====       =====       ======       =====       =====

     Our quarterly results of operations have varied significantly in the past
as a result of various factors, part of which are beyond our control.
Accordingly, revenues and net income, if any, in any particular period may be
lower than revenues and net income, if any, in a preceding or comparable period.
Period-to-period comparisons of our result of operations may not be meaningful,
and you should not rely upon them as indications of our future performance.

SEASONALITY

     We experience seasonality in our revenues, with the third quarter typically
having lower levels of revenues due to the summer months in Europe. We expect
that this seasonality will continue for the foreseeable future.


                                       37



CONDITIONS IN ISRAEL

     We are incorporated under the laws of, and our principal executive offices
and manufacturing and research and development facilities are located in the
State of Israel. A Accordingly, we are influenced to a limited extent by the
political, economic and military conditions affecting Israel. Specifically, we
could be adversely affected by any major hostilities involving Israel, the
interruption or curtailment of trade between Israel and its present trading
partners, or a significant downturn in the economic or financial condition of
Israel.

POLITICAL CONDITIONS

     Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors, and a state of
hostility, varying from time to time in intensity and degree, has led to
security and economic problems for Israel. Although Israel has entered into
various agreements with Egypt, Jordan and the Palestinian Authority, there has
been an increase in unrest and terrorist activity in Israel, which began in
September 2000 and which has continued with varying levels of severity through
2006. In July 2006, an armed conflict began between Israel and Hezbollah forces
in Lebanon, which involved rocket attacks on populated areas in the northern
parts of Israel. On August 14, 2006, a cease-fire between Hezbollah and Israel
took effect. This situation has had an adverse effect on Israel's economy,
primarily in the geographical areas directly harmed by this conflict. We do not
believe that the political and security situation has had any material impact on
our business to date; however, this situation may effect us in the future. Any
future armed conflict, political instability or violence in the region may have
a negative effect on those research and development activities that we conduct
in Israel and may adversely affect our share price.

     Furthermore, some countries, companies and organizations continue to
participate in a boycott of Israeli firms. We do not believe that the boycott
has had a material adverse effect on our business, but restrictive laws,
policies or practices directed towards Israel or Israeli businesses may have an
adverse impact on the expansion of our business.

     In addition, some of our directors, executive officers and employees in
Israel are obligated to annual reserve duty in the Israeli Defense Forces and
are may be called for active duty under emergency circumstances at any time. If
a military conflict or war arises, these individuals could be required to serve
in the military for extended periods of time. Our operations could be disrupted
by the absence for a significant period of key employees or a significant number
of other employees due to military service. Any disruption in our operations
could adversely affect our business. To date, no executive officer or key
employee has been recruited for military service for any significant time
period.

TRADE AGREEMENTS

     Israel is a member of the United Nations, the International Monetary Fund,
the International Bank for Reconstruction and Development and the International
Finance Corporation. Israel is also a signatory to the General Agreement on
Tariffs and Trade, which provides for reciprocal lowering of trade barriers
among its members. Israel has also been granted preferences under the
Generalized System of Preferences from Japan. These preferences allow Israel to
export the products covered by these programs either duty free or at reduced
tariffs.

     Israel and the United States entered into a Free Trade Agreement, or FTA,
in 1985. Under the FTA, most products receive immediate duty-free status. The
FTA eliminated all tariff and some non-tariff barriers on most trade between the
two countries in 1995. Israel became associated with the European Economic
Community, now known as the European Union, under a 1975 Free Trade Agreement,
which confers some advantages with respect to Israeli exports to most European
countries and obligates Israel to lower its tariffs with respect to imports from
those countries over a number of years. Israel is a member of the European
Union's Sixth Research and Development Program, giving Israelis access to
research and development tenders in the European Union countries. Since 1993, a
free trade agreement has been in effect between Israel and the European Free
Trade Association, or EFTA, whose members include Switzerland, Norway, Iceland
and Liechtenstein. The agreement grants the exporting countries of EFTA trading
with Israel conditions similar to those Israel enjoys with the United States. In
recent years, Israel has established commercial and trade relations with a
number of other nations, including Russia, China, India and other nations in
Asia and Eastern Europe, with which Israel previously had not had such
relations.


                                       38

IMPACT OF CURRENCY FLUCTUATIONS AND OF INFLATION

Our financial statements are denominated in U.S. dollars. Nevertheless, a
majority of our sales are made, and a majority of our expenses are incurred, in
other currencies, particularly Euros, Japanese yen, NIS and the British pound.
We maintain substantial non-U.S. dollar balances of assets, including cash and
accounts receivable, and liabilities, including accounts payable. Fluctuations
in the value of the currencies in which we do business relative to the U.S.
dollar could have a material adverse effect on our business, results of
operations and financial condition by decreasing the U.S. dollar value of assets
held in other currencies and increasing the U.S. dollar amount of liabilities
payable in other currencies.

The U.S. dollar cost of our operations in Israel is influenced by the
extent to which any increase in the rate of inflation in Israel is (or is not)
offset, or is offset on a lagging basis, by a devaluation of the NIS in relation
to the U.S. dollar. When the rate of inflation in Israel exceeds the rate of
devaluation of the NIS against the dollar, companies experience increases in the
dollar cost of their operations in Israel. Unless offset by a devaluation of the
NIS, inflation in Israel will have a negative effect on our profitability, as we
receive payments in dollars or dollar linked NIS for most of our sales, while we
incur a portion of our expenses in NIS.

The following table sets forth, for the periods indicated, information with
respect to the rate of inflation in Israel, the rate of devaluation of the NIS
against the U.S. dollar, and the rate of inflation in Israel adjusted for such
devaluation:

ISRAELI INFLATION
YEAR ENDED ISRAELI CONSUMER ISRAELI INFLATION ISRAELI DEVALUATION ADJUSTED FOR
DECEMBER 31, PRICE INDEX RATE % RATE % DEVALUATION %
------------ ----------- ------ ------ -------------

2002 108.2 6.5 7.3 (0.7)
2003 99.4 (8.1) (9.2) (7.6)
2004 100.6 1.2 (1.6) 2.8
2005 103.0 2.4 6.8 (4.4)
2006 102.9 (0.01) (8.0) 8.0

A devaluation of the NIS in relation to the U.S. dollar has the effect of
reducing the U.S. dollar amount of any of our expenses or liabilities which are
payable in NIS (unless such expenses or payables are linked to the U.S. dollar).
Such devaluation also has the effect of decreasing the U.S. dollar value of any
asset, which consists of NIS or receivables payable in NIS (unless such
receivables are linked to the U.S. dollar). Conversely, any increase in the
value of the NIS in relation to the U.S. dollar has the effect of increasing the
U.S. dollar value of any unlinked NIS assets and the U.S. dollar amounts of any
unlinked NIS liabilities and expenses.

Because exchange rates between the NIS and the U.S. dollar fluctuate
continuously, with a historically declining trend in the value of the NIS,
exchange rate fluctuations and especially larger periodic devaluations will have
an impact on our profitability and period-to-period comparisons of our results.
We cannot assure you that in the future our results of operations may not be
materially adversely affected by currency fluctuations.

CORPORATE TAX RATE

In 2006, Israeli companies were subject to income tax at the rate of 31% of
taxable income. However, eight investment programs at our facility in Or Yehuda
have been granted "approved enterprise" status under the Law for Encouragement
of Capital Investments, 1959 commonly referred to as the Investment Law, and we
are, therefore, eligible for some tax benefits. Subject to compliance with
applicable requirements, the portion of our income derived from the approved
enterprise programs will be tax-exempt for a period of two to four years
commencing in the first year in which an approved enterprise generates taxable
income and will be subject, for a period of five to eight years, to a reduced
corporate tax of 25%. However, these benefits will not be available to us with
respect to any income derived by our non-Israeli subsidiaries.

On April 1, 2005, an amendment to the Investment Law came into effect that
has significantly changed the provisions of the Investment Law. The amendment
limits the scope of enterprises which may be approved by the Investment Center
Investment Center of the Ministry of Industry and Trade of the State of Israel,
or the Investment Center, by setting criteria for the approval of a facility as
an approved enterprise, such as provisions generally requiring that at least 25%
of the approved enterprise's income will be derived from export. Additionally,
the amendment enacted major changes in the manner in which tax benefits are
awarded under the Investment Law so that companies no longer require Investment
Center approval in order to qualify for tax benefits.


     However, the April 2005 amendment to the Investment Law provides that terms
and benefits included in any certificate of approval granted prior to the
amendment will remain subject to the provisions of the law as they were on the
date of such approval. Therefore, our existing approved enterprise programs will
generally not be subject to the provisions of the April 2005 amendment. As a
result of the amendment, tax-exempt income will subject us to taxes upon
distribution or liquidation and we may be required to record deferred tax
liability with respect to such tax-exempt income. As of December 31, 2006, we
did not generate income under the provision of the amended Investment Law.

     As of December 31, 2006, our net operating loss carry-forwards for Israeli
tax purposes was approximately $27.7 million and the net operating loss
carry-forwards of our U.S. subsidiaries for U.S. tax purposes amounted to
approximately $11.7 million. Our U.S. net operating loss carry-forwards can be
carried forward and offset against taxable income for 15 to 20 years and will
expire in the years 2010 through 2025. Under current Israeli tax laws, operating
loss carry forwards do not expire, and are linked to the Israeli inflation rate
and may be offset against future taxable income. As of December 31, 2006, our
subsidiaries in Europe and Japan have estimated total available tax loss
carry-forward of $15.7 million and $2.4 million, respectively, to offset against
future taxable income for 15-20 years and five years, respectively.

     Israeli companies are subject to "company tax" on their taxable income. The
applicable rate was 31% in 2006 and will be reduced to 29% in 2007, 27% in 2008,
26% in 2009 and 25% in 2010 and thereafter. However, the effective tax rate
payable by a company, which derives income from an approved enterprise (as
further discussed below), may be considerably less.

     We received final tax assessments for the years 1997 to 2002 from the
Israeli tax authorities and have submitted an appeal to the District Court of
Tel Aviv-Jaffa with respect to such tax assessments. As of April 2007, one open
issue remains to be settled by the court, while all other issues were resolved
with no additional taxes to be paid by us. Our management believes, based on the
advice of its legal advisors, that the probability of an unfavorable outcome to
our company on this matter is remote, therefore no provision was provided in the
financial statements in respect of this matter.

RECENTLY ISSUED ACCOUNTING STANDARDS

     In July 2006, the FASB issued FASB Interpretation No. 48 "Accounting for
Uncertainty in Income Taxes an Interpretation of FASB Statement No. 109," or FIN
48. FIN 48 clarifies the accounting for income taxes by prescribing the minimum
recognition threshold a tax position is required to meet before being recognized
in the financial statements. FIN 48 utilizes a two-step approach for evaluating
tax positions. Recognition (step one) occurs when an enterprise concludes that a
tax position, based solely on its technical merits, is more-likely-than-not to
be sustained upon examination. Measurement (step two) is only addressed if step
one has been satisfied (when the position is more-likely-than-not to be
sustained). Under step two, the tax benefit is measured as the largest amount of
benefit, determined on a cumulative probability basis that is
more-likely-than-not to be realized upon ultimate settlement. FIN 48 applies to
all tax positions related to income taxes subject to the FASB SFAS No. 109,
"Accounting for income taxes". This includes tax positions considered to be
"routine" as well as those with a high degree of uncertainty. FIN 48 has
expanded disclosure requirements, which include a tabular roll forward of the
beginning and ending aggregate unrecognized tax benefits as well as specific
detail related to tax uncertainties for which it is reasonably possible the
amount of unrecognized tax benefit will significantly increase or decrease
within twelve months. These disclosures are required at each annual reporting
period unless a significant change occurs in an interim period. FIN 48 is
effective for fiscal years beginning after December 15, 2006. The cumulative
effect of applying FIN 48 will be reported as an adjustment to the opening
balance of retained earnings. We do not expect that the adoption of FIN 48 will
cause a significant impact on our financial position.


                                       40

In September 2006, the Staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 108, "CONSIDERING THE EFFECTS OF PRIOR YEAR
MISSTATEMENTS WHEN QUANTIFYING MISSTATEMENTS IN CURRENT YEAR FINANCIAL
STATEMENTS," or SAB 108. SAB 108 was issued in order to eliminate the diversity
of practice surrounding how public companies quantify financial statement
misstatements. Traditionally, there have been two widely-recognized methods for
quantifying the effects of financial statement misstatements: the "roll-over"
method and the "iron curtain" method. The roll-over method focuses primarily on
the impact of a misstatement on the income statement--including the reversing
effect of prior year misstatements--but its use can lead to the accumulation of
misstatements in the balance sheet. The iron-curtain method, on the other hand,
focuses primarily on the effect of correcting the period-end balance sheet with
less emphasis on the reversing effects of prior year errors on the income
statement. Prior to our application of the guidance in SAB 108, we used the
roll-over method for quantifying financial statement misstatements. In SAB 108,
the Staff of the Securities and Exchange Commission issued staff established an
approach that requires quantification of financial statement misstatements based
on the effects of the misstatements on each of the company's financial
statements and the related financial statement disclosures. This model is
commonly referred to as a "dual approach" because it requires quantification of
errors under both the iron curtain and the roll-over methods.

SAB 108 permits existing public companies to initially apply its provisions
either by (i) restating prior financial statements as if the "dual approach" had
always been applied or (ii) recording the cumulative effect of initially
applying the "dual approach" as adjustments to the carrying values of assets and
liabilities as of January 1, 2006 with an offsetting adjustment recorded to the
opening balance of retained earnings.

We elected to record the effects of applying SAB 108 using the cumulative
effect transition method. The following table summarizes the effects (up to
January 1, 2006) of applying the guidance in SAB 108 (in thousands):

PERIOD IN WHICH THE MISSTATEMENT
ORIGINATED
--------------------------------------
YEAR ENDED DECEMBER 31,
-------- -----------------------
CUMULATIVE ADJUSTMENT
PRIOR TO RECORDED AS OF
JANUARY 1, JANUARY 1,
2004 2004 2005 2006
-------- -------- -------- --------
(U.S $ in thousands)
-----------------------------------------------------

Accrued depreciation of land lease rights (1) 112 14 14 140
-------- -------- -------- --------
Impact on net income (loss) 112 14 14
======== ======== ========
Accumulated deficit (2) 140
========

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

(1) Prior to the consolidated financial statements for the year ended December
31, 2006, we have not amortized our lease rights in land related to our
headquarters in Or Yehuda, Israel. The accumulated amortization as at
December 31, 2005 of $140,000 has been recorded against accumulated
deficit.

(2) Represents the net increase in the accumulated deficit recorded as of
January 1, 2006 to record the initial application of SAB 108.

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements,"
or SFAS No. 157. SFAS No. 157 provides a single definition of fair value, a
framework for measuring fair value, and expanded disclosures concerning fair
value. Previously, different definitions of fair value were contained in various
accounting pronouncements creating inconsistencies in measurement and
disclosures. SFAS No. 157 applies under those previously issued pronouncements
that prescribe fair value as the relevant measure of value, except SFAS No.
123(R) and related interpretations. SFAS No. 157 does not apply to accounting
standards that require or permit measurement similar to fair value but are not
intended to measure fair value. SFAS No. 157 is effective for fiscal years
beginning after November 15, 2007. We are currently evaluating the impact of
adopting SFAS No. 157.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities," or SFAS No. 159. SFAS No. 159
provides companies with an option to report selected financial assets and
liabilities at fair value. Generally accepted accounting principles have
required different measurement attributes for different assets and liabilities
that can create artificial volatility in earnings. The Standard's objective is
to reduce both complexity in accounting for financial instruments and the
volatility in earnings caused by measuring related assets and liabilities
differently. SFAS No. 159 is effective as of the beginning of an entity's first
fiscal year beginning after November 15, 2007. We are currently evaluating the
impact of adopting SFAS No. 159.




B.   LIQUIDITY AND CAPITAL RESOURCES

     Historically, we have financed our operations through cash generated by
operations, funds generated by our public offerings in 1991 (approximately $8.5
million), 1996 (approximately $5.0 million) and 2000 (approximately $79.6
million), private equity investments in 1998 (approximately $12.2 million), as
well as from research and development and marketing grants primarily from the
Government of Israel. In addition, we have also financed our operations through
short-term loans and borrowings under available credit facilities.

     We expended approximately $1.0 million for capital expenditures in 2006 as
compared to $1.1 in 2005, the majority of which was attributable to the purchase
of computers, peripheral equipment and software. We currently do not have
significant capital spending or purchase commitments. However, we anticipate a
moderate increase in capital expenditures and lease commitments consistent with
our anticipated growth in operations, infrastructure and personnel.

     As of December 31, 2006, we had approximately $8.2 million in cash and cash
equivalents and working capital of approximately $8.6 million as compared to
$9.1 million in cash and cash equivalents and working capital of approximately
$13.5 million at December 31, 2005.

     In August 2005, we entered into an agreement with a third party financial
institution under which we were entitled to utilize a credit facility of up to
an aggregate $1.2 million, which was available to us until December 31, 2006,
the purpose of which was to fund our total commitments under an ERP (enterprise
resource planning) project we entered into during 2005 with a number of
companies that are engaged in the software and hardware businesses and the
implementation of ERP projects. Under the financing terms, we must repay amounts
utilized under this facility plus 5.6%-6.6% interest in 36 monthly installments
from the date of receipt of the funding. As of December 31, 2006, we utilized an
aggregate $497,000 of the available funding. See "Item 7B. Major Shareholders
and Related Party Transactions - Related Party Transactions" regarding the
involvement in this project of Matrix-One1 Ltd.

     As of December 31, 2006, we used $1.9 million of our credit facility at the
First International Bank of Israel Ltd. and $2.3 million of our credit facility
at the HaPoalim Bank Ltd. We currently have an unutilized credit line of
approximately $0.3 million and $0.7 million at the First International Bank of
Israel Ltd. and the HaPoalim Bank Ltd., respectively. For the purpose of
obtaining these credit lines and other services from these banks, we are
required to comply with the following financial covenants:

     o    our cash and cash equivalents and short term investment may not, at
          any time, be less than $6.5 million;

     o    our shareholders' equity may not, at any time, be less than 45% of our
          total balance sheet and $36 million;

     o    our total financial obligations (such as short and long term loans
          from banking institutions or commitments due to debentures) may not
          exceed $7 million and 10% of our total balance sheet;

     o    our yearly EBIDTA (earnings before interest depreciation taxes and
          amortization) will not, be less than $2.5 million; and

     o    we are committed not to pledge under any general floating charge, for
          any purpose, all or part of our assets in favor of any third party
          without receiving the prior written consent of First International
          Bank of Israel Ltd.


                                       42




     If we do not comply with all or part of these financial covenants, or upon
the occurrence of certain events specified in the agreements with such banks,
both of the banks will be entitled to request the immediate repayment of such
credit lines. As of December 31, 2006, we were in compliance with some of our
financial covenants and had received a waiver from the banks for those financial
covenants that we did not comply with.

CASH FLOWS

     The following table summarizes our cash flows for the periods presented:


                                                          Year ended December 31,
                                                           -------------------
                                                            2005         2006
                                                           ------       ------
                                                        (U.S. dollars in thousands)

Net cash provided by operating activities                   5,597        3,831
Net cash used in investing activities                       5,148        5,185
Net cash provided by financing activities                     765          672
Net decrease (increase) in cash and cash equivalents        1,536         (954)
Cash and cash equivalents at beginning of period            7,580        9,116
Cash and cash equivalents at end of period                  9,116        8,162

     Net cash provided by operating activities was approximately $3.8 million
for the year ended December 31, 2006, primarily attributable to a decrease in
trade receivable of $2.9 million and appreciation and amortization expenses of
$5.7 million. Net cash provided by operating activities was approximately $5.6
million for the year ended December 31, 2005, primarily attributable to a
decrease in trade receivable of $4.6 million and appreciation and amortization
expenses of $5.1 million.

     Net cash used in investing activities was approximately $5.2 million for
the year ended December 31, 2006 compared to approximately $5.1 million for the
year ended December 31, 2005. These amounts were primarily attributable to
investments in fixed assets and capitalized software costs, as well as an
additional investment in our subsidiary Advanced Answers on Demand Holding
Corporation in 2006.

     Net cash provided by financing activities was approximately $0.7 million
for the year ended December 31, 2006 compared to approximately $0.8 million for
the year ended December 31, 2005, primarily attributable to a decrease in our
short-term credit in these two years

     Since our initial public officering, we have initiated a number of stock
repurchase programs. On November 3, 2004, our Board of Directors approved our
most recent stock repurchase program for the repurchase of up to $2 million of
our ordinary shares. From the commencement of the program through December 31,
2005, we had repurchased under this program an aggregate 364,200 ordinary shares
at a total purchase price of $999,000. We did not continue the program during
2006 and have no current intention to continue the program in the foreseeable
future.

     We believe our existing cash and cash equivalents will be sufficient to
support our current operating plan at least through June 30, 2008; however, we
have based this estimate on assumptions that may prove to be incorrect.
Therefore, if we do not generate sufficient cash from operations, we may be
required to obtain additional financing. Such financing may not be available in
the future, or, if available, will be on terms satisfactory to us.


                                       43




C.   RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES

RESEARCH AND DEVELOPMENT

     The software industry is characterized by rapid technological change and is
highly competitive with respect to timely product innovation. We must maintain
compatibility and competitiveness in the face of ongoing changes in industry
standards.

     We place considerable emphasis on research and development to improve and
expand the functionality of our technology and to develop new applications. We
believe that our future success will depend upon our ability to maintain our
technological leadership, to enhance our existing products and to introduce new
commercially viable products addressing the needs of our customers on a timely
basis. We also intend to support emerging technologies as they are introduced in
the same way we have supported new technologies in the past. We will continue to
devote a significant portion of our resources to research and development. We
believe that internal development of our technology is the most effective means
of achieving our strategic objective of providing an extensive, integrated and
feature-rich development technology.

     During the year ended December 31, 2006, we invested our resources in six
main areas:

     o    eDeveloper VERSION 10 PRODUCT RELEASE, FOLLOWED BY THE UNIX AND THE
          ISERIES SERVER RELEASES.

     o    RICH INTRANET CLIENT. This is a new technology for eDeveloper Intranet
          solution. Based on eDeveloper browser client engine, we developed a
          Java-based client that provides full thin-client functionality using
          standard widget toolkit (SWT) open source technology. The advantages
          of the new technology is its ability to run on any platform,
          significantly reducing the cost of maintenance. We are continuing to
          develop the technology in a two phase plan. The first phase will
          provide a limited set of client functionalities. The second phase will
          provide rich client functionalities with the aim to use this client as
          the only eDeveloper client module. We plan to release the first
          version of the rich client during the third quarter of 2007 and
          perform a controlled and limited release.

     o    A NEW VERSION OF IBOLT. iBOLT Version 3 was the main focus of the
          iBOLT development in 2006. The new version delivers a full range of
          new functionalities as well as performance improvements. Some of the
          main functionalities include New Data Mapper, expression editor, user
          defined storages, resource management and component software
          development kit (SDK). We plan to release the first version of iBOLT
          Version 3 during the fourth quarter of 2007 using a controlled and
          limited release.

     o    IBOLT SPECIAL EDITION FOR SAP R3. This Special Edition of iBOLT takes
          advantage of iBOLT's modularity to offer SAP R3 ISV's the opportunity
          to license iBOLT as their integration environment for R3 versions that
          are not supported by SAP integration suit. The technology supports
          both access of R3 objects as well as being accessed by the R3 event
          mechanism. The iBOLT R3 SE also opens SAP R3 to the large channel of
          existing Magic solution providers, allowing them to seamlessly
          integrate their existing solutions with SAP R3 streamlining the
          process and reducing integration time.

     o    We have continued to invest in the development of our unique browser
          client technology.

     o    We have continued to develop the Hermes software. HERMES Release 3
          incorporates new and advanced functionalities. HERMES Release 3
          software is already operating in full production at Frankfurt airport
          (with Fraport Cargo Services and LUG aircargo Handling) and is also
          being launched by HERMES users in China (ICCS in Shenzhen) and Europe
          (Menzies Aviation in the United Kingdom and Prague, GroundForce in
          Portugal and Spain). During the second half of 2007, HERMES Release 3
          is expected to be deployed at major air cargo centers in Europe (such
          as in Amsterdam), Africa and the United States (such as in Los
          Angeles).


                                       44

Our research and development and support personnel work closely with our
customers and prospective customers to determine their requirements and to
design enhancements and new releases to meet their needs. We periodically
release enhancements and upgrades to our core products. In the years ended
December 31, 2004, 2005 and 2006, we invested $ 7.3 million, $7.6 million and
$7.5 million, respectively, in research and development. Research and
development activities take place in our facilities in Israel, India, Japan, the
United States and Europe.

As of December 31, 2006, we employed 145 employees in research and
development activities, of which 58 persons were located in Israel, 59 persons
in India, eight persons in Japan, three in Europe and 17 persons in the United
States. Our product development team includes technical writers who prepare user
documentation for our products. In addition, we have also entered into
arrangements with subcontractors for the preparation of product user
documentation and certain product development work.

D. TREND INFORMATION

In 2007, we intend to continue our tight cost control in order to achieve
the highest profitability possible.

See Item 5A. "Operating and Financial Review and Prospects - Results of
Operation" for additional trend information.

E. OFF-BALANCE SHEET ARRANGEMENTS

We are not a party to any off-balance sheet arrangements. In addition, we
have no unconsolidated special purpose financing or partnership entities that
are likely to create material contingent obligations.

F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

The following table summarizes our minimum contractual obligations as of
December 31, 2006 and the effect we expect them to have on our liquidity and
cash flow in future periods.

Contractual Obligations Payments due by period
----------------------- -----------------------------------------------------
less than 1
Total year 1-3 years 3-5 years
-------- -------- -------- --------
(U.S. dollars in thousands)

Operating lease obligations $7.8 $2.7 $4.7 $0.4

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A. DIRECTORS AND SENIOR MANAGEMENT

Set forth below are the name, age, principal position and a biographical
description of each of our directors and executive officers:

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

David Assia (1) 55 Chairman of the Board of Directors and Acting Chief
Executive Officer
Ziv Zviel 37 Vice President Finance and Acting Chief Financial Officer
Guy Bernstein 37 Director
Gad Goldstein 47 Director
Itiel Efrat (2) 42 Outside director
Elan Penn (1) (2) 55 Outside director
Eli Reifman 37 Director
Naamit Salomon 42 Director
Yehezkel Zeira (2) 62 Director

----------

(1) Member of our Option Committee

(2) Member of our Audit Committee




     Messrs. David Assia, Guy Bernstein, Gad Goldstein and Yehezkel Zeira and
Mrs. Naamit Salomon were elected at 2006 last annual general meeting of
shareholders for a one year period, to serve as director until our 2007 annual
general meeting of shareholders. In January 2007, our board of directors
appointed Mr. Eli Reifman to serve as a director until our 2007 annual general
meeting of shareholders. Messrs. Itiel Efrat and Elan Penn will serve as our
outside directors pursuant to the provisions of the Israeli Companies Law for
three-year terms until January 28, 2008 and December 7, 2009, respectively,
following which their service may be renewed for one additional three-year term.

     In March 2007, we appointed Mr. Eitan Naor as our new President and chief
executive officer, who will commence to serve in such capacity as of July 1,
2007.

     DAVID ASSIA, a co-founder of our company, has served as a director since
our inception in 1983 and assumed the position of chairman of our board of
directors in January 2002, and he has served as our acting chief executive
officer since August 2005. Mr. Assia served as chairman of our board of
directors from 1986 until October 2000 and served as vice chairman of our board
of directors from October 2000 until reassuming the position of chairman of our
board of directors in January 2002. From 1986 until September 1997, Mr. Assia
served as our chief executive officer. Mr. Assia was managing director of Mashov
Computers Ltd. between 1980 and 1986 and has served as the chairman of its board
of directors since 1989. Mr. Assia also serves as a director of Aladdin
Knowledge Systems Ltd., Enformia Ltd., Radview Software, The Weitzman Institute
of Sciences, RRSat Global Communications Network Ltd. and The Israel Association
of Software Houses. Mr. Assia holds a B.A. degree in economics and statistics
and M.B.A. degree, both from Tel Aviv University.

     ZIV ZVIEL has served as our vice president finance and acting chief
financial officer since November 2005. Prior thereto and from 2003, Mr. Zviel
served as director of finance of our Israeli subsidiary and as our corporate
controller from the beginning of 2002. Prior thereto and from 2000, Mr. Zviel
was an audit manager at the hi-technology practice of Ernst & Young in Tel-Aviv,
Israel. Mr. Zviel is a certified public accountant (CPA) in Israel and holds a
B.A. degree in accounting and economy and M.B.A. degree in information systems,
both from Bar-Ilan University in Israel.

     GUY BERNSTEIN has served as a director of our company since December 2006.
Mr. Bernstein has served as the chief financial officer and a member of the
board of directors of Emblaze Ltd. since April 2004. From 1999 to 2004, Mr.
Bernstein served as chief financial and operations officer of our company. Mr.
Bernstein also acted as the interim chief executive officer of two of our
subsidiaries, Magic Software Enterprises (Israel) Ltd. and Coretech Consulting
Group. From 1994 to 1997, Mr. Bernstein was senior manager for Kost, Forer,
Gabbay & Kasierer, a member of Ernst & Young Global. Mr. Bernstein is a
certified public accountant (CPA) in Israel and holds a B.A. degree in
accounting and economics from Tel-Aviv University.

     GAD GOLDSTEIN has served as a director of our company since December 1998.
Mr. Goldstein has been president of Formula Systems since April 1995 and has
served as a director of Formula Systems (1985) Ltd.since January 1985. From 1985
to 1995, Mr. Goldstein served as vice president-finance of Formula Systems
(1985) Ltd. Mr. Goldstein is also the chairman of the board of directors of
BluePhoenix Solutions Ltd. and a director of other companies within the Formula
Systems group, including Matrix IT Ltd., Formula Vision Technologies Ltd. and
Sapiens International Corporation N.V. Mr. Goldstein holds a B.A. degree in
economics and M.B.A. degree, both from Tel Aviv University.

     ITIEL EFRAT has served as an outside director of our company since December
2006. Mr. Efrat is the founder and has served as co-managing director of ERB
Ltd., a leading financial consulting firm, since 1995. Mr. Efrat is the founder
and a member of the Board of Directors of ESOP-Excellence Trust Company since
2004. Mr. Efrat is a certified public accountant (CPA) in Israel and holds a
B.A. degree in accounting and economics from Tel-Aviv College of Management.


                                       46




     ELAN PENN has served as an outside director of our company since December
2005. Mr. Penn has served as chief executive officer and chairman of Penn
Publishing Ltd., a private company based in Tel Aviv, Israel since 2001. From
2000 to 2001, Mr. Penn served as vice president of finance and administration of
A.I. Research and Development Ltd. Mr. Penn was chief executive officer of Sivan
Computer Training Company Ltd. during the years 1998 and 2000. From 1992 to
2000, Mr. Penn served as vice president of finance and administration of Mashov
Computers Ltd. From 1987 to 1991 and again from 1992 to 1997, Mr. Penn served as
our company's vice president of finance and administration. Mr. Penn also serves
as a director of Healthcare Technologies Ltd. Mr. Penn holds a B.A. degree in
economics from the Hebrew University of Jerusalem a Ph.D. in management science
from the University of London.

     ELI REIFMAN was appointed by our board of directors to serve as a director
of our company in January 2007. In 1994, Mr. Reifman co-founded Emblaze Ltd., an
Israeli company publicly traded on the Aim Stock Exchange, and has served as its
vice-chairman since December 2006. Mr. Reifman served as the chief executive
officer of Emblaze Ltd. from September 2000 until December 2006.

     NAAMIT SALOMON has served as a director of our company since March 2003.
Ms. Salomon has served as vice president finance of Formula Systems (1985) Ltd.
since August 1997. Ms. Salomon also serves as a director of BluePhoenix
Solutions Ltd., Sapiens International Corporation N.V. and Ki-bi Mobile
Technologies Ltd. From 1990 through August 1997, Ms. Salomon was controller of
two large privately held companies in the Formula Systems group. Ms. Salomon
holds a B.A. degree in economics and business administration from Ben Gurion
University and L.L.M. degree from Bar-Ilan University.

     YEHEZKEL ZEIRA has served as an independent director of our company since
December 2005. Mr. Zeira has been an independent information technologies
consultant since 2001. From 2000 to 2001, Mr. Zeira served as executive vice
president international of Ness Technologies Inc., and from 1970 to 2000, Mr.
Zeira served in various positions at Advanced Technology Ltd., including as
chief executive officer which position he assumed in 1982. Mr. Zeira also serves
as a director of Tim Computers and Systems Ltd., Kalanit Carmon Software
Services Ltd. and Dafron Ltd. Mr. Zeira is also a lecturer at Ben Gurion
University Faculty of Engineering. Mr. Zeira holds a B. Sc. degree in industrial
engineering and M. Sc. degree in operations research, both from the Technion -
Israel Institute of Technology and has participated in the Harvard Business
School program for management development.

         The following table lists our other key employees:

NAME               AGE      POSITION
----------         ---      -----------------------------------------------------------
Amit Ben-Zvi       40       Vice President, Marketing
Amit Birk          36       Vice President, Mergers and Acquisitions, General Counsel
                            and Corporate Secretary
Avikam Perry       50       Vice President, Research and Development
Oren Inbar         49       Vice President, President and Chief Executive Officer Magic
                            Software Enterprises Inc.
Regev Yativ        38       Vice President, International Sales

     AMIT BEN-ZVI has served as our vice president, iBOLT division since
September 2005. From July 2002 to July 2005, Mr. Ben-Zvi served as chief
executive officer of WizCom Technologies, a publicly traded company specializing
in scanning pens and mobile data capture products. Prior thereto and from
January 2000, Mr. Ben-Zvi served as the chief executive officer of ISYS
Operational Management Systems Ltd., a software applications company based in
Israel. From December 1997 to January 2000, Mr. Ben-Zvi served as chief
operating officer Top Imaging Systems Ltd., a publicly traded company. Mr.
Ben-Zvi holds a B.A. degree in accounting and LLB degree, both from Tel-Aviv
University.

     AMIT BIRK has served as vice president, mergers and acquisitions, general
counsel and corporate secretary since May 1999. From 1997 to 1998, Mr. Birk was
an associate at Avital Dromi & Co., a leading law firm in Tel Aviv, Israel. Mr.
Birk holds an L.L.B. degree from the University of Sheffield, M.B.A. degree from
Bar Ilan University and a Practical Engineer degree from ORT College. Mr. Birk
is also a certified mediator.


                                       47




     AVIKAM PERRY has served as our vice president, research and development
since July 1997. Mr. Perry joined our company in July 1992 and has held various
positions, including group and product manager, development department manager
and vice president, product development. Mr. Perry holds a B.Sc. degree in
mathematics and computer science from Tel Aviv University.

     OREN INBAR has served as the president and chief executive officer of our
U.S. subsidiary, Magic Software Enterprises Inc., since May 2002. Mr. Inbar
joined us in February 1997 as sales manager and served as a managing director of
our Israeli operations from June 1998 until May 2000. From May 2000 until May
2001, Mr. Inbar served as our vice president sales Europe. Mr. Inbar holds a
B.Sc. degree in industrial psychology from the University of South Africa.

     REGEV YATIV has served as vice president international sales since October
2006, responsible for our business activities and branches in Europe and Japan,
as well as the Israel-based team that oversees the distribution network in the
Asia Pacific region, Latin America and South Africa. From September 2002 until
June 2006, Mr. Yativ served as our vice president and managing director of
Europe, Middle East and Africa, based at our Netherlands office. From 2001 to
2002, Mr. Yativ served as chief operating officer of Agro Marches Int. Paris, a
company specializing in software and eBusiness platforms and managed its
branches across Europe. From 1999 to 2001, Mr. Yativ was the chief executive
officer of G.E.D B.V. in Amsterdam, an investments and business development
group dealing in software and eBusiness solutions throughout Europe. From 1996
to 1999, Mr. Yativ served as vice president international sales of the NASDAQ
traded Edusoft Ltd., specialized in Educational Software sales world wide. Mr.
Yativ holds a B.A. degree from Tel Aviv University.

B.   COMPENSATION

     The following table sets forth all compensation we paid with respect to all
of our directors and executive officers as a group for the year ended December
31, 2006.

                                            Salaries, fees,
                                            commissions and   Pension, retirement and
                                                bonuses         similar benefits
                                                --------            --------

All directors and executive officers as a
  group (nine persons)                          $420,477            $110,069

     During the year ended December 31, 2006, we paid to each of our outside and
independent directors an annual fee of approximately $8,750 and a per meeting
attendance fee of approximately $338. Those fees are paid based on the fees
detailed in a schedule published semi-annually by the Committee for Public
Directors under the Israeli Securities Law. We provide automobiles to our
executive officers at our expense.

     As of December 31, 2006, our directors and executive officers as a group,
then consisting of nine persons, held options to purchase an aggregate of
223,863 ordinary shares, at exercise prices ranging from $0.80142 to $5.95 per
share (after the dividend adjustment), vesting immediately. Of such options,
options to purchase 2,779 ordinary shares expire in 2012, options to purchase
162,584 ordinary shares expire in 2013, options to purchase 2,500 ordinary
shares expire in 2014 and options to purchase 56,000 options expire in 2015. All
such options were granted under our 2000 Employee Stock Option Plan. See Item
6.E., "Directors, Senior Management and Employees - Share Ownership - Stock
Option Plans."

ACTING CHIEF EXECUTIVE OFFICER COMPENSATION

     On April 15, 1995, we entered into an agreement with Mr. David Assia who
then served as our president and chief executive officer and a director of our
company and is currently serving as our acting chief executive officer and
chairman of our board of directors. Mr. Assia served as our chief executive
officer until September 1997 and assumed the position of acting chief executive
officer in August 2005. Mr. Assia has served as a director since our inception
in 1983, served as chairman of our board of directors from 1986 until October
2000 and served as vice chairman of our board of directors from October 2000
until reassuming the position of chairman of our board of directors in January
2002. The agreement was amended on January 20, 1998 when Mr. Assia resigned from
his position as chief executive officer and his responsibilities changed. The
agreement, as amended, provides for a base salary and a package of benefits
including an annual bonus and options to purchase ordinary shares, and contains
certain non-competition and confidentiality provisions. Under the agreement, in
the event Mr. Assia's employment was terminated without cause at any time
beginning 2001 and until 2006, Mr. Assia would have been entitled to severance
pay ranging from 12 months salary to 20 months salary. Thereafter and until
2014, he will be entitled to severance pay, which will be reduced gradually to
12 months salary. In addition, Mr. Assia is entitled to the benefits provided
under Israeli law upon termination of his employment. Such benefits include
severance payments equal to his last monthly salary times each year of
employment with us. Under the agreement, the term of Mr. Assia's employment will
continue until such time as we terminate it, subject to providing Mr. Assia with
20 months prior written notice. Mr. Assia may terminate the agreement upon six
months prior notice.


                                       48




     At our 2006 annual general meeting, our shareholders approved an amendment
to Mr. Assia's employment terms, such that effective as of January 1, 2006, he
is entitled to base compensation at a monthly cost to our company of $20,000 per
month and annual variable compensation of the greater of :(i) 3% of the yearly
net profit (excluding intercompany transactions) of our subsidiary Magic
Software Japan K.K plus 4% of the annual net profit (excluding intercompany
transactions) of our subsidiary CarPro Systems Ltd.; or (ii) 3% of the operating
profit of our company. At such meeting, our shareholders also approved the grant
of bonus to Mr. Assia in the amount of $21,162 for his time and contribution to
our company.

C.   BOARD PRACTICES

INTRODUCTION

     According to the Israeli Companies Law and our Articles of Association, the
management of our business is vested in our board of directors. The board of
directors may exercise all powers and may take all actions that are not
specifically granted to our shareholders. Our executive officers are responsible
for our day-to-day management. The executive officers have individual
responsibilities established by our chief executive officer and board of
directors. Executive officers are appointed by and serve at the discretion of
the board of directors, subject to any applicable agreements.

ELECTION OF DIRECTORS

     Our articles of association provide for a board of directors consisting of
no less than three and no more than eleven members or such other number as may
be determined from time to time at a general meeting of shareholders. Our board
of directors is currently composed of eight directors.

     Pursuant to our articles of association, all of our directors are elected
at our annual general meeting of shareholders, which are required to be held at
least once during every calendar year and not more than 15 months after the last
preceding meeting. Except for our outside directors (as described below), our
directors are elected by a vote of the holders of a majority of the voting power
represented and voting at such meeting and hold office until the next annual
meeting of shareholders following the annual meeting at which they were
appointed. Directors (other than outside directors) may be removed earlier from
office by resolution passed at a general meeting of our shareholders. Our board
of directors may temporarily fill vacancies in the board until the next annual
meeting of shareholders, provided that the total number of directors will not
exceed the maximum number permitted under our articles of association.

     Under the Israeli Companies Law, our board of directors is required to
determine the minimum number of directors who must have "accounting and
financial expertise" (as such term is defined in regulations promulgated under
the Israeli Companies Law). In determining such number, the board of directors
must consider, among other things, the type and size of the company and the
scope of and complexity of its operations. Our board of directors will include
at least one director who has "accounting and financial expertise," within the
meaning of the regulations promulgated under the Israeli Companies Law.

     We are exempt from the requirements of the NASDAQ Marketplace Rules with
regard to the nomination process of directors, since we are a controlled company
within the meaning of NASDAQ Marketplace Rule 4350(c)(5). See below in this Item
6C. "Directors, Senior Management and Employees - Board Practices - NASDAQ
Exemptions for a Controlled Company."


                                       49




OUTSIDE AND INDEPENDENT DIRECTORS

     OUTSIDE DIRECTORS. The Israeli Companies Law requires companies
incorporated under the laws of the State of Israel with shares that have been
offered to the public in or outside of Israel to appoint at least two outside
directors. No person may 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 or had, on or within the two years preceding the date of the
person's appointment to serve as outside director, any affiliation with the
company or any entity controlling, controlled by or under common control with
the company. The term "affiliation" includes an employment relationship, a
business or professional relationship maintained on a regular basis, control and
service as an "office holder" as defined in the Israeli Companies Law, however,
"affiliation" does not include service as a director of a private company prior
to its first public offering if the director was appointed to such office for
the purpose of serving as an outside director following the company's first
public offering.

     In addition, no person may serve as an outside director if the person's
position or other 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. If, at the time
outside directors are to be appointed, all current members of the board of
directors are of the same gender, then at least one outside director must be of
the other gender.

     As of January 2006, at least one of the outside directors must have
"accounting and financial expertise" and the other outside directors must have
"professional expertise," as such terms are defined by regulations promulgated
under the Israeli Companies Law.

     The outside directors are elected by a majority vote at a shareholders
meeting. The shareholders voting in favor of their election must include at
least one-third of the shares of the non-controlling shareholders of the company
who voted on the matter (not including abstentions). This minority approval
requirement need not be met if the total shareholdings of those non-controlling
shareholders who vote against their election represent 1% or less of all of the
voting rights in the company.

     In general, outside directors serve for a three-year term and may be
reelected to one additional three-year term. However, Israeli companies listed
on certain stock exchanges outside Israel, including The NASDAQ Global Market,
may appoint an outside director for additional terms of not more than three
years subject to certain conditions. Such conditions include the determination
by the audit committee and board of directors, that in view of the director's
professional expertise and special contribution to the company's board of
directors and its committees, the appointment of the outside director for an
additional term is in the best interest of the company.

     An outside director may be removed from office at the initiative of the
board of directors at a special general meeting of shareholders, if the board
resolves that the statutory requirements for that person's appointment as
outside director no longer exist, or that the outside director has violated his
or her duty of loyalty to the company. The resolution of the special general
meeting of shareholders regarding the termination of office of an outside
director requires the same majority that is required for the election of an
outside director. The court may order the termination of the office of an
outside director on the same grounds, following a motion filed by a director or
a shareholder. If an outside directorship becomes vacant, the board of directors
is required under the Israeli Companies law to convene a shareholders meeting
immediately to appoint a new outside director.

     Each committee of the board of directors that is authorized to exercise
powers vested in the board of directors must include at least one outside
director and the audit committee must include all the outside directors. An
outside director is entitled to compensation as provided in regulations adopted
under the Israeli Companies Law and is otherwise prohibited from receiving any
other compensation, directly or indirectly, in connection with such service.

     Until the lapse of two year from termination of office, we may not engage
an outside director to service as an office holder and cannot employ or receive
services from that person, either directly or indirectly, including through a
corporation controlled by that person.


                                       50




     INDEPENDENT Directors. NASDAQ Marketplace Rules require us to establish an
audit committee comprised of at least three members and only of independent
directors each of whom satisfies the respective "independence" requirements of
the Securities and Exchange Commission and NASDAQ.

     As a controlled company, within the meaning of NASDAQ Marketplace Rule
4350(c)(5), we are exempted from the NASDAQ Marketplace Rule which requires that
a majority of our board of directors must qualify as independent directors,
within the meaning of the NASDAQ Marketplace Rules. See Item 6.C. "Directors,
Senior Management and Employees - Board Practices - NASDAQ Exemptions for a
Controlled Company."

     Our Board of Directors has determined that Messrs. Itiel Efrat and Mr.
Elann Penn both qualify as independent directors under the Securities and
Exchange Commission and NASDAQ requirements and as outside directors under the
Israeli Companies Law requirements. Our Board of Directors has further
determined that Mr. Yehezkel Zeira qualifies as an independent director under
the Securities and Exchange Commission and NASDAQ requirements

COMMITTEES OF THE BOARD OF DIRECTORS

     AUDIT COMMITTEE. Our audit committee, established in accordance with
Section 114 of the Israeli Companies Law and Section 3(a)(58)(A) of the
Securities Exchange Act of 1934, assists our board of directors in overseeing
the accounting and financial reporting processes of our company and audits of
our financial statements, including the integrity of our financial statements,
compliance with legal and regulatory requirements, our independent public
accountants' qualifications and independence, the performance of our internal
audit function and independent public accountants, finding any defects in the
business management of our company for which purpose the audit committee may
consult with our independent auditors and internal auditor, proposing to the
board of directors ways to correct such defects and such other duties as may be
directed by our board of directors.

     Our audit committee also has the responsibility of approving related-party
transactions as required by law. Under Israeli law, an audit committee may not
approve an action or a transaction with a controlling shareholder, or with an
office holder, unless at the time of approval two outside directors are serving
as members of the audit committee and at least one of the outside directors was
present at the meeting in which an approval was granted.

     Our audit committee is currently composed of Messrs. Efrat, Penn and Zeira,
each of whom satisfies the respective "independence" requirements of the
Securities and Exchange Commission and NASDAQ. We also comply with Israeli law
requirements for audit committee members. Mr. Elan Penn has been elected as the
chairperson of the audit committee. Our Board of Directors has determined that
Mr. Penn qualifies as a financial expert. The audit committee meets at least
once each quarter.

     OPTION COMMITTEE. Our board of directors has established an option
committee, which administers our option plans (see Item 6E. Directors, Senior
Management and Employees - Share Ownership - Stock Option Plans"). Messrs. David
Assia, Amit Birk, Elan Penn and Ziv Zviel are the current members of our option
committee. Our option committee meets approximately once each quarter.

INTERNAL AUDIT

     The Israeli Companies Law also requires the board of directors of a public
company to appoint an internal auditor proposed by the audit committee. A person
who does not satisfy the Israeli Companies Law's independence requirements may
not be appointed as an internal auditor. The role of the internal auditor is to
examine, among other things, the compliance of the company's conduct with
applicable law and orderly business practice. Our internal auditor complies with
the requirements of the Israeli Companies Law.

DIRECTORS' SERVICE CONTRACTS

     OUR ACTING CHIEF EXECUTIVE OFFICER. In January 1998, we entered into an
amended employment agreement with Mr. David Assia, currently our acting chief
executive officer and the Chairman of our Board of Directors. See Item 6B.
"Directors, Senior Management and Employees - Compensation - Acting Chief
Executive Officer Compensation."


                                       51




     OTHER. Except as set forth above and in Item 6B. "Directors, Senior
Management and Employees - Compensation," there are no arrangements or
understandings between us and any of our subsidiaries, on the one hand, and any
of our directors, on the other hand, providing for benefits upon termination of
their employment or service as directors of our company or any of our
subsidiaries.

APPROVAL OF RELATED PARTY TRANSACTIONS UNDER ISRAELI LAW

     The Israeli Companies Law codifies the fiduciary duties that "office
holders," including directors and executive officers, owe to a company. An
office holder is defined in the Israeli Companies Law as a director, general
manager, chief business manager, deputy general manager, vice general manager,
executive vice president, vice president, another manager directly subordinate
to the managing director or any other person assuming the responsibilities of
any of the foregoing positions without regard to such person's title.

     The Israeli Companies Law requires that an office holder promptly disclose,
no later than the first board meeting in which such transaction is discussed,
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, or by any corporation in which the office holder is a 5% or greater
shareholder, holder of 5% or more of the voting power, 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 by the Israeli
Companies Law as a transaction not in the ordinary course of business, not on
market terms, or that is likely to have a material impact on the company's
profitability, assets or liabilities.

     In the case of a transaction that is not an extraordinary transaction,
after the office holder complies with the above disclosure requirement, board
approval is required unless the articles of association of the company provide
otherwise. The transaction must not be adverse to the company's interest. If the
transaction is an extraordinary transaction, then, in addition to any approval
required by the articles of association, it must be approved by the audit
committee and the board of directors, and, under specified circumstances, by a
meeting of the shareholders.

     Subject to certain exceptions provided for in the regulations promulgated
under the Israeli Companies Law, agreements regarding directors' terms of
employment require the approval of the board of directors and the audit
committee. In all matters in which a director has a personal interest, including
matters of his/her terms of employment, he/she shall not be permitted to vote on
the matter or be present in the meeting in which the matter is considered.
However, should a majority of the audit committee or the board of directors have
a personal interest in the matter, all of the directors are permitted to vote on
the matter and attend the meeting in which the matter is considered and the
matter requires the approval of the shareholders at a general meeting.

     According to the Israeli Companies Law, the disclosure requirements
discussed above also apply to a controlling shareholder of a public company.
Such requirements also apply to certain shareholders of a public company, with
respect to private placements that will increase their relative holdings in the
company. In general, extraordinary transactions with a controlling shareholder
or in which a controlling shareholder has a personal interest, and agreements
relating to employment and compensation terms of a controlling shareholder
require the approval of the audit committee, board of directors and
shareholders. The term "controlling shareholder" is defined as a shareholder who
has the ability to direct the activities of a company, other than if such power
derives solely from the shareholder's position on the board of directors or any
other position with the company. The definition also includes shareholders that
hold 25% or more of the voting rights if no other shareholder owns more than 50%
of the voting rights in the company. The shareholder approval must either
include at least one-third of the shares held by disinterested shareholders who
actively participate in the voting process (without taking abstaining votes into
account), or, alternatively, the total shareholdings of the disinterested
shareholders who vote against the transaction must not represent more than one
percent of the voting rights in the company.


                                       52




     Private placements in a public company require approval by a company's
board of directors and shareholders in the following cases:

     (a) A private placement that meets all of the following conditions: (i) the
private placement will increase the relative holdings of a shareholder that
holds 5% or more of the company's outstanding share capital, assuming the
exercise of all of the securities convertible into shares held by that person,
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; (ii) 20%
or more of the voting rights in the company prior to such issuance are being
offered; and (iii) all or part of the consideration for the offering is not cash
or registered securities, or the private placement is not being offered at
market terms.

     (b) A private placement that results in anyone becoming a controlling
shareholder of the public company.

     In addition, under the Israeli Companies Law, certain transactions or a
series of transactions are considered to be one private placement.

     Any placement of securities that does not fit the above description may be
issued at the discretion of the Board of Directors.

     Under the Israeli Companies Law, a shareholder has a duty to act in good
faith towards the company and other shareholders and refrain from abusing his
power in the company, including, among other things, voting in the general
meeting of shareholders on the following matters: any amendment to the Articles
of Association; an increase of the company's authorized share capital; a merger;
or approval of certain interested party transactions that require shareholder
approval under the Israeli Companies Law.

     In addition, any controlling shareholder, any shareholder who knows that it
possesses power to determine the outcome of a shareholder vote and any
shareholder who has the power to appoint or prevent the appointment office
holder in the company is under a duty to act with fairness towards the company.
The breach of such duty is governed by Israeli contract law. The Israeli
Companies Law does not describe the substance of this duty. The Israeli
Companies Law requires that specified types of transactions, actions and
arrangements be approved as provided for in a company's articles of association
and in some circumstances by the audit committee, by the board of directors and
by the shareholders. The vote required by the audit committee and the board of
directors for approval of these matters, in each case, is a majority of the
disinterested directors participating in a duly convened meeting.

PROVISIONS RESTRICTING CHANGE IN CONTROL OF OUR COMPANY

     Tender Offer. A person wishing to acquire shares or any class of shares of
a publicly traded Israeli company and who would as a result hold over 90% of the
company's issued and outstanding share capital or of a class of shares which are
listed, is required by the Israeli Companies Law to make a tender offer to all
of the company's shareholders for the purchase of all of the issued and
outstanding shares of the company. If the shareholders who do not respond to the
offer hold less than 5% of the issued share capital of the company, all of the
shares that the acquirer offered to purchase will be transferred to the acquirer
by operation of law. The Israeli Companies Law provides for an exception
regarding the threshold requirement for a shareholder that prior to and
following February 2000 holds over 90% of a company's issued and outstanding
share capital. However, the shareholders may petition the court to alter the
consideration for the acquisition. If the dissenting shareholders hold more than
5% of the issued and outstanding share capital of the company, the acquirer may
not acquire additional shares of the company from shareholders who accepted the
tender offer if following such acquisition the acquirer would then own over 90%
of the company's issued and outstanding share capital.

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


                                       53




     Merger. The Israeli Companies Law permits merger transactions if approved
by each party's board of directors and the majority of each party's shares voted
on the proposed merger at a shareholders' meeting called on at least 21 days'
prior notice. Under the Israeli Companies Law, merger transactions may be
approved by holders of a simple majority of our shares present, in person or by
proxy, at a general meeting and voting on the transaction. In determining
whether the required majority has approved the merger, if shares of a company
are held by the other party to the merger, or by any person holding at least 25%
of the outstanding voting shares or 25% of the means of appointing directors of
the other party to the merger, then a vote against the merger by holders of the
majority of the shares present and voting, excluding shares held by the other
party or by such person, or anyone acting on behalf of either of them, is
sufficient to reject the merger transaction. If the transaction would have been
approved but for the exclusion of the votes of certain shareholders as provided
above, a court may still approve the merger upon the request of holders of at
least 25% of the voting rights of a company, if the court holds that the merger
is fair and reasonable, taking into account the value of the parties to the
merger and the consideration offered to the shareholders. Upon the request of a
creditor of either party to the proposed merger, the court may delay or prevent
the merger 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 executed unless at least 30 days have passed from the receipt of the
shareholders' approval and 50 days have passed from the time that a proposal for
approval of the merger has been filed with the Israeli Registrar of Companies.

EXCULPATION, INDEMNIFICATION AND INSURANCE OF DIRECTORS AND OFFICERS

EXCULPATION OF OFFICE HOLDERS

     The Israeli Companies Law provides that an Israeli company cannot exculpate
an office holder from liability with respect to a breach of his duty of loyalty,
but may, if permitted by its articles of association, exculpate in advance an
office holder from his liability to the company, in whole or in part, with
respect to a breach of his or her duty of care. However, a company may not
exculpate in advance a director from his or her liability to the company with
respect to a breach of his duty of care in the event of distributions.

INSURANCE FOR OFFICE HOLDERS

     The Israeli Companies Law provides that a company may, if permitted by its
articles of association, insure an office holder for acts or omissions performed
by the office holder in such capacity for:

     o    A breach of his or her duty of care to the company or to another
          person;

     o    A breach of his or her duty of loyalty to the company, provided that
          the office holder acted in good faith and had reasonable cause to
          assume that his act would not prejudice the company's interests; and

     o    A financial liability imposed upon the office holder in favor of
          another person.

INDEMNIFICATION OF OFFICE HOLDERS

     The Israeli Companies Law provides that a company may, if permitted by its
articles of association, indemnify an office holder for acts or omissions
performed by the office holder in such capacity for:

     o    A financial liability imposed on the office holder in favor of another
          person by any judgment, including a settlement or an arbitrator's
          award approved by a court;

     o    Reasonable litigation expenses, including attorney's fees, actually
          incurred by the office holder as a result of an investigation or
          proceeding instituted against him or her by a competent authority,
          provided that such investigation or proceeding concluded without the
          filing of an indictment against the office holder or the imposition of
          any financial liability in lieu of criminal proceedings, or concluded
          without the filing of an indictment against the office holder and a
          financial liability was imposed on the officer holder in lieu of
          criminal proceedings with respect to a criminal offense that does not
          require proof of criminal intent; and


                                       54




     o    Reasonable litigation expenses, including attorneys' fees, incurred by
          such office holder or which were imposed on him by a court, in
          proceedings the company instituted against the office holder or that
          were instituted on the company's 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 a
          crime which does not require proof of criminal intent.

     In accordance with the Israeli Companies Law, a company's articles of
association may permit the company to:

     o    Undertake in advance to indemnify an office holder, except that with
          respect to a financial liability imposed on the office holder by any
          judgment, settlement or court-approved arbitration award, the
          undertaking must be limited to types of occurrences, which, in the
          opinion of the company's board of directors, are, at the time of the
          undertaking, foreseeable due to the company's activities and to an
          amount or standard that the board of directors has determined is
          reasonable under the circumstances; and

     o    Retroactively indemnify an office holder of the company.

LIMITATIONS ON EXCULPATION, INSURANCE AND INDEMNIFICATION

     The Israeli Companies Law provides that neither a provision of the articles
of association permitting the company to enter into a contract to insure the
liability of an office holder, nor a provision in the articles of association or
a resolution of the board of directors permitting the indemnification of an
office holder, nor a provision in the articles of association exempting an
office holder from duty to the company shall be valid, where such insurance,
indemnification or exemption relates to any of the following:

     o    a breach by the office holder of his duty of loyalty, except with
          respect to insurance coverage or indemnification if the office holder
          acted in good faith and had reasonable grounds to assume that the act
          would not prejudice the company;

     o    a breach by the office holder of his duty of care if such breach was
          committed intentionally or recklessly, unless the breach was committed
          only negligently;

     o    any act or omission committed with intent to derive an unlawful
          personal gain; and

     o    any fine or forfeiture imposed on the office holder.

     In addition, pursuant to the Israeli Companies Law, exemption of,
procurement of insurance coverage for, an undertaking to indemnify or
indemnification of an office holder must be approved by the audit committee and
the board of directors and, if such office holder is a director or a controlling
shareholder or a relative of the controlling shareholder, also by the
shareholders general meeting. A special majority at the general meeting is
required if a controlling shareholder is interested in such transaction as an
office holder or as a relative of an office holder, as described above.

     Our articles of association allow us to insure, indemnify and exempt our
office holders to the fullest extent permitted by law, subject to the provisions
of the Israeli Companies Law. We currently maintain a directors' and officers'
liability insurance policy with a per claim and aggregate coverage limit of $15
million, including legal costs incurred world-wide. However, pursuant to the
approval of our audit committee, board of directors and shareholders, we are
authorized to procure a directors and officers liability insurance policy with a
per claim and aggregate coverage limit of up to $20 million. We have entered
into indemnification agreements with four of our directors. Under such
indemnification agreements, indemnification will not exceed 25% of our capital
in any one case and in the aggregate for all persons, and will be limited to
events covered by our directors' and officer's insurance policy and to amounts
exceeding the amounts covered by such insurance policy.


                                       55




NASDAQ EXEMPTIONS FOR A CONTROLLED COMPANY

     We are a controlled company within the meaning of NASDAQ Marketplace Rule
4350(c)(5), or Rule 4350(c)(5), since Formula Systems (1985) Ltd. holds more
than 50% of our voting power.

     Under Rule 4350(c)(5), a controlled company is exempt from the requirements
of NASDAQ Marketplace Rule 4350(c) that would otherwise require that

     o    the majority of the company's board of directors must qualify as
          independent directors, as defined under NASDAQ Marketplace Rules.

     o    the compensation of the chief financial officer and all other
          executive officers must be determined, or recommended to the board of
          directors for determination, either by (i) a majority of the
          independent directors or (ii) a compensation committee comprised
          solely of independent directors.

     o    director nominees must either be selected or recommended for the board
          of directors' selection, either by (a) a majority of independent
          directors or (b) a nominations committee comprised solely of
          independent directors .

NASDAQ MARKETPLACE RULES AND HOME COUNTRY PRACTICES

     Under NASDAQ Marketplace Rule 4350, or Rule 4350, foreign private issuers,
such as our company, are permitted to follow certain home country corporate
governance practices instead of certain provisions of Rule 4350, without the
need to seek individual exemptions from NASDAQ. A foreign private issuer that
elects to follow a home country practice instead of any of such provisions of
Rule 4350, must submit to NASDAQ, in advance, a written statement from an
independent counsel in such issuer's home country certifying that the issuer's
practices are not prohibited by the home country's laws.

     On June and November 2005, we provided NASDAQ with a notice of
non-compliance with Rule 4350. We informed NASDAQ that we do not comply with the
following requirements of Rule 4350, and instead follow Israeli law and practice
in respect of such requirements:

     o    The requirement that our independent directors will have regularly
          scheduled meetings at which only independent directors are present.
          Under Israeli law independent directors are not required to hold
          executive sessions.

     o    The requirement that we distribute to shareholders, and file with
          NASDAQ, copies of an annual report containing audited financial
          statements of our company and its subsidiaries within a reasonable
          period of time prior to our annual meeting of shareholders. Under
          Israeli law, as a company that is publicly traded both in Israel and
          outside of Israel, we are not required to distribute such annual
          reports to our shareholders. Our annual report on Form 20-F and
          audited financial statements are available on our website
          (www.magicsoftware.com).

D.   EMPLOYEES

     At December 31, 2006, we and our 13 wholly-owned subsidiaries and one
controlled subsidiary had 503 employees worldwide, of which 159 employees were
based in Israel, 123 employees were based in Asia, 73 employees were based in
Europe and 148 employees were based in North America. Of such employees, 145
employees were employed in research and development, 179 employees were employed
in technical support and consulting, 90 employees were employed in marketing and
sales and 89 employees were employed in operations and administration.

     At December 31, 2005, we and our 18 wholly-owned subsidiaries and one
controlled subsidiary had 567 employees worldwide, of which 180 employees were
based in Israel, 127 employees were based in Asia, 108 employees were based in
Europe and 152 employees were based in North America. Of such employees, 149
employees were employed in research and development, 204 employees were employed
in technical support and consulting, 106 employees were employed in marketing
and sales and 108 employees were employed in operations and administration.


                                       56




     At December 31, 2004, we and our then 17 wholly-owned subsidiaries and two
controlled subsidiaries had 543 employees worldwide, of which 190 employees were
based in Israel, 115 employees were based in Asia, 108 employees were based in
Europe and 130 employees were based in North America. Of such employees, 149
employees were employed in research and development, 187 employees were employed
in technical support and consulting, 94 employees were employed in marketing and
sales and 112 employees were employed in operations and administration.

     At the time of commencement of employment, our employees generally sign
written employment agreements specifying basic terms and conditions of
employment as well as non-disclosure, confidentiality and non-compete
provisions.

     We are subject to Israeli labor laws and regulations with respect to our
Israeli employees. These laws principally concern matters such as paid annual
vacation, paid sick days, length of the workday and work week, minimum wages,
pay for overtime, insurance for work-related accidents, severance pay and other
conditions of employment.

     Furthermore, our Israeli employees and we are subject to some provisions of
the collective bargaining agreements between the Histadrut, the General
Federation of Labor in Israel, and the Coordination Bureau of Economic
Organizations, including the Industrialists association, by order of the Israeli
Ministry of Labor and Welfare. These provisions principally concern cost of
living increases, recreation pay and other conditions of employment. We provide
our employees with benefits and working conditions above the required minimums.
Our employees are not represented by a labor union. To date, we have not
experienced any work stoppages and we consider our relations with our employees
to be excellent.

E.   SHARE OWNERSHIP

BENEFICIAL OWNERSHIP OF EXECUTIVE OFFICERS AND DIRECTORS

     The following table sets forth certain information as of June 25, 2007
regarding the beneficial ownership by each of our directors and executive
officers:

                                                    Number of Ordinary
                                                        Shares            Percentage of
Name                                               Beneficially Owned (1)  Ownership (2)
----                                                    ---------             ----

David Assia                                             1,372,730 (3)         4.36
Ziv Zviel                                                  30,708 (4)            *
Guy Bernstein                                                  --               --
Gad Goldstein (5)                                              --               --
Itiel Efrat                                                    --               --
Elan Penn                                                  18,000 (5)            *
Eli Reifman                                                    --               --
Naamit Salomon                                                 --               --
Yehezkel Zeira                                             18,000 (5)            *
All directors and executive officers as a group 9
persons)                                                1,439,438             4.57%

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

*    Less than 1%


                                       57




(1)  Beneficial ownership is determined in accordance with the rules of the
     Securities and Exchange Commission and generally includes voting or
     investment power with respect to securities. Ordinary shares relating to
     options currently exercisable or exercisable within 60 days of the date of
     this table are deemed outstanding for computing the percentage of the
     person holding such securities but are not deemed outstanding for computing
     the percentage of any other person. Except as indicated by footnote, and
     subject to community property laws where applicable, the persons named in
     the table above have sole voting and investment power with respect to all
     shares shown as beneficially owned by them.

(2)  The percentages shown are based on 31,437,557 ordinary shares issued and
     outstanding as of June 25, 2007 (excluding 1,275,368 ordinary shares held
     as treasury stock).

(3)  Includes 157,155 ordinary shares subject to currently exercisable options
     granted under our 2000 Stock Option Plan, having an average exercise price
     of $2.0 per share. Of such options, options to purchase 2,779 ordinary
     shares expire in 2012 and options to purchase 154,376 ordinary shares
     expire in 2013. Options granted prior to the dividend distribution in
     February 2003 reflect adjustments made to such options as a result of the
     dividend distribution.

(4)  Subject to currently exercisable options granted under our 2000 Stock
     Option Plan, having an average exercise price of $2.29 per share. Of such
     options, options to purchase 8,208 ordinary shares expire in 2013, options
     to purchase2,500 ordinary shares expire in 2014 and options to purchase
     20,000 ordinary shares expire in 2015. Options granted prior to the
     dividend distribution in February 2003 reflect adjustments made to such
     options as a result of the dividend distribution.

(5)  Subject to currently exercisable options granted under our 2000 Stock
     Option Plan, having an exercise price of $1.5 per share which expire in
     2015.

STOCK OPTION PLANS

1991 STOCK OPTION PLAN

     Our 1991 Employee Stock Option Plan, or the 1991 Plan, as amended,
authorized the grant of options to purchase an aggregate of 6,750,000 ordinary
shares. Employees and directors of our company and its subsidiaries were
eligible to participate in the 1991 Plan. The 1991 Plan had a ten-year term and
no options were granted under the 1991 Plan after July 31, 2001.

     During 2006, options to purchase 48,512 ordinary shares were exercised
under the 1991 Plan at an average exercise price of $1.80 per share. As of
December 31, 2006, options to purchase 261,463 ordinary shares were outstanding
under the 1991 Plan having an average exercise price of $3.19 per share. As of
December 31, 2006, our executive officers and directors as a group, then
consisting of nine persons, did not hold any options under the 1991 Plan.

2000 STOCK OPTION PLAN

     In 2000, we adopted our 2000 Employee Stock Option Plan, or the 2000 Plan,
under which we may grant options to employees, officers, directors and
consultants of our company and its subsidiaries. The 2000 Plan initially
authorized the grant of options to purchase up to 3,000,000 ordinary shares. In
January 2004, our shareholders approved an increase in the number of shares
available for grant under the 2000 Plan by 1,000,000 ordinary shares and in
December 2005 our shareholders approved an additional increase in the number of
shares available for grant under the 2000 Plan by 600,000 ordinary shares. As
such, up to an aggregate of 4,600,000 ordinary shares may be issued under the
2000 Plan.

     Awards under the 2000 Plan may be granted in the forms of incentive stock
options as provided in Section 422 of the U.S. Internal Revenue Code of 1986, as
amended, non-qualified stock options, options granted pursuant to Section 102 of
the Israeli Tax Ordinance and options granted pursuant to Section 3.9 of the
Israeli Tax Ordinance. The 2000 Plan has a term of ten years and will terminate
in November 2010. No award of options may be made after such date.


                                       58




     Our Board of Directors and Option Committee, which was appointed by the
board of directors, administer the 2000 Plan. Subject to the provisions of the
2000 Plan and applicable law, the Option Committee has the authority, in its
sole discretion, to:

     o    Propose to grant awards under the 2000 Plan and recommend to the board
          of directors the persons to whom such awards be granted;

     o    Determine the form, terms and conditions of the written stock option
          agreement evidencing the option, including (but not limited to) the
          type of option and the number of shares to which it pertains, the
          option price, the option period and its vesting schedule, and
          exercisability of the option in special cases (such as death,
          retirement, disability and change of control);

     o    Prescribe the form and provisions of the notice of exercise and
          payment of the option;

     o    Nominate a trustee for options issued under Section 102 of the Israeli
          Tax Ordinance, in accordance with the provisions of such Section 102;

     o    Adjust any or all of the number and type of shares that thereafter may
          be made the subject of options, the number and type of shares subject
          to outstanding options, and the grant or exercise price with respect
          to any option, or, if deemed appropriate, make provision for a cash
          payment to the holder of any outstanding option in order to prevent
          dilution or enlargement of the benefits or potential benefits intended
          to be made available under the 2000 Plan in the event of any dividend
          or other distribution, recapitalization, stock split, reverse stock
          split, reorganization, merger, consolidation, split-up, spin-off,
          combination, repurchase, or exchange of shares or other securities;

     o    Interpret the provisions of the 2000 Plan; and

     o    Prescribe, amend, and rescind rules and regulations relating to the
          2000 Plan or any award thereunder as it may deem necessary or
          advisable.

     Neither the board of directors nor the Option Committee may, without the
consent of the optionee, alter or in any way impair the rights of such optionee
under any award previously granted. Neither the termination of the 2000 Plan nor
the change of control of our company (except to the extent provided in the 2000
Plan) will affect any option previously granted.

     Under the 2000 Plan, the option price per share may not be less than 65% of
the fair market value (as such term is defined in the 2000 Plan) of such share
on the date of the award; except that, that in the case of an award of an
incentive stock option made to a 10% owner (as such term is defined in the 2000
Plan), the option price per share may not be less than 110% of the fair market
value of such share on the date of the award.

     An option may not be exercisable after the expiration of ten years from the
date of its award, except that in case of an incentive stock option made to a
10% owner (as such term is defined in the 2000 Plan), such option may not be
exercisable after the expiration of five years from its date of award. No option
may be exercised after the expiration of its term.

     Options are not assignable or transferable by the optionee, other than by
will or the laws of descent and distribution, and may be exercised during the
lifetime of the optionee only by the optionee or his guardian or legal
representative; provided, however, that during the optionee's lifetime, the
optionee may, with the consent of the Option Committee transfer without
consideration all or any portion of his options to members of the optionee's
immediate family, a trust established for the exclusive benefit of members of
the optionee's immediate family, or a limited liability company in which all
members are members of the optionee's immediate family.


                                       59




     During 2006, options to purchase 62,000 ordinary shares were granted under
the 2000 Plan (including options that were forfeited without being exercised)
having an average exercise price of $1.69 per share, and options to purchase
204,834 ordinary shares were exercised at an average exercise price of $1.1278
per share. As of December 31, 2006, options to purchase 2,091,169 ordinary
shares were outstanding under the 2000 Plan having an average exercise price of
$2.43 per share. As of December 31, 2006, our executive officers and directors
as a group, then consisting of nine persons, held options to purchase 223,863
ordinary shares under the 2000 Plan having an average exercise price of $3.24
per SHARE.

     As of December 29, 2005, our Board of Directors resolved to accelerate the
vesting period of all of the outstanding unvested options as of such date, for
the purchase of an aggregate 611,517 ordinary shares, with vesting periods from
January 1, 2006 through March 2009, so that these options became fully vested.
These options had an average exercise price of $3.46 per share. All of the
accelerated options had an exercise price exceeding our market price on such
date. The ordinary shares that may be purchased upon exercise of the accelerated
options shall be subject to a holding period, according to which the optionees
will be entitled to sell the purchased shares over a three year period, 1/36 of
the purchased shares per month. Our foregoing decision to accelerate the vesting
of such options and to grant fully vested options in the future was primarily
due to the issuance of SFAS No. 123 (revised 2004), "Share-Based Payment," which
requires all unvested stock options to be treated as a compensation expense as
of January 1, 2006.

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A.   MAJOR SHAREHOLDERS

     We are controlled by Formula Systems (1985) Ltd., which holds 50.10% of our
ordinary shares.

     The following table sets forth certain information as of June 25, 2007
regarding the beneficial ownership by all shareholders known to us to own
beneficially 5.0% or more of our ordinary shares:

                               Number of Ordinary Shares  Percentage of
Name                              Beneficially Owned(1)   Ownership (2)
                                      ----------            -----

Formula Systems (1985) Ltd. (3)       15,750,989            50.10%

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

(1)  Beneficial ownership is determined in accordance with the rules of the
     Securities and Exchange Commission and generally includes voting or
     investment power with respect to securities. Ordinary shares relating to
     options currently exercisable or exercisable within 60 days of the date of
     this table are deemed outstanding for computing the percentage of the
     person holding such securities but are not deemed outstanding for computing
     the percentage of any other person. Except as indicated by footnote, and
     subject to community property laws where applicable, the persons named in
     the table above have sole voting and investment power with respect to all
     shares shown as beneficially owned by them.

(2)  The percentages shown are based on 31,437,557 ordinary shares issued and
     outstanding as of June 25, 2007 (excluding 1,275,368 ordinary shares held
     as treasury stock).

(3)  The address of Formula Systems (1985) Ltd. is 3 Hagalim Boulevard, Herzliya
     Pituach, Israel.

MAJOR SHAREHOLDERS VOTING RIGHTS

     Our major shareholders do not have different voting rights.

RECORD HOLDERS

     Based on a review of the information provided to us by our U.S. transfer
agent, as of June 18 2006, there were 107 record holders, of which 86 record
holders holding approximately 47.46% of our ordinary shares had registered
addresses in the United States, including banks, brokers and nominees. These
numbers are not representative of the number of beneficial holders of our shares
nor are they representative of where such beneficial holders reside, since many
of these ordinary shares were held of record by banks, brokers or other
nominees.


                                       60




B.   RELATED PARTY TRANSACTIONS

     During 2005, we entered into an ERP (enterprise resource planning) project
with a number of companies that are engaged in the software and hardware
businesses and the implementation of ERP projects. See Item 5B. "Operating and
Financial Review and Prospects - Liquidity and Capital Resources." In connection
with this ERP project, in July 2005 we entered into a memorandum of
understanding with Matrix-One1 Ltd., valued at approximately $670,000. Until the
end of 2006, we performed only part of the project, in the amount of $497,000.
Matrix-One1 Ltd. is a subsidiary of Matrix IT Ltd., a company held by our major
shareholder, Formula Systems (1985) Ltd.

C.   INTERESTS OF EXPERTS AND COUNSEL

     Not applicable.

ITEM 8. FINANCIAL INFORMATION

A.   CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

     See the consolidated financial statements, including the notes thereto,
included in Item 18.

EXPORT SALES

     Our export sales constitute a significant portion of our total sales
volume. See Note 13 to our consolidated financial statements.

LEGAL PROCEEDINGS

     We received final tax assessments for the years 1997 to 2002 from the
Israeli tax authorities and have appealed to the District Court of Tel Aviv -
Jaffa with respect to such tax assessments. As of May 2006, one open issue
remains to be settled by the court (which management believes will result in a
maximum tax payment of no more than $0.7 million), while all other issues were
resolved with no additional taxes to be paid by us. Since our management, based
on the advice of its legal advisors, believes that the probability of an
unfavorable outcome to our company on this matter is remote, no provision was
provided in the financial statements in respect of this matter.

     In June 2004, an Israeli company filed a lawsuit against us in the District
Court of Tel Aviv - Jaffa seeking NIS 8.0 million (approximately $1.84 million),
with an option to increase this amount to NIS 16,989,356 (approximately $3.9
million), for recovery of damages allegedly caused by our failure to integrate a
software application. During the last three years, the parties tried to settle
the case with an external mediator. This attempt failed recently and the parties
returned to the court to proceed with the court proceedings. Preliminary court
proceedings have commenced, such as disclosure of documents and questionnaires.
Due to the preliminary stage of this litigation, we are not able to assess the
outcome of the lawsuit nor can we make any estimate of the amount of damages;
therefore, no provision has been made for the lawsuit.

     In May 2005, a client of our subsidiary Magic Software Enterprises (Israel)
Ltd. filed a lawsuit against the subsidiary claiming an alleged breach of the
agreement between the parties. The plaintiff is seeking damages in the amount of
$335,641. The claim was moved to arbitration. Due to the preliminary stage of
this litigation, we are not able to assess the outcome of the lawsuit nor can we
make any estimate of the amount of damages; therefore, no provision has been
made for the lawsuit.

     In February 2006, a client of our subsidiary CarPro Systems Ltd. filed a
lawsuit against the subsidiary in the Magistrate's Court of Tel Aviv - Jaffa
claiming an alleged breach of the agreement between the parties. The plaintiff
is seeking damages in the amount of NIS 1,053,531 (approximately $256,958). The
claim had been moved to arbitration, which will commence in August 2007. Due to
the preliminary stage of this litigation, we are not able to assess the outcome
of the lawsuit nor can we make any estimate of the amount of damages; therefore,
no provision has been made for the lawsuit.


                                       61




     In March 2006, a client of our Magic solution provider in France filed a
lawsuit against the Magic solution provider and our subsidiary Magic Software
Enterprises (France) S.A.R.L. in the commercial court in Paris claiming an
alleged breach of the agreement between the parties. The plaintiff is seeking
damages in the amount of Euro 548,000. Due to the preliminary stage of this
litigation, we are not able to assess the outcome of the lawsuit nor can we make
any estimate of the amount of damages; therefore, no provision has been made for
the lawsuit.

     From time to time, claims arising in the ordinary course of our business
are brought against us. In the opinion of our management, these claims will not
have a material adverse effect on our financial position, liquidity or results
of operations.

DIVIDEND DISTRIBUTIONS POLICY

     In February 2003, following receipt of the approval of the District Court
of Tel Aviv, we paid a cash dividend to our shareholders of $0.40 per ordinary
share. The total dividend amounted to $11,844,713.

     We currently intend to retain all future earnings for use in our business
and do not anticipate paying any further cash dividends on our ordinary shares
in the foreseeable future under our current financial condition. Any future
dividend policy will be determined by the board of directors and will be based
upon conditions then existing, including our results of operations, financial
condition, current and anticipated cash needs, contractual restrictions and
other conditions as the board of directors may deem relevant.

     According to the Israeli Companies Law, a company may distribute dividends
out of its profits provided that there is no reasonable concern that such
dividend distribution will prevent the company from paying all its current and
foreseeable obligations, as they become due. Notwithstanding the foregoing,
dividends may be paid with the approval of a court, provided that there is no
reasonable concern that such dividend distribution will prevent the company from
satisfying its current and foreseeable obligations, as they become due. Profits,
for purposes of the Israeli Companies Law, means the greater of retained
earnings or earnings accumulated during the preceding two years, after deducting
previous distributions that were not deducted from the surpluses. In the event
cash dividends are declared, such dividends will be paid in NIS.

B.   SIGNIFICANT CHANGES

     Since the date of the annual consolidated financial statements included in
this annual report, no significant change has occurred.

ITEM 9. THE OFFER AND LISTING

A.   OFFER AND LISTING DETAILS

ANNUAL STOCK INFORMATION

     The following table sets forth, for each of the years indicated, the range
of high ask and low bid prices of our ordinary shares on the NASDAQ Global
Market and the Tel Aviv Stock Exchange:

                                NASDAQ GLOBAL MARKET   TEL AVIV STOCK EXCHANGE*
                                --------------------    --------------------
                                  HIGH        LOW         HIGH        LOW
                                --------    --------    --------    --------

YEAR

2002                            $   2.10    $   0.72    $   2.15    $   0.88
2003                            $   4.85    $   0.79    $   4.69    $   0.83
2004                            $   8.70    $   2.51    $   8.65    $   2.60
2005                            $   3.54    $   1.44    $   3.49    $   1.41
2006                            $   2.37    $   1.41    $   2.22    $   1.41

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

     * The U.S. dollar price of shares on the Tel Aviv Stock Exchange is
determined by dividing the price of an ordinary share in New Israeli Shekels by
the representative exchange rate of the New Israeli Shekel against the U.S.
dollar on the same date.


                                       62




QUARTERLY STOCK INFORMATION

     The following table sets forth, for each of the financial quarters in the
two most recent financial years and subsequent period, the range of high ask and
low bid prices of our ordinary shares on the NASDAQ Global Market and the Tel
Aviv Stock Exchange:

                                NASDAQ GLOBAL MARKET   TEL AVIV STOCK EXCHANGE*
                                --------------------    --------------------
                                  HIGH        LOW         HIGH        LOW
                                --------    --------    --------    --------

2005
First Quarter                   $   3.54    $   2.90    $   3.49    $   3.05
Second Quarter                  $   3.25    $   1.80    $   3.25    $   1.87
Third Quarter                   $   2.25    $   1.59    $   2.21    $   1.64
Fourth Quarter                  $   2.00    $   1.44    $   1.91    $   1.41

2006
First Quarter                   $   1.85    $   1.46    $   1.82    $   1.48
Second Quarter                  $   2.22    $   1.57    $   2.17    $   1.55
Third Quarter                   $   2.33    $   1.41    $   2.14    $   1.41
Fourth Quarter                  $   2.37    $   1.62    $   2.22    $   1.64

2007
First Quarter                   $   2.90    $   2.14    $   2.87    $   2.35

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

     * The U.S. dollar price of shares on the Tel Aviv Stock Exchange is
determined by dividing the price of an ordinary share in New Israeli Shekels by
the representative exchange rate of the New Israeli Shekel against the U.S.
dollar on the same date.

MONTHLY STOCK INFORMATION

     The following table sets forth, for the most recent six months, the range
of high ask and low bid prices of our ordinary shares on the NASDAQ Global
Market and the Tel Aviv Stock Exchange:

                                NASDAQ GLOBAL MARKET   TEL AVIV STOCK EXCHANGE*
                                --------------------    --------------------
                                  HIGH        LOW         HIGH        LOW
                                --------    --------    --------    --------

December 2006                   $   2.37    $   1.93    $   2.26    $   1.95
January 2007                    $   2.86    $   2.37    $   2.63    $   2.02
February 2007                   $   2.90    $   2.35    $   2.55    $   2.11
March 2007                      $   2.54    $   2.31    $   2.23    $   2.05
April 2007                      $   2.52    $   2.14    $   2.18    $   1.94
May 2007                        $   2.60    $   2.32    $   2.28    $   2.08

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

     * The U.S. dollar price of shares on the Tel Aviv Stock Exchange is
determined by dividing the price of an ordinary share in New Israeli Shekels by
the representative exchange rate of the New Israeli Shekel against the U.S.
dollar on the same date.

B.   PLAN OF DISTRIBUTION

     Not applicable.

C.   MARKETS

     Our ordinary shares have traded on the NASDAQ Global Market (under the
symbol "MGIC") since our initial public offering on August 16, 1991. Since
November 16, 2000, our ordinary shares have also traded on the Tel Aviv Stock
Exchange.


                                       63



D.   SELLING SHAREHOLDERS

     Not applicable.

E.   DILUTION

     Not applicable.

F.   EXPENSE OF THE ISSUE

     Not applicable.

ITEM 10. ADDITIONAL INFORMATION

A.   SHARE CAPITAL

     Not applicable.

B.   MEMORANDUM AND ARTICLES OF ASSOCIATION

     SET OUT BELOW IS A DESCRIPTION OF CERTAIN PROVISIONS OF OUR ARTICLES OF
ASSOCIATION AND OF THE ISRAELI COMPANIES LAW RELATED TO SUCH PROVISIONS. THIS
DESCRIPTION IS ONLY A SUMMARY AND DOES NOT PURPORT TO BE COMPLETE AND IS
QUALIFIED BY REFERENCE TO THE FULL TEXT OF THE ARTICLES OF ASSOCIATION, WHICH
ARE INCORPORATED BY REFERENCE AS EXHIBITS TO THIS ANNUAL REPORT, AND TO ISRAELI
LAW.

PURPOSES AND OBJECTS OF THE COMPANY

     We are registered with the Israeli Companies Registry and have been
assigned company number 52-003674-0. Section 2 of our memorandum of association
provides that we were established for the purpose of engaging in all fields of
the computer business and in any other lawful activity permissible under Israeli
law.

THE POWERS OF THE DIRECTORS

     Under the provisions of the Israel Companies Law and our articles of
association, a director cannot participate in a meeting nor vote on a proposal,
arrangement or contract in which he or she is materially interested. In
addition, our directors cannot vote compensation to themselves or any members of
their body without the approval of our audit committee and our shareholders at a
general meeting. See "Item 6C. Directors, Senior Management and Employees -
Board Practices - Approval of Related Party Transactions Under Israeli Law."

     The authority of our directors to enter into borrowing arrangements on our
behalf is not limited, except in the same manner as any other transaction by us.

     Under our articles of association, retirement of directors from office is
not subject to any age limitation and our directors are not required to own
shares in our company in order to qualify to serve as directors.

RIGHTS ATTACHED TO SHARES

     Our authorized share capital consists of 50,000,000 ordinary shares of a
nominal value of NIS 0.1 each. All outstanding ordinary shares are validly
issued, fully paid and non-assessable. The rights attached to the ordinary
shares are as follows:


                                       64




     DIVIDEND RIGHTS. Holders of our ordinary shares are entitled to the full
amount of any cash or share dividend subsequently declared. The board of
directors may declare interim dividends and propose the final dividend with
respect to any fiscal year only out of the retained earnings, in accordance with
the provisions of the Israeli Companies Law. See "Item 8A. Financial Information
- Consolidated and Other Financial Information - Dividend Distributions Policy."
All unclaimed dividends or other monies payable in respect of a share may be
invested or otherwise made use of by the Board of Directors for our benefit
until claimed. Any dividend unclaimed after a period of three years from the
date of declaration of such dividend will be forfeited and will revert to us;
provided, however, that the Board of Directors may, at its discretion, cause us
to pay any such dividend to a person who would have been entitled thereto had
the same not reverted to us. We are not obligated to pay interest or linkage
differentials on an unclaimed dividend.

     VOTING RIGHTS. Holders of ordinary shares have one vote for each ordinary
share held on all matters submitted to a vote of shareholders. Such 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.

     The quorum required at any meeting of shareholders consists of at least two
shareholders present in person or represented by proxy who hold or represent, in
the aggregate, at least one-third (33%) of the voting rights in the company. A
meeting adjourned for lack of a quorum is generally adjourned to the same day in
the following week at the same time and place or any time and place as the
directors designate in a notice to the shareholders. At the reconvened meeting,
the required quorum consists of any two members present in person or by proxy.

     Under our articles of association, all resolutions require approval of no
less than a majority of the voting rights represented at the meeting in person
or by proxy and voting thereon.

     Pursuant to our articles of association, our directors (except outside
directors) are elected at our annual general meeting of shareholders by a vote
of the holders of a majority of the voting power represented and voting at such
meeting and hold office until the next annual general meeting of shareholders
and until their successors have been elected. All the members of our Board of
Directors (except the outside directors) may be reelected upon completion of
their term of office. Formula Systems (1985) Ltd., which beneficially owns
approximately 50.10% of our ordinary shares, is likely to be able to elect all
of our directors other than our outside directors. See "Item 7A. Major
Shareholders and Related Party Transactions - Major Shareholders." For
information regarding the election of outside directors, see "Item 6C.
Directors, Senior Management and Employees - Board Practices -- Election of
Directors."

     RIGHTS TO SHARE IN THE COMPANY'S PROFITS. Our shareholders have the right
to share in our profits distributed as a dividend and any other permitted
distribution. See this Item 10B. "Additional Information - Memorandum and
Articles of Association - Rights Attached to Shares - Dividend Rights."

     RIGHTS TO SHARE IN SURPLUS IN THE EVENT OF LIQUIDATION. In the event of our
liquidation, after satisfaction of liabilities to creditors, our assets will be
distributed to the holders of ordinary shares in proportion to the nominal value
of their holdings. This right may be affected by the grant of preferential
dividend or distribution rights to the holders of a class of shares with
preferential rights that may be authorized in the future.

     LIABILITY TO CAPITAL CALLS BY THE COMPANY. Under our memorandum of
association and the Israeli Companies Law, the liability of our shareholders to
provide us with additional funds is limited to the par value of the shares held
by them.

     LIMITATIONS ON ANY EXISTING OR PROSPECTIVE MAJOR SHAREHOLDER. See Item 6C.
"Directors and Senior Management -Board Practices - Approval of Related Party
Transactions Under Israeli Law."

CHANGING RIGHTS ATTACHED TO SHARES

     According to our articles of association, the rights attached to any class
of shares may be modified or abrogated by us, subject to the consent in writing
of, or sanction of a resolution passed by, the holders of a majority of the
issued shares of such class at a separate general meeting of the holders of the
shares of such class.


                                       65




ANNUAL AND EXTRAORDINARY MEETINGS

     Under the Israeli Companies Law a company must convene an annual meeting of
shareholders at least once every calendar year and within fifteen months of the
last annual meeting. Depending on the matter to be voted upon, notice of at
least 21 days or 35 days prior to the date of the meeting is required. Our board
of directors may, in its discretion, convene additional meetings as "special
general meetings." With respect to "special general meetings notice of at least
35 days prior to the date of the meeting is required. In addition, the board
must convene a special general meeting upon the demand of two of the directors,
25% of the nominated directors, one or more shareholders having at least 5% of
the outstanding share capital and at least 1% of the voting power in the
company, or one or more shareholders having at least 5% of the voting power in
the company. See Item 10B. "Additional Information - Memorandum and Articles of
Association - Rights Attached to Shares - Voting Rights."

LIMITATIONS ON THE RIGHTS TO OWN SECURITIES IN OUR COMPANY

     Neither our memorandum of association or our articles of association nor
the laws of the State of Israel restrict in any way the ownership or voting of
shares by non-residents, except with respect to subjects of countries which are
in a state of war with Israel.

PROVISIONS RESTRICTING CHANGE IN CONTROL OF OUR COMPANY

     The Israeli Companies Law requires that mergers between Israeli companies
be approved by the board of directors and general meeting of shareholders of
both parties to the transaction. The approval of the board of directors of both
companies is subject to such boards' confirmation that there is no reasonable
doubt that following the merger the surviving company will be able to fulfill
its obligations towards its creditors. Each company must notify its creditors
about the contemplated merger. Under the Israeli Companies Law, our articles of
association are deemed to include a requirement that such merger be approved by
an extraordinary resolution of the shareholders, as explained above. The
approval of the merger by the general meetings of shareholders of the companies
is also subject to additional approval requirements as specified in the Israeli
Companies Law and regulations promulgated thereunder. See also "Item 6C.
Directors, Senior Management and Employees - Board Practices - - Approval of
Related Party Transactions Under Israeli Law."

DISCLOSURE OF SHAREHOLDERS OWNERSHIP

     The Israeli Securities Law and the regulations promulgated thereunder
require that a company whose shares are traded on a stock exchange in Israel, as
in the case of our company, report the share ownership of its interested
parties. An interested party is defined under the Israeli Securities Law as any
one of the following: (i) a person holding 5% or more of the company's issued
capital stock or voting power, or who is entitled to appoint one or more of the
company's directors or its general manager; or (ii) any person acting as a
director or general manager of the company; or (iii) any company, in which any
of the above persons either holds 25% or more of its capital stock or voting
power or is entitled to appoint 25% or more of its directors.

CHANGES IN OUR CAPITAL

     Changes in our capital are subject to the approval of the shareholders by a
majority of the votes of shareholders present at the meeting, in person or by
proxy, and voting on the matter.

C.   MATERIAL CONTRACTS

     None.

D.   EXCHANGE CONTROLS

     Israeli law and regulations do not impose any material foreign exchange
restrictions on non-Israeli holders of our ordinary shares. In May 1998, a new
"general permit" was issued under the Israeli Currency Control Law, 1978, which
removed most of the restrictions that previously existed under such law, and
enabled Israeli citizens to freely invest outside of Israel and freely convert
Israeli currency into non-Israeli currencies.


                                       66




     Non-residents of Israel who purchase our ordinary shares will be able to
convert dividends, if any, thereon, and any amounts payable upon our
dissolution, liquidation or winding up, as well as the proceeds of any sale in
Israel of our ordinary shares to an Israeli resident, into freely repatriable
dollars, at the exchange rate prevailing at the time of conversion, provided
that the Israeli income tax has been withheld (or paid) with respect to such
amounts or an exemption has been obtained.

E.   TAXATION

     The following is a discussion of Israeli and United States tax consequences
material to our shareholders. To the extent that the discussion is based on new
tax legislation which has not been subject to judicial or administrative
interpretation, we cannot assure you that the views expressed in the discussion
will be accepted by the appropriate tax authorities or the courts. The
discussion is not intended, and should not be construed, as legal or
professional tax advice and is not exhaustive of all possible tax considerations

     HOLDERS OF OUR ORDINARY SHARES SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO
THE UNITED STATES, ISRAELI OR OTHER TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP
AND DISPOSITION OF ORDINARY SHARES, INCLUDING, IN PARTICULAR, THE EFFECT OF ANY
FOREIGN, STATE OR LOCAL TAXES.

ISRAELI TAX CONSIDERATIONS

     The following is a summary of some of the current tax law applicable to
companies in Israel, with special reference to its effect on us. The following
also contains a discussion of specified Israeli tax consequences to our
shareholders and government programs benefiting us. To the extent that the
discussion is based on tax legislation that has not been subject to judicial or
administrative interpretation, there can be no assurance that the views
expressed in the discussion will be accepted by the tax authorities in question.
The discussion is not intended, and should not be construed, as legal or
professional tax advice and is not exhaustive of all possible tax
considerations.

GENERAL CORPORATE TAX STRUCTURE

     Israeli companies are generally subject to company tax on their taxable
income. The applicable rate is 31% in 2006, 29% in 2007, 27% in 2008, 26% in
2009 and 25% in 2010 and thereafter.

     Under the Income Tax Law (Adjustment for Inflation) 1985, income for tax
purposes is generally measured in terms of earnings in NIS adjusted for the
increase in the Israeli CPI.

TAX BENEFITS UNDER THE LAW FOR THE ENCOURAGEMENT OF CAPITAL INVESTMENTS, 1959

     The Law for the Encouragement of Capital Investment, 1959, or the
Investment Law, provides that a proposed capital investment in production
facilities or other eligible facilities may be designated as an "approved
enterprise." To obtain "approved enterprise" status, an application to the
Investment Center of the Ministry of Industry and Trade, or the Investment
Center, needs to be submitted. Each instrument of approval for an approved
enterprise relates to a specific investment program that is defined both by the
financial scope of the investment, including sources of funds, and by the
physical characteristics of the facility or other assets.

     The tax benefits available under any instrument of approval relate only to
taxable profits attributable to the specific program and are contingent upon
meeting the criteria set out in the instrument of approval. If a company has
more than one approval or only a portion of its capital investments are
approved, its effective tax rate is the weighted average of the applicable
rates. As explained below, following the amendment of the Investment Law which
became effective on April, 1, 2005, companies may receive tax benefits under the
law without applying for an approved enterprise status.


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TAX BENEFITS FOR INCOME FROM APPROVED ENTERPRISES APPROVED BEFORE APRIL 1, 2005

     Before April 1, 2005 an approved enterprise was entitled to either receive
a grant from the Government of Israel or an alternative package of tax benefits,
or the Alternative Benefits. We have elected to forego the entitlement to grants
and have applied for the Alternative Benefits, under which undistributed income
that we generate from our approved enterprises will be completely tax exempt.
The period of such tax exemption for a company electing the Alternative Benefits
ranges between two and ten years, depending upon the location within Israel and
the type of the approved enterprise. Because we are located in Or Yehuda, the
period of tax exemption applicable is two to four years (as described below).

     On expiration of the exemption period, the approved enterprise would be
eligible for beneficial tax rates otherwise available for approved enterprises
under the Investment Law (for our company, a rate of 25%) for the remainder of
the otherwise applicable benefits period.

     Alternative Benefits are available until the earlier of (i) seven
consecutive years, commencing in the year in which the specific approved
enterprise first generates taxable income, (ii) 12 years from commencement of
production and (iii) 14 years from the date of approval of the approved
enterprise status.

     Dividends paid out of income generated by an approved enterprise (or out of
dividends received from a company whose income is generated by an approved
enterprise) are generally subject to withholding tax at the rate of 15%. This
withholding tax is deductible at source by the approved enterprise. The 15% tax
rate is limited to dividends and distributions out of income derived during the
benefits period and actually paid at any time up to 12 years thereafter. Since
we elected the Alternative Benefits track, we will be subject to payment of
corporate tax at the rate of 25% in respect of the gross amount of the dividend
that we may distribute out of profits which were exempt from corporate tax in
accordance with the provisions of the Alternative Benefits track. If we are also
deemed to be a "Foreign Investors' Company," or "FIC," and if the FIC (the
definition of which appears below) is at least 49% owned by non-Israeli
residents, the corporate tax rate paid by us in respect of the dividend we may
distribute from income derived by our approved enterprises during the tax
exemption period may be taxed at a lower rate.

     Since we have elected the Alternative Benefits package, we are not obliged
to attribute any part of dividends that we may distribute to exempt profits, and
we may decide from which year's profits to declare dividends. We currently
intend to reinvest any income that we may in the future derive from our approved
enterprise programs and not to distribute the income as a dividend.

     If we qualify as a FIC, our approved enterprises will be entitled to
additional tax benefits. Subject to certain conditions, a FIC is a company with
a level of foreign investment of more than 25%. The level of foreign investment
is measured as the percentage of rights in the company (in terms of shares,
rights to profits, voting and appointment of directors), and of combined share
and loan capital, that are owned, directly or indirectly, by persons who are not
residents of Israel. Such a company will be eligible for an extension of the
period during which it is entitled to tax benefits under its approved enterprise
status (so that the benefit periods may be up to ten years) and for further tax
benefits if the level of foreign investment exceeds 49%.

     The Investment Center of the Ministry of Industry and Trade has granted
approved enterprise status under Israeli law to eight investment programs at our
manufacturing facility. We have elected the alternative package of benefits with
respect to each of these approved enterprise programs.

     The benefits available to an approved enterprise are subject to the
fulfillment of conditions stipulated in the Investment Law and its regulations
and the criteria in the specific certificate of approval, as described above. If
a company does not meet these conditions, it would be required to refund the
amount of tax benefits, together with consumer price index linkage adjustment
and interest.


                                       68




TAX BENEFITS UNDER AN AMENDMENT THAT BECAME EFFECTIVE ON APRIL 1, 2005

     On April 1, 2005, a amendment to the Investment Law became effective. The
Investment Law provides that terms and benefits included in any certificate of
approval that was granted before the April 2005 amendment came into effect will
remain subject to the provisions of the Investment Law as they were on the date
of such approval.

     Under the April 2005 amendment, "approved enterprise" status will continue
to be granted by the Investment Center to qualifying investments. However, the
amendment limits the scope of enterprises which may be approved by the
Investment Center by setting criteria for the approval of a facility as an
approved enterprise, such as provisions generally requiring that at least 25% of
the approved enterprise's income will be derived from export.

     The April 2005 amendment provides that approved enterprise status will only
be necessary for receiving grants. As a result, it is no longer necessary for a
company to acquire approved enterprise status in order to receive the tax
benefits previously available under the Alternative Benefits provisions. Rather,
a company may claim the tax benefits offered by the Investment Law directly in
its tax returns, provided that its facilities meet the criteria for tax benefits
set out by the amendment. Companies are entitled to approach the Israeli Tax
Authority for a pre-ruling regarding their eligibility for benefits under the
amendment.

     Tax benefits are available under the April 2005 amendment to production
facilities (or other eligible facilities), which are generally required to
derive more than 25% of their business income from export. In order to receive
the tax benefits, the amendment states that the company must make an investment
which meets all the conditions set out in the amendment for tax benefits and
exceeds a minimum amount specified in the Investment Law. Such investment allows
the company to receive a "benefited enterprise" status, and may be made over a
period of no more than three years ending at the end of the year in which the
company requested to have the tax benefits apply to the benefited enterprise,
referred to as the Year of Election. Where the company requests to have the tax
benefits apply to an expansion of existing facilities, only the expansion will
be considered to be a benefited enterprise and the company's effective tax rate
will be the weighted average of the applicable rates. In this case, the minimum
investment required in order to qualify as a benefited enterprise is required to
exceed a certain amount or certain percentage of the value of the company's
production assets before the expansion.

     The extent of the tax benefits available under the April 2005 amendment to
qualifying income of a benefited enterprise are determined by the geographic
location of the benefited enterprise. The location will also determine the
period for which tax benefits are available.

     Dividends paid out of income derived by a benefited enterprise will be
treated similarly to payment of dividends by an approved enterprise under the
Alternative Benefits track. Therefore, dividends paid out of income derived by a
benefited enterprise (or out of dividends received from a company whose income
is derived from a benefited enterprise) are generally subject to withholding tax
at the rate of 15% (deductible at source). The reduced rate of 15% is limited to
dividends and distributions out of income derived from a benefited enterprise
during the benefits period and actually paid at any time up to 12 years
thereafter. A company qualifying for tax benefits under the amendment which pays
a dividend out of income derived by its benefited enterprise during the tax
exemption period will be subject to tax in respect of the gross amount of the
dividend at the otherwise applicable rate of 25%, (or lower in the case of a
qualified "FIC" which is at least 49% owned by non-Israeli residents). The
dividend recipient would be subject to tax at the rate of 15% on the amount
received which tax would be deducted at source.

     As a result of the April 2005 amendment, tax-exempt income generated under
the provisions of the new law will subject us to taxes upon distribution of the
tax-exempt income to shareholders or liquidation of the company, and we may be
required to record a deferred tax liability with respect to such tax-exempt
income.

     The April 2005 amendment sets a minimal amount of foreign investment
required for a company to be regarded a FIC.


                                       69




TAX BENEFITS AND GRANTS FOR RESEARCH AND DEVELOPMENT

     Israeli tax law allows, under certain conditions, a tax deduction in the
year incurred for expenditures (including capital expenditures) in scientific
research and development projects if the expenditures are approved by the
relevant Israeli government ministry (determined by the field of research) and
the research and development is for the promotion of the enterprise and is
carried out by or on behalf of the company seeking such deduction. Expenditures
not so approved are deductible over a three-year period. However, expenditures
made out of proceeds made available to us through government grants are not
deductible according to Israeli law.

LAW FOR THE ENCOURAGEMENT OF INDUSTRY (TAXES), 1969

     The following preferred corporate tax benefits, among others, are available
to Industrial Corporations, which may be applicable to us:

     o    Amortization of purchases of know-how and patents over eight years for
          tax purposes.

     o    Amortization of expenses incurred in connection with certain public
          security issuances over a three-year period.

     o    Tax exemption for shareholders who held shares before a public
          offering on capital gains derived from the sale (as defined by law) of
          securities, if realized after more than five years from the public
          issuance of additional securities of the company. (As of November
          1994, this exemption was repealed, however, it applies to our
          shareholders pursuant to a grand-fathering clause.) This exemption
          applies only to gains that accrued before January 1, 2003.

     o    Accelerated depreciation rates on equipment and buildings.

SPECIAL PROVISIONS RELATING TO TAXATION UNDER INFLATIONARY CONDITIONS

     The Income Tax Law (Inflationary Adjustments), 1985, generally referred to
as the Inflationary Adjustments Law, represents an attempt to overcome the
problems presented to a traditional tax system by an economy undergoing rapid
inflation. The Inflationary Adjustments Law is highly complex. The features that
are material to us can be described as follows:

     o    When the value of a company's equity, as calculated under the
          Inflationary Adjustments Law, exceeds the depreciated cost of its
          fixed assets (as defined in the Inflationary Adjustments Law), a
          deduction from taxable income is permitted equal to the product of the
          excess multiplied by the applicable annual rate of inflation. The
          maximum deduction permitted in any single tax year is 70% of taxable
          income, with the unused portion permitted to be carried forward,
          linked to the increase in the consumer price index.

     o    If the depreciated cost of a company's fixed assets exceeds its
          equity, the product of the excess multiplied by the applicable annual
          rate of inflation is added to taxable income.

     o    Subject to certain limitations, depreciation deductions on fixed
          assets and losses carried forward are adjusted for inflation based on
          the increase in the Israeli consumer price index.

     The Minister of Finance may, with the approval of the Knesset Finance
Committee, determine by decree, during a certain fiscal year (or until February
28th of the following year) in which the rate of increase of the Israeli
consumer price index will not exceed or did not exceed, as applicable, 3%, that
some or all of the provisions of the Inflationary Adjustments Law shall not
apply with respect to such fiscal year, or, that the rate of increase of the
Israeli consumer price index relating to such fiscal year shall be deemed to be
0%, and to make the adjustments required to be made as a result of such
determination.


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ISRAELI CAPITAL GAINS TAX

     Until the end of the year 2002, and provided we maintained our status as an
industrial corporation, capital gains from the sale of our securities were
generally exempt from Israeli Capital Gains Tax. This exemption did not apply to
a shareholder whose taxable income was determined pursuant to the Israeli Income
Tax Law (Inflationary Adjustments) 1985, or to a person whose gains from selling
or otherwise disposing of our securities were deemed to be business income.

     From January 1, 2003, capital gains from the sale of our securities were
generally subject to tax. On January 1, 2006 an amendment to the Israeli tax
regime became effective, referred to as the 2006 Tax Reform. The 2006 Tax Reform
significantly changed the tax rates applicable to income derived from
securities.

     According to the 2006 Tax Reform, an individual is subject to a 20% tax
rate on real capital gains derived from the sale of shares, as long as the
individual is not a "substantial shareholder" (generally a shareholder with 10%
or more of the right to profits, right to nominate a director and voting rights)
in the company issuing the shares.

     A substantial shareholder will be subject to tax at a rate of 25% in
respect of real capital gains derived from the sale of shares issued by the
company in which he or she is a substantial shareholder. The determination of
whether the individual is a substantial shareholder will be made on the date
that the securities are sold. In addition, the individual will be deemed to be a
substantial shareholder if at any time during the 12 months preceding this date
he had been a substantial Shareholder.

     Non-Israeli residents are exempt from Israeli capital gains tax on any
gains derived from the sale of shares in an Israeli corporation publicly traded
on the TASE and/or on a foreign stock exchange, provided such gains do not
derive from a permanent establishment of such shareholders in Israel and that
such shareholders did not acquire their shares prior to the issuer's initial
public offering. However, non-Israeli corporations will not be entitled to such
exemption if an Israeli resident (i) has a controlling interest of 25% or more
in such non-Israeli corporation, or (ii) is the beneficiary of or is entitled to
25% or more of the revenues or profits of such non-Israeli corporation, whether
directly or indirectly .

     In some instances where our shareholders may be liable to Israeli tax on
the sale of their ordinary shares, the payment of the consideration may be
subject to the withholding of Israeli tax at the source.

     Pursuant to the treaty between the governments of the United States and
Israel with respect to taxes on income, or 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.

ISRAELI TAX ON DIVIDEND INCOME

TAXATION OF ISRAELI RESIDENTS

     Israeli resident individuals are generally subject to Israeli income tax on
the receipt of dividends paid on our ordinary shares, other than bonus shares
(share dividends) or stock dividends, at the rate of 20%, or 25% for a
shareholder that is considered a material shareholder within the meaning of the
Israeli Tax Ordinance, at any time during the 12-month period preceding such
distribution. Dividends paid on our ordinary shares to Israeli resident
companies are exempt from such tax (except with respect to dividends that are
distributed from the income derived outside of Israel, which are subject to the
25% tax rate).


                                       71




     Trust funds, pension funds and other institutions which are exempt from tax
based on Section 9(2) of the Israeli Tax Ordinance are exempt from the tax on
dividend distributions.

     The withholding tax on dividends paid on our ordinary shares is 20%
(including for a shareholder considered a material shareholder within the
meaning of the Israeli Tax Ordinance).

     Dividends paid from income derived from our approved enterprise or
benefited enterprise are subject to tax, which is withheld at the source at the
rate of 15%, although we cannot assure you that we will designate the profits
that are being distributed in a way that will reduce shareholders' tax
liability.

TAXATION OF NON-ISRAELI RESIDENTS

     Under Israeli tax law, a distribution of dividends from income attributable
to an approved enterprise will be subject to tax in Israel at the rate of 15%,
which is withheld and paid by the company paying the dividend, if the dividend
is distributed during the benefits period or within the following 12 years (but
the 12-year limitation does not apply to a Foreign Investors' Company). Any
distribution of dividends from income that is not attributable to an approved
enterprise will be subject to tax in Israel at the rate of 25%, except that
dividends distributed on or after January 1, 2006 to an individual who is deemed
"a non-substantial shareholder" will be subject to tax at the rate of 20%.

     Under the US-Israel Tax Treaty, Israeli withholding tax on dividends paid
to a U.S. treaty resident may not in general exceed 25%, or 15% in the case of
dividends paid out of the profits of an approved enterprise. Where the recipient
is a U.S. corporation owning 10% or more of the voting stock of the paying
corporation and the dividend is not paid from the profits of an approved
enterprise, the Israeli tax withheld may not exceed 12.5%, subject to certain
conditions.

UNITED STATES FEDERAL INCOME TAX CONSEQUENCES

     The following is a summary of certain material U.S. federal income tax
consequences that apply to U.S. Holders who hold ordinary shares as capital
assets. This summary is based on the United States Internal Revenue Code of
1986, as amended, or the Code, Treasury regulations promulgated thereunder,
judicial and administrative interpretations thereof, and the U.S.-Israel Tax
Treaty, all as in effect on the date hereof and all of which are subject to
change either prospectively or retroactively. This summary does not address all
tax considerations that may be relevant with respect to an investment in
ordinary shares. This summary does not account for the specific circumstances of
any particular investor, such as:

     o    broker-dealers,

     o    financial institutions,

     o    certain insurance companies,

     o    investors liable for alternative minimum tax,

     o    tax-exempt organizations,

     o    non-resident aliens of the U.S. or taxpayers whose functional currency
          is not the U.S. dollar,

     o    persons who hold the ordinary shares through partnerships or other
          pass-through entities,

     o    persons who acquire their ordinary shares through the exercise or
          cancellation of employee stock options or otherwise as compensation
          for services,

     o    investors that actually or constructively own 10% or more of our
          voting shares, and

     o    investors holding ordinary shares as part of a straddle, or
          appreciated financial position or a hedging or conversion transaction.


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     If a partnership or an entity treated as a partnership for U.S. federal
income tax purposes owns ordinary shares, the U.S. federal income tax treatment
of a partner in such a partnership will generally depend upon the status of the
partner and the activities of the partnership. A partnership that owns ordinary
shares and the partners in such partnership should consult their tax advisors
about the U.S. federal income tax consequences of holding and disposing of
ordinary shares.

     This summary does not address the effect of any U.S. federal taxation other
than U.S. federal income taxation. In addition, this summary does not include
any discussion of state, local or foreign taxation.

     You are urged to consult your tax advisors regarding the foreign and United
States federal, state and local tax considerations of an investment in ordinary
shares.

     For purposes of this summary, a U.S. Holder is:

     o    an individual who is a citizen or, for U.S. federal income tax
          purposes, a resident of the United States;

     o    a corporation created or organized in or under the laws of the United
          States or any political subdivision thereof;

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

     o    a trust that (a) is subject to the primary supervision of a court
          within the United States and the control of one or more U.S. persons
          or (b) has a valid election in effect under applicable U.S. Treasury
          regulations to be treated as a U.S. person.

TAXATION OF DIVIDENDS

     The gross amount of any distributions received with respect to ordinary
shares, including the amount of any Israeli taxes withheld therefrom, will
constitute dividends for U.S. federal income tax purposes to the extent of our
current and accumulated earnings and profits, as determined for U.S. federal
income tax purposes. You will be required to include this amount of dividends in
gross income as ordinary income. Distributions in excess of our current and
accumulated earnings and profits will be treated as a non-taxable return of
capital to the extent of your tax basis in the ordinary shares and any amount in
excess of your tax basis will be treated as gain from the sale of ordinary
shares. See "-Disposition of Ordinary Shares" below for the discussion on the
taxation of capital gains. Dividends will not qualify for the dividends-received
deduction generally available to corporations under Section 243 of the Code.

     Dividends that we pay in NIS, including the amount of any Israeli taxes
withheld therefrom, will be included in your income in a U.S. dollar amount
calculated by reference to the exchange rate in effect on the day such dividends
are received. A U.S. Holder who receives payment in NIS and converts NIS into
U.S. dollars at an exchange rate other than the rate in effect on such day may
have a foreign currency exchange gain or loss that would be treated as ordinary
income or loss. U.S. Holders should consult their own tax advisors concerning
the U.S. tax consequences of acquiring, holding and disposing of NIS.

     Subject to complex limitations, any Israeli withholding tax imposed on such
dividends will be a foreign income tax eligible for credit against a U.S.
Holder's U.S. federal income tax liability (or, alternatively, for deduction
against income in determining such tax liability). The limitations set out in
the Code include computational 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. Dividends
generally will be treated as foreign-source passive category income or, in the
case of certain U.S. Holders, general category income for United States foreign
tax credit purposes. Further, there are special rules for computing the foreign
tax credit limitation of a taxpayer who receives dividends subject to a reduced
tax, see discussion below. A U.S. Holder will be denied a foreign tax credit
with respect to Israeli income tax withheld from dividends received on the
ordinary shares to the extent such U.S. Holder has not held the ordinary shares
for at least 16 days of the 31-day period beginning on the date which is 15 days
before the ex-dividend date or to the extent such U.S. Holder is under an
obligation to make related payments with respect to 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 16-day holding period required by the statute. The rules relating to
the determination of the foreign tax credit are complex, and you should consult
with your personal tax advisors to determine whether and to what extent you
would be entitled to this credit.


                                       73




     Subject to certain limitations, "qualified dividend income" received by a
noncorporate U.S. Holder in tax years beginning on or before December 31, 2010
will be subject to tax at a reduced maximum tax rate of 15 percent.
Distributions taxable as dividends paid on the ordinary shares should qualify
for the 15 percent rate provided that either: (i) we are entitled to benefits
under the income tax treaty between the Untied States and Israel, or the Treaty,
or (ii) the ordinary shares are readily tradable on an established securities
market in the United States and certain other requirements are met. We believe
that we are entitled to benefits under the Treaty and that the ordinary shares
currently are readily tradable on an established securities market in the United
States. However, no assurance can be given that the ordinary shares will remain
readily tradable. The rate reduction does not apply unless certain holding
period requirements are satisfied. With respect to the ordinary shares, the U.S.
Holder must have held such shares for at least 61 days during the 121-day period
beginning 60 days before the ex-dividend date. The rate reduction also does not
apply to dividends received from passive foreign investment companies, see
discussion below, or in respect of certain hedged positions or in certain other
situations. U.S. Holders of ordinary shares should consult their own tax
advisors regarding the effect of these rules in their particular circumstances.

DISPOSITION OF ORDINARY SHARES

     If you sell or otherwise dispose of ordinary shares, you will recognize
gain or loss for U.S. federal income tax purposes in an amount equal to the
difference between the amount realized on the sale or other disposition and the
adjusted tax basis in ordinary shares. Subject to the discussion below under the
heading "Passive Foreign Investment Companies," such gain or loss will generally
be capital gain or loss and will be long-term capital gain or loss if you have
held the ordinary shares for more than one year at the time of the sale or other
disposition. In general, any gain that you recognize on the sale or other
disposition of ordinary shares will be U.S.-source for purposes of the foreign
tax credit limitation; losses will be generally allocated against U.S. source
income. Deduction of capital losses is subject to certain limitations under the
Code.

     In the case of a cash basis U.S. Holder who receives NIS in connection with
the sale or disposition of ordinary shares, the amount realized will be based on
the U.S. dollar value of the NIS received with respect to the ordinary shares as
determined on the settlement date of such exchange. A U.S. Holder who receives
payment in NIS and converts NIS into United States dollars at a conversion rate
other than the rate in effect on the settlement date may have a foreign currency
exchange gain or loss that would be treated as ordinary income or loss.

     An accrual basis U.S. Holder may elect the same treatment required of cash
basis taxpayers with respect to a sale or disposition of ordinary shares,
provided that the election is applied consistently from year to year. Such
election may not be changed without the consent of the Internal Revenue Service,
or the IRS. In the event that an accrual basis U.S. Holder does not elect to be
treated as a cash basis taxpayer (pursuant to the Treasury regulations
applicable to foreign currency transactions), such U.S. Holder may have a
foreign currency gain or loss for U.S. federal income tax purposes because of
differences between the U.S. dollar value of the currency received prevailing on
the trade date and the settlement date. Any such currency gain or loss would be
treated as ordinary income or loss and would be in addition to gain or loss, if
any, recognized by such U.S. Holder on the sale or disposition of such ordinary
shares.

PASSIVE FOREIGN INVESTMENT COMPANIES

     For U.S. federal income tax purposes, we will be considered a passive
foreign investment company, or PFIC, for any taxable year in which either (i)
75% or more of our gross income is passive income, or (ii) the average
percentage of our assets for the taxable year which are produced or held for the
production of passive income is at least 50%. For this purpose, passive income
includes generally dividends, interest, royalties, rents, annuities and the
excess of gains over losses from the disposition of assets which produce passive
income. If we were determined to be a PFIC for U.S. federal income tax purposes,
highly complex rules would apply to U.S. Holders owning ordinary shares.
Accordingly, you are urged to consult your tax advisors regarding the
application of such rules.


                                       74




     Based on our current and projected income, assets and activities, we
believe that we are not currently a PFIC nor do we expect to become a PFIC in
the foreseeable future. However, because the determination of whether we are a
PFIC is based upon the composition of our income and assets from time to time,
there can be no assurances that we will not become a PFIC for any future taxable
year.

     If we are treated as a PFIC for any taxable year, then, dividends would not
qualify for the reduced maximum tax rate, discussed above, and, unless you elect
either to treat your investment in ordinary shares as an investment in a
"qualified electing fund", or a QEF election, or to "mark-to-market" your
ordinary shares, as described below,

     o    you would be required to allocate income recognized upon receiving
          certain dividends or gain recognized upon the disposition of ordinary
          shares ratably over the holding period for such ordinary shares,

     o    the amount allocated to each year during which we are considered a
          PFIC other than the year of the dividend payment or disposition would
          be subject to tax at the highest individual or corporate tax rate, as
          the case may be, and an interest charge would be imposed with respect
          to the resulting tax liability allocated to each such year,

     o    the amount allocated to the current taxable year and any taxable year
          before we became a PFIC would be taxable as ordinary income in the
          current year, and

     o    you would be required to make an annual return on IRS Form 8621
          regarding distributions received with respect to ordinary shares and
          any gain realized on your ordinary shares.

     If you make either a timely QEF election or a timely mark-to-market
election in respect of your ordinary shares, you would not be subject to the
rules described above. If you make a timely QEF election, you would be required
to include in your income for each taxable year your pro rata share of our
ordinary earnings as ordinary income and your pro rata share of our net capital
gain as long-term capital gain, whether or not such amounts are actually
distributed to you. You would not be eligible to make a QEF election unless we
comply with certain applicable information reporting requirements. We will
provide U.S. Holders with the information needed to report income and gain under
a QEF election if we are classified as a PFIC.

     Alternatively, assuming the ordinary shares qualify as "marketable stock"
within the meaning of section 1296(e) of the Code, if you elect to
"mark-to-market" your ordinary shares, you will generally include in income, in
each year in which we are considered a PFIC, any excess of the fair market value
of the ordinary shares at the close of each tax year over your adjusted basis in
the ordinary shares. If the fair market value of the ordinary shares had
depreciated below your adjusted basis at the close of the tax year, you may
generally deduct the excess of the adjusted basis of the ordinary shares over
its fair market value at that time. However, such deductions would generally be
limited to the net mark-to-market gains, if any, that you included in income
with respect to such ordinary shares in prior years. Income recognized and
deductions allowed under the mark-to-market provisions, as well as any gain or
loss on the disposition of ordinary shares with respect to which the
mark-to-market election is made, is treated as ordinary income or loss, except
that in a year that we are not considered a PFIC, a gain or loss will be treated
as capital gain or loss.

BACKUP WITHHOLDING AND INFORMATION REPORTING

     Payments in respect of ordinary shares may be subject to information
reporting to the U.S. Internal Revenue Service and to U.S. backup withholding
tax at a rate equal to the fourth lowest income tax rate applicable to
individuals, which, under current law, is 28%. Backup withholding will not
apply, however, if you (i) are a corporation or fall within certain exempt
categories, and demonstrate the fact when so required, or (ii) furnish a correct
taxpayer identification number and make any other required certification.


                                       75




     Backup withholding is not an additional tax. Amounts withheld under the
backup withholding rules may be credited against a U.S. Holder's U.S. tax
liability, and a U.S. Holder may obtain a refund of any excess amounts withheld
under the backup withholding rules by filing the appropriate claim for refund
with the IRS.

     Any U.S. Holder who holds 10% or more in vote or value of our ordinary
shares will be subject to certain additional United States information reporting
requirements.

U.S. GIFT AND ESTATE TAX

     An individual U.S. Holder of ordinary shares will generally be subject to
U.S. gift and estate taxes with respect to ordinary shares in the same manner
and to the same extent as with respect to other types of personal property.

F.   DIVIDEND AND PAYING AGENTS

     Not applicable.

G.   STATEMENT BY EXPERTS

     Not applicable.

H.   DOCUMENTS ON DISPLAY

     We are subject to the reporting requirements of the United States
Securities Exchange Act of 1934, as amended, as applicable to "foreign private
issuers" as defined in Rule 3b-4 under the Exchange Act, and in accordance
therewith, we file annual and interim reports and other information with the
Securities and Exchange Commission.

     As a foreign private issuer, we are exempt from certain provisions of the
Exchange Act. Accordingly, our proxy solicitations are not subject to the
disclosure and procedural requirements of Regulation 14A under the Exchange Act,
transactions in our equity securities by our officers and directors are exempt
from reporting and the "short-swing" profit recovery provisions contained in
Section 16 of the Exchange Act. However, we distribute annually to our
shareholders an annual report containing financial statements that have been
examined and reported on, with an opinion expressed by, an independent public
accounting firm, and we file reports with the Securities and Exchange Commission
on Form 6-K containing unaudited financial information for the first three
quarters of each fiscal year.

     This annual report and the exhibits thereto and any other document we file
pursuant to the Exchange Act may be inspected without charge and copied at
prescribed rates at the following Securities and Exchange Commission public
reference rooms: 100 F Street, N.E., Room 1580, Washington, D.C. 20549; and on
the Securities and Exchange Commission Internet site (http://www.sec.gov) and on
our website www.magicsoftware.com. You may obtain information on the operation
of the Securities and Exchange Commission's public reference room in Washington,
D.C. by calling the Securities and Exchange Commission at 1-800-SEC-0330. The
Exchange Act file number for our Securities and Exchange Commission filings is
0-30198.

     The documents concerning our company that are referred to in this annual
report may also be inspected at our offices located at 5 Haplada Street, Or
Yehuda 60218, Israel.

I.   SUBSIDIARY INFORMATION

     Not applicable.


                                       76




ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS

     We are exposed to a variety of market risks, primarily changes in interest
rates affecting our investments in marketable securities and foreign currency
fluctuations.

INTEREST RATE RISK

     Except for our exposure to market risk for changes in interest rates
relating to our investments in marketable securities, we do not have any
substantial risk which is derived from a change in interest rates.

FOREIGN CURRENCY EXCHANGE RISK

     Our financial results may be negatively impacted by foreign currency
fluctuations. Our foreign operations are transacted through a global network of
subsidiaries. As a result, these sales and related expenses are denominated in
currencies other than the U.S. dollar. Because our financial results are
reported in U.S. dollars, our results of operations may be adversely impacted by
fluctuations in the rates of exchange between the U.S. dollar and such other
currencies as the financial results of our foreign subsidiaries are converted
into U.S. dollars in consolidation. From time to time, we use derivative or
hedge instruments to cover part of our exposures.

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     Not applicable.

                                     PART II

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     None.

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

     Not applicable.

ITEM 15. CONTROLS AND PROCEDURES

     We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms, and that such
information is accumulated and communicated to our chief executive officer and
chief financial officer to allow timely decisions regarding required disclosure.
Our management, including our acting chief executive officer and acting chief
financial officer, conducted an evaluation of our disclosure controls and
procedures, as defined under Exchange Act Rule 13a-15(e), as of the end of the
period covered by this Annual Report on Form 20-F. Based upon that evaluation,
our acting chief executive officer and acting chief financial officer have
concluded that, as of such date, our disclosure controls and procedures were
effective.

ITEM 15T. CONTROLS AND PROCEDURES

     Not applicable.


                                       77




ITEM 16. RESERVED

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

     Our board of directors has determined that Mr. Elan Penn, an outside
director, meets the definition of an audit committee financial expert, as
defined by rules of the Securities and Exchange Commission. For a brief listing
of Mr. Penn's relevant experience, see Item 6.A. "Directors, Senior Management
and Employees -- Directors and Senior Management."

ITEM 16B. CODE OF ETHICS

     We have adopted a code of ethics that applies to our chief executive
officer and all senior financial officers of our company, including the chief
financial officer, chief accounting officer or controller, or persons performing
similar functions. The code of ethics is publicly available on our website at
WWW.MAGICSOFTWARE.COM. Written copies are available upon request. If we make any
substantive amendment to the code of ethics or grant any waivers, including any
implicit waiver, from a provision of the codes of ethics, we will disclose the
nature of such amendment or waiver on our website.

ITEM 16C. PRINCIPAL ACCOUNTING FEES AND SERVICES

FEES PAID TO INDEPENDENT PUBLIC ACCOUNTANTS

     The following table sets forth, for each of the years indicated, the fees
paid to our principal independent registered public accounting firm. All of such
fees were pre-approved by our Audit Committee.

                                Year Ended December 31,
                                -----------------------
Services Rendered                 2005           2006
-----------------               --------       --------

Audit (1)                       $170,000       $142,000
Audit-related                          -              -
Tax (2)                         $ 18,000       $ 18,000
Other (3)                       $  1,000       $  7,000
                                --------       --------
Total                           $189,000       $167,000

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

(1)  Audit fees relate to services that would normally be provided in connection
     with statutory and regulatory filings or engagements, including services
     that generally only the independent accountant can reasonably provide.

(2)  Tax fees relate to services performed by the tax division for tax
     compliance, planning, and advice.

(3)  Other fees relate mainly to strategic consulting services.

PRE-APPROVAL POLICIES AND PROCEDURES

     Our Audit Committee has adopted a policy and procedures for the
pre-approval of audit and non-audit services rendered by our independent
registered public accountants, Kost Forer Gabbay & Kasierer, a member of Ernst &
Young Global. Pre-approval of an audit or non-audit service may be given as a
general pre-approval, as part of the audit committee's approval of the scope of
the engagement of our independent auditor, or on an individual basis. Any
proposed services that exceed general pre-approved levels also require specific
pre-approval by our audit committee. The policy prohibits retention of the
independent public accountants to perform the prohibited non-audit functions
defined in Section 201 of the Sarbanes-Oxley Act of 2002 or the rules of the
Securities and Exchange Commission, and also requires the Audit Committee to
consider whether proposed services are compatible with the independence of the
public accountants.


                                       78




ITEM 16D. EXEMPTIONS FROM THE LISTING REQUIREMENTS AND STANDARDS FOR AUDIT
          COMMITTEE

     Not applicable.

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

     Neither we nor any affiliated purchaser has purchased any of our securities
during 2006.

                                    PART III

ITEM 17. FINANCIAL STATEMENTS

     Not applicable.

ITEM 18. FINANCIAL STATEMENTS

Index to Financial Statements                                            F-1

Reports of Independent Registered Public Accounting Firm                 F-2

Consolidated Balance Sheets                                        F-3 - F-4

Consolidated Statements of Operations                                    F-5

Statements of Changes in Shareholders' Equity                            F-6

Consolidated Statements of Cash Flows                              F-7 - F-8

Notes to Consolidated Financial Statements                        F-9 - F-43

Appendix A - Details of Subsidiaries and Affiliated Company             F-44

ITEM 19. EXHIBITS

INDEX TO EXHIBITS

EXHIBIT   DESCRIPTION

3.1       Memorandum of Association of the Registrant(1)

3.2       Articles of Association of the Registrant(2)

4.1       Specimen of Ordinary Share Certificate(3)

8         List of Subsidiaries of the Registrant

10.1      1991 Employee Stock Option Plan, as amended(4)

10.2      2000 Employee Stock Option Plan(5)


                                       79




12.1      Certification of Acting Chief Executive Officer pursuant to Rule
          13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as
          amended

12.2      Certification of Acting Chief Financial Officer pursuant to Rule
          13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as
          amended

13.1      Certification of Acting Chief Executive Officer pursuant to 18 U.S.C.
          1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
          2002

13.2      Certification of Acting Chief Financial Officer pursuant to 18 U.S.C.
          1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
          2002

15.1      Consent of Kost Forer Gabbay & Kasierer, a Member of Ernst & Young
          Global

15.2      Consent of Levy Cohen & Co., Chartered Accountants (relating to Magic
          Software Enterprises (UK) Limited)

15.3      Consent of Levy Cohen & Co., Chartered Accountants (relating to Hermes
          Logistics Technologies Limited)

15.4      Consent of ASG Audit Corporation, a Member of Grant Thornton
          International (relating to Magic Software Japan K.K.)

15.5      Consent of KDA Audit Corporation (relating to Magic Software Japan
          K.K.)

15.6      Consent of Mock & Partners International, Registered Accountants
          (relating to Magic Benelux B.V.)

15.7      Consent of Maria Negyeffy, Registered Auditors (relating to Magic
          (Onyx) Magyarorszag Szoftverhaz Kft.)

15.8      Consent of Federico Pozzi, Registered Auditors (relating to Magic
          Italy Srl.)

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

(1)  Filed as Exhibit 3.2 to the registrant's registration statement on Form
     F-1, registration number 33-41486, and incorporated herein by reference.

(2)  Filed as Exhibit 3.1 to the registrant's registration statement on Form
     F-1, registration number 33-41486, and incorporated herein by reference.

(3)  Filed as Exhibit 4.1 to the registrant's registration statement on Form
     F-1, registration number 33-41486, and incorporated herein by reference.

(4)  Filed as Exhibit 10.1 to the registrant's annual report on Form 20-F for
     the year ended December 31, 2000 , and incorporated herein by reference.

(5)  Filed as Exhibit 10.2 to the registrant's annual report on Form 20-F for
     the year ended December 31, 2000, and incorporated herein by reference.


                                       80


              MAGIC SOFTWARE ENTERPRISES LTD. AND ITS SUBSIDIARIES

                        CONSOLIDATED FINANCIAL STATEMENTS

                             AS OF DECEMBER 31, 2006

                                 IN U.S. DOLLARS

                                      INDEX

                                                              PAGE
                                                           ----------

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM       F-2

CONSOLIDATED BALANCE SHEETS                                F-3 - F-4

CONSOLIDATED STATEMENTS OF OPERATIONS                         F-5

STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY                 F-6

CONSOLIDATED STATEMENTS OF CASH FLOWS                      F-7 - F-8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 F-9 - F-43

DETAILS OF SUBSIDIARIES AND AFFILIATE                         F-44


                                     F - 1



             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

                             TO THE SHAREHOLDERS OF

                         MAGIC SOFTWARE ENTERPRISES LTD.

     We have audited the accompanying consolidated balance sheets of Magic
Software Enterprises Ltd. (the "Company") and its subsidiaries as of December
31, 2005 and 2006, and the related consolidated statements of operations,
changes in shareholders' equity and cash flows for each of the three years in
the period ended December 31, 2006. These financial statements are the
responsibility of Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
financial statements of certain subsidiaries, which statements reflect total
assets of 10% and 18% as of December 31, 2005 and 2006, respectively, and total
revenues of 39%, 18% and 33% for each of the three years in the period ended
December 31, 2006. Those statements were audited by other auditors whose reports
have been furnished to us, and our opinion, insofar as it relates to the amounts
included for those subsidiaries, is based solely on the reports of the other
auditors.

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

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

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

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

                                              /s/ Kost Forer Gabbay and Kasierer
Tel-Aviv, Israel                                 KOST FORER GABBAY & KASIERER
June 26, 2007                                  A Member of Ernst & Young Global


                                     F - 2


                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

                                                                                 DECEMBER 31,
                                                                              ------------------
                                                                                2005       2006
                                                                              -------    -------

    ASSETS

CURRENT ASSETS:

  Cash and cash equivalents                                                   $ 9,116    $ 8,162
  Short-term bank deposits                                                        368         69
  Marketable securities (Note 3)                                                4,381      4,649
  Trade receivables (net of allowance for doubtful accounts of $ 2,210 and
    $ 1,836 at December 31, 2005 and 2006, respectively)                       14,572     12,365
  Other accounts receivable and prepaid expenses (Note 4)                       2,832      2,472
  Inventory                                                                       400        328
                                                                              -------    -------

TOTAL current assets                                                           31,669     28,045
                                                                              -------    -------

LONG-TERM INVESTMENTS:
  Long-term lease deposits                                                        805        576
  Investments in affiliated companies                                             198        213
  Severance pay fund                                                            2,135      2,176
                                                                              -------    -------

TOTAL long-term investments                                                     3,138      2,965
                                                                              -------    -------

PROPERTY AND EQUIPMENT, NET (Note 5)                                            6,955      6,414
                                                                              -------    -------

OTHER INTANGIBLE ASSETS, NET (Note 6)                                          11,199     10,863
                                                                              -------    -------

GOODWILL (Note 7)                                                              20,762     21,624
                                                                              -------    -------

                                                                              $73,723    $69,911
                                                                              =======    =======

The accompanying notes are an integral part of the consolidated financial
statements.


                                     F - 3




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)

                                                                                   DECEMBER 31,
                                                                              -----------------------
                                                                                2005          2006
                                                                              ---------     ---------

    LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
  Short-term credit and current maturities of long-term loans (Note 8)        $   4,183     $   4,514
  Trade payables                                                                  3,319         3,491
  Accrued expenses and other accounts payable (Note 9)                           10,696        11,399
                                                                              ---------     ---------

TOTAL current liabilities                                                        18,198        19,404
                                                                              ---------     ---------

ACCRUED SEVERANCE PAY                                                             2,527         2,499
                                                                              ---------     ---------

LONG-TERM LOANS (Note 10)                                                           165           233
                                                                              ---------     ---------

MINORITY INTEREST                                                                   528           131
                                                                              ---------     ---------

COMMITMENTS AND CONTINGENTIES (Note 15)

SHAREHOLDERS' EQUITY (Note 12):
  Share capital:

    Authorized: 50,000,000 Ordinary shares of NIS 0.1 par value at
      December 31, 2005 and 2006; Issued: 32,345,867 and 32,599,213
      shares at December 31, 2005 and 2006, respectively; Outstanding:
      31,070,499 and 31,323,845 shares at December 31, 2005 and 2006,
      respectively                                                                  829           834
  Additional paid-in capital                                                    106,072       106,375
  Accumulated other comprehensive loss                                           (1,514)       (1,337)
  Treasury shares, at cost: 1,275,368 Ordinary shares at December 31, 2005
    and 2006.                                                                    (6,772)       (6,772)
  Accumulated deficit                                                           (46,310)      (51,456)
                                                                              ---------     ---------

TOTAL shareholders' equity                                                       52,305        47,644
                                                                              ---------     ---------

                                                                              $  73,723     $  69,911
                                                                              =========     =========

The accompanying notes are an integral part of the consolidated financial
statements.


                                     F - 4




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT PER SHARE DATA)

                                                                    YEAR ENDED DECEMBER 31,
                                                             -----------------------------------
                                                               2004         2005         2006
                                                             --------     --------     --------

Revenues (Note 13):

  Software sales                                             $ 28,022     $ 25,103     $ 22,336
  Maintenance and technical support                            12,555       14,376       14,935
  Consulting services                                          24,590       21,511       24,454
                                                             --------     --------     --------

TOTAL revenues                                                 65,167       60,990       61,725
                                                             --------     --------     --------

Cost of revenues:

  Software sales                                                6,462        8,483        7,016
  Maintenance and technical support                             3,199        2,679        3,615
  Consulting services                                          15,818       15,514       18,087
                                                             --------     --------     --------

TOTAL cost of revenues                                         25,479       26,676       28,718
                                                             --------     --------     --------

Gross profit                                                   39,688       34,314       33,007
                                                             --------     --------     --------

Operating costs and expenses:
  Research and development, net (Note 14a)                      3,845        3,733        3,942
  Selling and marketing                                        17,157       18,510       16,777
  General and administrative                                   15,384       16,332       15,572
  Restructuring and Impairment                                      -            -        2,157
                                                             --------     --------     --------

TOTAL operating expenses, net                                  36,386       38,575       38,448
                                                             --------     --------     --------

Operating income (loss)                                         3,302       (4,261)      (5,441)
Financial income (expenses), net (Note 14b)                       912         (811)         410
Other income, net (Note 1f)                                         -        1,169          278
                                                             --------     --------     --------

Income (loss) before taxes on income                            4,214       (3,903)      (4,753)
Taxes on income (Note 11)                                         281          491          325
                                                             --------     --------     --------

                                                                3,933       (4,394)      (5,078)
Equity in earnings of affiliates                                   79           19           15
Minority interest in losses (earnings) of subsidiaries             78         (232)          57
                                                             --------     --------     --------

Net income (loss)                                            $  4,090     $ (4,607)    $ (5,006)
                                                             ========     ========     ========

Basic and diluted net earnings (loss) per share (Note 16)    $   0.13     $  (0.15)    $  (0.16)
                                                             ========     ========     ========

The accompanying notes are an integral part of the consolidated financial
statements.


                                     F - 5




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

                                                                                                    ACCUMULATED
                                                                                  ADDITIONAL           OTHER          TREASURY                           COMPREHENSIVE     TOTAL
                                                                     SHARE         PAID-IN          COMPREHENSIVE      SHARES           ACCUMULATED         INCOME      SHAREHOLDERS'
                                                                    CAPITAL        CAPITAL           INCOME (LOSS)     AT COST            DEFICIT           (LOSS)         EQUITY
                                                                    --------       --------           --------         --------           --------         --------       --------

Balance as of January 1, 2004                                       $    805       $104,765           $    (80)        $ (5,773)          $(45,793)                       $ 53,924
  Other comprehensive income:
    Foreign currency translation adjustments                               -              -                384                -                  -         $    384            384
    Unrealized gains from available-for-sale securities, net               -              -                  2                -                  -                2              2
  Net income                                                               -              -                  -                -              4,090            4,090          4,090
                                                                                                                                                           --------

  Total comprehensive income                                                                                                                               $  4,476
                                                                                                                                                           ========
  Exercise of stock options and warrants                                  22          1,227                  -                -                  -                           1,249
  Purchase of Treasury shares                                              -              -                  -             (102)                 -                            (102)
                                                                    --------       --------           --------         --------           --------                        --------
Balance as of December 31, 2004                                          827        105,992                306           (5,875)           (41,703)                         59,547
    Realized losses from available-for-sale securities                     -              -                 36                -                  -                              36
  Other comprehensive loss:
    Foreign currency translation adjustments                               -              -             (1,578)               -                  -         $ (1,578)        (1,578)
    Unrealized losses from available-for-sale securities                   -              -               (278)               -                  -             (278)          (278)
  Net loss                                                                 -              -                  -                -             (4,607)          (4,607)        (4,607)
                                                                                                                                                           --------

  Total comprehensive loss                                                                                                                                 $ (6,463)
                                                                                                                                                           ========
  Exercise of stock options                                                2             80                  -                -                  -                              82
  Purchase of Treasury shares                                              -              -                  -             (897)                 -                            (897)
                                                                    --------       --------           --------         --------           --------                        --------

Balance as of December 31, 2005                                          829        106,072             (1,514)          (6,772)           (46,310)                         52,305
  Effect of SAB 108                                                                                                                           (140)                           (140)
                                                                                                                                          --------                        --------
                                                                                                                                           (46,450)                         52,165

  Stock based compensation expenses                                                      27                                                                                     27
    Realized losses from available-for-sale securities                     -              -                  5                -                  -                               5
  Other comprehensive loss:

    Foreign currency translation adjustments                               -              -                 22                -                  -               22             22
    Unrealized gain from available-for-sale securities                     -              -                150                -                  -              150            150
  Net loss                                                                 -              -                  -                -             (5,006)          (5,006)        (5,006)
                                                                                                                                                           --------

  Total comprehensive loss                                                                                                                                 $ (4,834)
                                                                                                                                                           ========
  Exercise of stock options                                                5            276                  -                -                  -                             281
                                                                    --------       --------           --------         --------           --------                        --------

Balance as of December 31, 2006                                     $    834       $106,375           $ (1,337)        $ (6,772)          $(51,456)                       $ 47,644
                                                                    ========       ========           ========         ========           ========                        ========

The accompanying notes are an integral part of the consolidated financial
statements.


                                     F - 6




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

                                                                              YEAR ENDED DECEMBER 31,
                                                                       ----------------------------------------
                                                                         2004            2005            2006
                                                                       --------        --------        --------

CASH FLOWS FROM OPERATING ACTIVITIES:

  Net income (loss)                                                    $  4,090        $ (4,607)       $ (5,006)
  Adjustments to reconcile net income (loss) to net cash
    provided by operating activities:
    Depreciation and amortization                                         4,649           5,139           5,464
    Equity in earnings of affiliates                                        (79)            (19)            (15)
    Minority interest in earnings (losses) of subsidiaries                  (78)            232             (57)
    Accrued severance pay, net                                               37             (30)            (69)
    Loss (gain) on sale of property and equipment                            (9)             16              56
    Stock-based compensation expenses                                         -               -              27
    Amortization of premiums and accrued interest on
      marketable securities, net                                            (53)             67              55
    Loss (gain) on sale of marketable securities                            (28)             68              10
    Gain on sale of subsidiary's operation                                    -               -            (278)
    Impairment of intangible asset                                            -               -             309
    Decrease in trade receivables                                           126           4,569           2,752
    Decrease (increase) in related parties receivables                        5             (28)            204
    Decrease (increase) in other accounts receivable and prepaid
      expenses                                                              (76)            471             242
    Decrease (increase) in inventory                                       (181)            (20)             72
    Increase (decrease) in trade payables                                  (488)            646              19
    Increase (decrease) in accrued expenses and other accounts
      payable                                                            (2,642)           (907)             46
                                                                       --------        --------        --------

Net cash provided by operating activities                                 5,273           5,597           3,831
                                                                       --------        --------        --------

CASH FLOWS FROM INVESTING ACTIVITIES:

  Capitalized software development costs                                 (3,472)         (3,909)         (3,535)
  Purchase of property and equipment                                     (1,006)         (1,123)         (1,032)
  Purchase of intangible assets                                            (374)              -               -
  Additional investment in subsidiaries (See note 1b-d)                  (1,626)              -          (1,910)
  Proceeds from sale of subsidiary's operation                                -               -             900
  Proceeds from sale of property and equipment                               23              18              97
  Proceeds from sale of marketable securities                               777             664             226
  Purchase of marketable securities                                      (5,921)           (199)           (408)
  Change in short-term and long-term deposits                              (317)           (599)            477
                                                                       --------        --------        --------

Net cash used in investing activities                                   (11,916)         (5,148)         (5,185)
                                                                       --------        --------        --------

The accompanying notes are an integral part of the consolidated financial
statements.


                                     F - 7




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

                                                                       YEAR ENDED DECEMBER 31,
                                                                 ----------------------------------
                                                                   2004         2005         2006
                                                                 --------     --------     --------

 CASH FLOWS FROM FINANCING ACTIVITIES:

   Proceeds from exercise of stock options and warrants          $  1,249     $     82     $    281
   Purchase of Treasury shares                                       (102)        (897)           -
   Short-term credit, net                                            (108)       1,979          328
   Repayment of long-term loan                                       (359)         (54)        (122)
   Proceeds from long-term loans                                      126          164          185
   Dividend to minority in subsidiary                                   -         (509)           -
                                                                 --------     --------     --------

 Net cash provided by financing activities                            806          765          672
                                                                 --------     --------     --------


 Effect of exchange rate changes on cash and cash equivalents        (164)         322         (272)
                                                                 --------     --------     --------

 Increase (decrease) in cash and cash equivalents                  (6,001)       1,536         (954)
 Cash and cash equivalents at beginning of the year                13,581        7,580        9,116
                                                                 --------     --------     --------

 Cash and cash equivalents at end of the year                    $  7,580     $  9,116     $  8,162
                                                                 ========     ========     ========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW ACTIVITIES:

            NET CASH PAID DURING THE YEAR FOR:

            Income taxes                                         $    281     $    424     $    433
                                                                 ========     ========     ========

            Interest                                             $     74     $    102     $    265
                                                                 ========     ========     ========

The accompanying notes are an integral part of the consolidated financial
statements.


                                     F - 8




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 1:- GENERAL

     a.   Magic Software Enterprises Ltd. (the "Company"), an Israeli
          corporation, and its subsidiaries ("the Group") develops, markets and
          supports software development and deployment technology ("the Magic
          technology") and applications developed using this Magic technology.
          Magic technology enables enterprises to accelerate the process of
          building and deploying software applications that can be rapidly
          customized and integrated with existing systems. The principal markets
          of the Company and its subsidiaries are Europe, Israel, the U.S. and
          Japan (see Note 13).

          As for information about the Company's holdings in subsidiaries and
          affiliated company, see Appendix A.

     b.   During 2004, in consideration of $ 1,240, the Company purchased an
          additional 20.96% equity interest in Advanced Answer on Demand
          Holdings Corp. ("AAOD"), a private Florida based company that provides
          integrated software solutions for the long-term healthcare industry.
          As a result, the Company's interest in AAOD's share capital increased
          to 83.89%.

          In February 2006, in consideration of $ 1,910, the Company purchased
          an additional 16.11% equity interest in AAOD. As a result, the
          Company's interest in AAOD's share capital increased to 100%. The
          purchase price was allocated, as follows:

          Customer relations *)                                        $   314
          Acquired technology*)                                            216
          Goodwill                                                         990
          Minority interest                                                390
                                                                       -------

          Total net assets acquired                                    $ 1,910
                                                                       =======

          *)   The customer relations and acquired technology are amortized on a
               straight-line basis over a period of five years.

     c.   During 2004, the Company purchased an additional equity interest of
          26% in Onyx Szoftverhaz Hungary, bringing its holding to 100% in
          consideration of $ 290. The excess of the cost over the net amounts
          assigned to the fair value of assets acquired and liabilities assumed
          was recorded as goodwill at the total amount of $ 69.

     d.   During 2004, the Company purchased an additional equity interest of
          12.5% from the minority in CarPro Systems Ltd., ("CarPro") bringing
          it's holding to 87.5%, in consideration of $ 96.

          During 2005, the Company invested an additional amount of
          approximately $ 214 in CarPro equity, bringing its holding to 90.48%.


                                     F - 9




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 1:- GENERAL (CONT.)

          On December 7, 2006, the Company has recorded a net gain of $278
          relating to the sale of CarPro's assets and liabilities, including the
          intellectual property (the RentPro and LeasePro software) and its
          customer base, to its distributor CarPro Systems International B.V.
          (the "Buyer"),. Additionally Magic Software Enterprises sold to the
          buyer a substantial number of licenses for Magic Software's products
          for continued use in the ongoing maintenance and enhancement of the
          CarPro software products. The combined sales price is $ 1,750 to be
          paid over a period of five years. The Company recognized the
          consideration from the sale of Carpro's operations on a cash basis and
          net of related expenses (including goodwill and other intangible
          assets write-offs).

     e.   During 2002, Magic U.K., a subsidiary of the Company established a
          joint venture company in the U.K., known as Hermes Logistics
          Technologies Ltd. Holding ("Hermes"), which owns the Intellectual
          Property ("IP") of the Hermes application.

          In 2004, the subsidiary purchased the remaining 49% interest in Hermes
          and increased its holdings to 100% for a cash consideration of
          approximately $ 354, which was recorded as other intangible assets,
          and committed to pay royalties to the seller in the amount of 1.75% of
          gross sales of the Hermes application for a period of 5 years (see
          Note 15e).

     f.   The Company has recorded a net income of $1,169 in 2005 relating to
          life insurance that the Company received in 2005 following the death
          of the former chief executive officer of the subsidiary AAOD in June
          2004.

     g.   On August 16, 2006, Magic's board of directors approved a
          comprehensive global Restructuring plan (the "Plan"). The Plan
          establishes the terms of the benefit arrangement, including the
          benefits that employees will receive upon termination. In accordance
          with Statement of Financial Accounting Standard No. 146, "Accounting
          for Costs Associated with Exit or Disposal Activities" ("SFAS No.
          146") the Company recorded $ 1,365 related to one-time termination
          benefits provided to terminated employees. As of December 31, 2006,
          all termination benefits were paid and substantially all terminated
          employees no longer provide services to the Company. In addition the
          Company wrote- off certain intangible assets related to the
          restructuring plan and incurred other exit costs in the amounts of $
          309 and $ 483 respectively.

NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES

     The consolidated financial statements have been prepared in accordance with
     accounting principles generally accepted in the U.S. ("U.S. GAAP"), applied
     on a consistent basis, as follows:

     USE OF ESTIMATES

     The preparation of financial statements in conformity with generally
     accepted accounting principles requires management to make estimates and
     assumptions that affect the amounts reported in the financial statements
     and accompanying notes. Actual results could differ from those estimates.


                                     F - 10




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     FINANCIAL STATEMENTS IN UNITED STATES DOLLARS

     A substantial portion of the revenues of the Company and certain of its
     subsidiaries is generated in U.S. dollars ("dollar"). In addition, a
     substantial portion of the Company's costs is incurred in dollars. The
     Company's management believes that the dollar is the currency of the
     primary economic environment in which the Company and its subsidiaries
     operate. Thus, the functional and reporting currency of the Company and
     certain of its subsidiaries is the dollar.

     Accordingly, monetary accounts maintained in currencies other than the
     dollar are remeasured into dollars in accordance with SFAS No. 52, "Foreign
     Currency Translation" ("SFAS No. 52"). All transaction gains and losses of
     the remeasurement of monetary balance sheet items are reflected in the
     statements of operations as financial income or expenses, as appropriate.

     The financial statements of foreign subsidiaries and of certain entities
     that are reported using the equity method of accounting, whose functional
     currency is not the U.S. dollar, have been translated into dollars. All
     balance sheet amounts have been translated using the exchange rates in
     effect at each balance sheet dates. Statement of operation amounts have
     been translated using the average exchange rate prevailing during each
     year. Such translation adjustments are reported as a component of
     accumulated other comprehensive income (loss) in shareholders' equity.

     PRINCIPLES OF CONSOLIDATION

     The consolidated financial statements include the accounts of the Company
     and its wholly and majority owned subsidiaries. Intercompany balances and
     transactions including profit from intercompany sales not yet realized
     outside the Group, have been eliminated upon consolidation.

     CASH EQUIVALENTS:

     Cash equivalents are short-term highly liquid investments that are readily
     convertible to cash with maturities of three months or less, at the date
     acquired.

     SHORT-TERM DEPOSITS

     Short-term deposits include deposits with original maturities of more than
     three months and less than one year which presented at cost, including
     accrued interest. The deposits are in U.S. dollars and in New Israeli
     Shekels and bear interest at an average annual rate of 4.94% and 4.24%,
     respectively.


                                     F - 11




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     MARKETABLE SECURITIES

     The Company accounts for investments in marketable securities in accordance
     with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
     Securities ("SFAS No. 115"). Management determines the appropriate
     classification of its investments in marketable debt securities at the time
     of purchase and reevaluates such determinations at each balance sheet date.
     Debt securities are classified as available - for - sale and reported at
     fair value.

     Debt securities that are designated as available-for-sale are stated at
     fair value, with unrealized gains and losses reported in accumulated other
     comprehensive income (loss), a separate component of shareholders' equity.
     Realized gains and losses on sales of investments, as determined on a
     specific identification basis, are included in financial income, net.

     INVENTORIES

     Inventories consist of software packaging, discs, printed materials,
     hardware devices and third party licenses, and are stated at the lower of
     cost or market value. Cost is determined by the "first-in, first-out"
     method.

     Inventory write-offs are provided to cover risks arising from slow-moving
     items, technological obsolescence, excess inventories, and for market
     prices lower than cost. In 2006, the Company wrote off approximately $ 237
     of slow-moving inventory of license, which was not part of the core
     business of the Company, related to the reorganization plan which was
     approved by the Company's management and Board of Directors during the
     third quarter of 2006.

     INVESTMENTS IN AFFILIATED COMPANIES

     In these financial statements, affiliated companies are companies held to
     the extent of 20% or more (which are not subsidiaries), where the Company
     can exercise significant influence over operating and financial policy of
     the affiliate. The investment in affiliated companies is accounted for by
     the equity method. Profits on inter-company sales, not realized outside the
     Group, were eliminated.

     Management periodically reviews the carrying value of the investments. If
     this review indicates that the cost is not recoverable, the carrying value
     is reduced to its estimated fair value. As of December 31, 2005 and 2006,
     no impairment indicators have been identified.

     PROPERTY AND EQUIPMENT NET

     Property and equipment are stated at cost, net of accumulated depreciation.
     Depreciation is computed by the straight-line method over the estimated
     useful lives of the assets at the following estimated useful lives:


                                     F - 12




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)

                                                                 YEARS
                                             --------------------------------------------

     Buildings                                                    25
     Computers and peripheral equipment                            3
     Office furniture and equipment                              7 - 15
     Motor vehicles                                                7
     Software for internal use                                     3
     Leasehold improvements                  Over the shorter of the lease term or useful
                                                           economic life

     The Group accounts for costs of computer software developed or obtained for
     internal use in accordance with Statement of Position No. 98-1, Accounting
     for the Costs of Computer Software Developed or Obtained for Internal Use
     ("SOP No. 98-1"). The SOP requires the capitalization of certain costs
     incurred in connection with developing or obtaining internal use software.

     During the year 2006, the Company capitalized $ 140 of software cost,
     related to the ERP (enterprise resource planning) system. Capitalized
     software costs are amortized by the straight-line method over their
     estimated useful life of three years. In September 2006, as part of the
     restructuring process held by the Company, the Software project was
     postponed.

     IMPAIRMENT OF LONG-LIVED ASSETS

     The Company's long-lived assets are reviewed for impairment in accordance
     with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
     Assets" ("SFAS No. 144") whenever events or changes in circumstances
     indicate that the carrying amount of an asset may not be recoverable.
     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 the fair value of the
     assets. As of December 31, 2005, no impairment indicators have been
     identified. For the year 2006 see Note 1g.

     OTHER INTANGIBLE ASSETS

     Intangible assets are comprised of distribution rights, acquired technology
     and customer relations, and are amortized over their useful life using a
     method of amortization that reflects the pattern in which the economic
     benefits of the intangible assets are consumed or otherwise used up.
     Distribution rights, acquired technology and customer relations are
     amortized on a straight line basis over a period of five years.


                                     F - 13




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     GOODWILL

     Under SFAS No. 142, "Goodwill and Other Intangible Assets," goodwill and
     intangible assets with an identifiable useful life are no longer amortized
     but are subject to annual impairment tests based on estimated fair value in
     accordance with SFAS No. 142. The Company conducts its annual test of
     impairment for goodwill in December of each year. In addition the Company
     tests for impairment periodically whenever events or circumstances occur
     subsequent to its annual impairment tests that indicate that the asset
     might be impaired. Indicators the Company considered important which could
     trigger an impairment include, but are not limited to, significant
     underperformance relative to historical or projected future operating
     results, significant changes in the manner of use of the acquired assets or
     the strategy for its overall business, significant negative industry or
     economic trends, a significant decline in its stock price for a sustained
     period and its market capitalization relative to net book value.

     The Company has three reporting units. The goodwill of each reporting unit
     was measured separately. The first step of the goodwill impairment test
     compared the carrying value of each reporting unit with its fair value on
     that date. Since the fair value of the reporting units exceeded their
     carrying amount, no impairment was identified in 2006.

     REVENUE RECOGNITION

     To date, the Company has derived its revenues from licensing the rights to
     use its software, maintenance and technical support and providing
     professional services. The Company sells its products primarily through its
     direct sales force and indirectly through distributors.

     The Company accounts for software sales in accordance with Statement of
     Position No. 97-2, "Software Revenue Recognition" as amended by Statement
     of Position 98-9, "Modifications of SOP 97-2, Software Revenue Recognition
     with Respect to Certain Transactions" ("SOP No. 97-2"). SOP No. 97-2
     generally requires revenues earned from software arrangements involving
     multiple elements to be allocated to each element based on the relative
     fair values of the elements determined by the vendor's specific objective
     evidence (VSOE) of fair value. Revenues are recognized under the "residual
     method" when VSOE of fair value exists for all undelivered elements and
     VSOE of fair value does not exist for all of the delivered elements, and
     when all SOP No. 97-2 criteria for revenue recognition are met. The VSOE of
     fair value of the undelivered elements included in multiple element
     arrangement (maintenance, support and services) is determined based on the
     price charged for the undelivered element when sold separately.

     Revenues from license fees are recognized when persuasive evidence of an
     agreement exists, delivery of the product has occurred, no significant
     obligations with regard to implementation remain, the fee is fixed or
     determinable, and collectibility is probable. The Company generally does
     not grant a right of return to its customers. When a right of return
     exists, the Company defers revenue until the right of return expires, at
     which time revenue is recognized provided that all other revenue
     recognition criteria are met.


                                     F - 14




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     Maintenance and technical support revenues are deferred and recognized on a
     straight-line basis over the term of the maintenance and support agreement.

     Revenue from consulting services consists of billable hours for services
     provided, recognized as the services are rendered.

     Arrangements that include consulting services are evaluated to determine
     whether those services are essential to the functionality of other elements
     of the arrangement. When services are considered essential, revenues under
     the arrangement are recognized using contract accounting based on Statement
     of Position No. 81-1, "Accounting for Performance of Construction-Type and
     Certain Production-Type Contracts" ("SOP 81-1") on a percentage of
     completion method based on inputs measures. Provisions for estimated losses
     on uncompleted contracts are made in the period in which such losses are
     first determined, in the amount of the estimated loss for the entire
     contract. As of December 31, 2006, no such estimated losses were
     identified.

     When consulting services are not considered essential, the revenues
     allocable to the consulting services are recognized as the services are
     performed. In most cases, the Company had determined that the services are
     not considered essential to the functionality of other elements of the
     arrangement.

     Deferred revenue includes unearned amounts received under maintenance and
     support contracts, and amounts received from customers but not yet
     recognized as revenues.

     RESEARCH AND DEVELOPMENT COSTS

     SFAS No. 86 "Accounting for the Costs of Computer Software to be Sold,
     Leased or Otherwise Marketed", ("SFAS No. 86") requires capitalization of
     certain software development costs subsequent to the establishment of
     technological feasibility. Based on the Company and its subsidiaries
     product development process, technological feasibility is established upon
     completion of a detailed program design and working model.

     Research and development costs incurred in the process of developing
     product improvements are generally charged to expenses as incurred.

     Significant costs incurred by the Company and its subsidiaries between
     completion of the detailed program design and a working model, and the
     point at which the product is ready for general release, have been
     capitalized.


                                     F - 15




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     Capitalized software costs are amortized by the greater of the amount
     computed using the: (i) ratio that current gross revenues from sales of the
     software to the total of current and anticipated future gross revenues from
     sales of that software, or (ii) the straight-line method over the estimated
     useful life of the product (three to five years). The Company assesses the
     recoverability of this intangible asset on a regular basis by determining
     whether the amortization of the asset over its remaining life can be
     recovered through undiscounted future operating cash flows from the
     specific software product sold. As of December 31, 2005 and 2006, no
     impairment losses have been identified.

     SEVERANCE PAY

     Pursuant to Section 14 of the Severance Compensation Act, 1963 ("Section
     14"), certain employees of the Company who elected to be included under
     this section, are entitled only to monthly deposits, at a rate of 8.33% of
     their monthly salary, made in their name with insurance companies. Payments
     in accordance with Section 14 release the Company from any future severance
     payments in respect of those employees. Deposits under Section 14 are not
     recorded as an asset in the Company's balance sheet.

     The liability of the Israeli companies for severance pay (for those who
     elected not to be included under Section 14) is calculated pursuant to
     Israel's Severance Pay Law, based on the most recent salary of the
     employees multiplied by the number of years of employment, as of the
     balance sheet date. Employees are entitled to one month's salary for each
     year of employment or a portion thereof. The Company's liability for all of
     its employees in Israel is fully provided by monthly deposits with
     insurance policies and by an accrual. The value of these policies is
     recorded as an asset in the Company's balance sheet.

     The deposited funds include profits accumulated up to the balance sheet
     date. The deposited funds may be withdrawn only upon the fulfillment of the
     obligation pursuant to Israel's Severance Pay Law or labor agreements. The
     value of the deposited funds is based on the cash surrendered value of
     these policies, and includes immaterial profits.

     Severance expenses for the years ended December 31, 2004, 2005 and 2006
     amounted to approximately $ 389, $ 453 and $ 463, respectively.

     ADVERTISING EXPENSES

     Advertising expenses are charged to selling and marketing expenses, as
     incurred. Advertising expenses for the years ended December 31, 2004, 2005
     and 2006 were $ 46, $ 119 and $ 87, respectively.


                                     F - 16




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     INCOME TAXES

     The Company and its subsidiaries account for income taxes in accordance
     with SFAS No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). This
     Statement prescribes the use of the liability method whereby deferred tax
     assets and liability account balances are determined based on differences
     between financial reporting and tax bases of assets and liabilities and are
     measured using the enacted tax rates and laws that will be in effect when
     the differences are expected to reverse. The Company and its subsidiaries
     provide a valuation allowance, if necessary, to reduce deferred tax assets
     to their estimated realizable value.

     TREASURY SHARES

     The Company repurchases its Ordinary shares from time to time in the open
     market and holds such shares as Treasury shares. The Company applies the
     "cost method" and presents the cost to repurchase such shares as a
     reduction in shareholders' equity. As of December 31, 2006, the Company did
     not sell any of the shares.

     BASIC AND DILUTED NET EARNINGS (LOSS) PER SHARE

     Basic net earnings (net loss) per share is computed based on the weighted
     average number of Ordinary shares outstanding during each year. Diluted
     earnings per share are computed based on the weighted average number of
     Ordinary shares outstanding during each year, plus dilutive potential
     Ordinary shares considered outstanding during the year, in accordance with
     SFAS No. 128, "Earnings Per Share" ("SFAS No. 128").

     Part of the outstanding stock options and warrants has been excluded from
     the calculation of the diluted earnings (net loss) per share because such
     securities are anti-dilutive for 2004, 2005 and 2006. The total weighted
     average number of shares related to the outstanding options and warrants
     excluded from the calculations of diluted earnings (net loss) per share was
     209,161, 1,298,186 and 883,884 for the years ended December 31, 2004, 2005
     and 2006, respectively.

     ACCOUNTING FOR STOCK-BASED COMPENSATION

     On January 1, 2006, the Company adopted Statement of Financial Accounting
     Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123(R)")
     which requires the measurement and recognition of compensation expense
     based on estimated fair values for all share-based payment awards made to
     employees and directors. SFAS 123(R) supersedes Accounting Principles Board
     Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), for
     periods beginning in fiscal 2006. In March 2005, the Securities and
     Exchange Commission issued Staff Accounting Bulletin No. 107 ("SAB 107")
     relating to SFAS 123(R). The Company has applied the provisions of SAB 107
     in its adoption of SFAS 123(R).


                                     F - 17




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     SFAS 123(R) requires companies to estimate the fair value of equity-based
     payment awards on the date of grant using an option-pricing model. The
     value of the portion of the award that is ultimately expected to vest is
     recognized as an expense over the requisite service periods in the
     Company's consolidated income statement. Prior to the adoption of SFAS
     123(R), the Company accounted for equity-based awards to employees and
     directors using the intrinsic value method in accordance with APB 25 as
     allowed under Statement of Financial Accounting Standards No. 123,
     "Accounting for Stock-Based Compensation" ("SFAS 123").

     The Company adopted SFAS 123(R) using the modified prospective transition
     method, which requires the application of the accounting standard starting
     from January 1, 2006, the first day of the Company's fiscal year 2006.
     Under that transition method, since all the unvested options had been
     accelerated prior to the adoption of statement 123(R), (see note 12),
     compensation cost recognized in the year ended December 31, 2006, includes
     compensation cost for all share-based payments granted subsequent to
     January 1, 2006, based on the grant-date fair value estimated in accordance
     with the provisions of Statement 123(R). Results for prior periods have not
     been restated.

     The Company recognizes compensation expenses for the value of its awards,
     which have graded vesting based on the straight line method over the
     requisite service period of each of the awards, net of estimated
     forfeitures. Estimated forfeitures are based on actual historical
     pre-vesting forfeitures.

     As a result of adopting SFAS 123(R) on January 1, 2006, the Company's
     income before income taxes and net income for the year ended December 31,
     2006, is $ 27 lower than if it had continued to account for stock-based
     compensation under APB 25.

     Prior to January 1, 2006, the Company applied the intrinsic value method of
     accounting for stock options as prescribed by APB 25, whereby compensation
     expense is equal to the excess, if any, of the quoted market price of the
     stock over the exercise price at the grant date of the award.

     The Pro-forma table below illustrates the effect of the Company's stock
     based compensation expense on net income and basic and diluted earnings per
     share for 2005 and 2004, had the Company applied the fair value recognition
     provisions of SFAS 123.

     The fair value for options granted in 2004 and 2005 is amortized over their
     vesting period and estimated at the date of grant using a Black-Scholes
     options pricing model with the following weighted average assumptions:

                                                    2004                 2005
                                                   -------              -------

     Dividend yield                                  0%                    0%
     Expected volatility                            67.3%                 80%
     Risk-free interest                              2.8%                  3.9%
     Expected life (in years)                        3                     5


                                     F - 18




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     The pro-forma table below reflects the Company's stock based compensation
     expense, net income (loss) and basic and diluted earnings per share for the
     years ended December 31 2004 and 2005, had the Company applied the fair
     value recognition provisions of SFAS 123, as follows:

                                                                  YEAR ENDED DECEMBER 31,
                                                                   -------------------
                                                                     2004        2005
                                                                   -------     -------

Net income (loss) - as reported                                    $ 4,090     $(4,607)
  Add: stock-based compensation expense recognized under APB 25          -           -
Deduct: stock-based compensation expense determined under fair
  value method for all awards                                         (820)     (2,599)
                                                                   -------     -------

Pro forma net income (loss):                                       $ 3,270     $(7,206)
                                                                   =======     =======

Net earnings (loss) per share:

Basic and diluted earnings (loss) per share, as reported           $  0.13     $ (0.15)
                                                                   =======     =======

Pro forma basic and diluted earnings (loss) per share              $  0.10     $ (0.23)
                                                                   =======     =======

     The Company estimates the fair value of stock options granted using the
     Black-Scholes-Merton option-pricing model. The option-pricing model
     requires a number of assumptions, of which the most significant are,
     expected stock price volatility, and the expected option term. Expected
     volatility was calculated based upon actual historical stock price
     movements over the most recent periods ending on the grant date, equal to
     the expected option term. The expected option term represents the period
     that the Company's stock options are expected to be outstanding and was
     determined based on historical experience of similar options, giving
     consideration to the contractual terms of the stock options. The Company
     has historically not paid dividends and has no foreseeable plans to issue
     dividends. The risk-free interest rate is based on the yield from U.S.
     Treasury zero-coupon bonds with an equivalent term.

     The following weighted assumptions were used in the model for 2006:

                                                      2006
                                                     -------

     Dividend yield                                    0%
     Expected volatility                               64%
     Risk-free interest                               4.7%
     Expected life (in years)                        5 years

     For purpose of pro-forma disclosures stock based compensation is amortized
     over the vesting period using the straight line method. Pro-forma
     compensation expense under SFAS 123, among other computational differences,
     does not consider potential pre-vesting forfeitures. Because of these
     differences, the pro-forma stock based compensation expense presented above
     for the prior years ended December 31 2004 and 2005 under SFAS 123 and the
     stock based compensation expense recognized during the current year ended
     December 31, 2006 under SFAS 123(R) are not directly comparable.


                                     F - 19




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     During the year ended December 31 2006, the Company recognized stock-based
     compensation expense related to employee stock options in the amount of $
     27, that were recorded as General and administrative expenses.

     As of December 31, 2006, the total unrecognized estimated compensation
     costs related to non-vested stock options granted prior to that date was $
     7, which is expected to be recognized over a period of up to 2.25 years.
     The Company recorded cash received from the exercise of stock options of $
     281.

     The Company accounts for stock option and warrant grants issued to
     non-employee using the guidance of SFAS No. 123(R), "Accounting for
     Stock-Based Compensation" and EITF No. 96-18: "Accounting for Equity
     Instruments that are Issued to Other Than Employees for Acquiring, or in
     Conjunction with Selling, Goods or Services," whereby the fair value of
     such option and warrant grants is determined using the Black-Scholes
     options pricing model at the earlier of the date at which the
     non-employee's performance is completed or a performance commitment is
     reached.

     CONCENTRATIONS OF CREDIT RISK

     Financial instruments which potentially subject the Company and its
     subsidiaries to concentration of credit risk consist principally of cash
     and cash equivalents, marketable securities and trade receivables.

     The Company's cash and cash equivalents are invested primarily in deposits
     with major banks worldwide, however, such cash and cash equivalents in the
     United States may be in excess of insured limits and are not insured in
     other jurisdictions. Management believes that the financial institutions
     that hold the Company's investments are financially sound, and accordingly,
     minimal credit risk exists with respect to these investments.

     The Company's marketable securities include investments in debentures of
     corporations, foreign banks, governments and commercial debentures.
     Management believes that those corporations and governments are financially
     sound and that the portfolios are well-diversified, and accordingly,
     minimal credit risk exists with respect to these marketable securities.

     Trade receivables of the Company and its subsidiaries are derived from
     sales to customers located primarily in the U.S., Europe, Japan and Israel.
     The Company performs ongoing credit evaluations of its customers and to
     date has not experienced any material losses. An allowance for doubtful
     accounts is determined with respect to those amounts that the Company has
     determined to be doubtful of collection. Moreover, in some of the
     subsidiaries there is an additional general allowance (based on a
     percentage of accounts receivables or revenue) which depends on the nature
     of the local market and local law requirements. The doubtful accounts
     expenses for the years ended December 31, 2005 and 2006 were $ 1,212 and $
     607, respectively.


                                     F - 20




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     DERIVATIVE INSTRUMENTS

     Statement of Financial Accounting Standard No. 133, "Accounting for
     Derivative Instruments and Hedging Activities" ("SFAS No. 133"), requires
     companies to recognize all of their derivative instruments as either assets
     or liabilities in the statement of financial position at fair value.

     The Company entered into a forward transaction for the sale of $ 1,250 at a
     future price of Euro 1.3225 per $ 1 as at December 1, 2006. During 2006,
     the Company recorded a net income of $ 6 related to this forward
     transaction.

     Besides the aforementioned foreign exchange contract, the Company and its
     subsidiaries have no off-balance-sheet concentration of credit risk such as
     option contracts or other foreign hedging arrangements.

     FAIR VALUE OF FINANCIAL INSTRUMENTS

     The following methods and assumptions were used by the Company and its
     subsidiaries in estimating their fair value disclosures for financial
     instruments:

     The carrying amounts of cash and cash equivalents, trade receivables and
     other accounts receivable, short-term bank credit, trade payables and other
     accounts payable approximate their fair value due to the short-term
     maturity of these instruments.

     The fair values for marketable securities are presented based on quoted
     market prices (see also Note 3).

     The carrying amount of the Company's long-term borrowing approximates its
     fair value. The fair value was estimated using discounted cash flow
     analyses, based on the Company's incremental borrowing rates for similar
     type of borrowing arrangements.

     IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS:

     a.   In September 2006, the SEC staff issued Staff Accounting Bulletin No.
          108, "Considering the Effects of Prior Year Misstatements when
          Quantifying Misstatements in Current Year Financial Statements." ("SAB
          108") SAB 108 was issued in order to eliminate the diversity of
          practice surrounding how public companies quantify financial statement
          misstatements.

          Traditionally, there have been two widely-recognized methods for
          quantifying the effects of financial statement misstatements: the
          "roll-over" method and the "iron curtain" method. The roll-over method
          focuses primarily on the impact of a misstatement on the income
          statement--including the reversing effect of prior year
          misstatements--but its use can lead to the accumulation of
          misstatements in the balance sheet. The iron-curtain method, on the
          other hand, focuses primarily on the effect of correcting the
          period-end balance sheet with less emphasis on the reversing effects
          of prior year errors on the income statement. Prior to our application
          of the guidance in SAB 108, we used the roll-over method for
          quantifying financial statement misstatements.


                                     F - 21


                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

          In SAB 108, the SEC staff established an approach that requires
          quantification of financial statement misstatements based on the
          effects of the misstatements on each of the company's financial
          statements and the related financial statement disclosures. This model
          is commonly referred to as a "dual approach" because it requires
          quantification of errors under both the iron curtain and the roll-over
          methods.

          SAB 108 permits existing public companies to initially apply its
          provisions either by (i) restating prior financial statements as if
          the "dual approach" had always been applied or (ii) recording the
          cumulative effect of initially applying the "dual approach" as
          adjustments to the carrying values of assets and liabilities as of
          January 1, 2006 with an offsetting adjustment recorded to the opening
          balance of retained earnings.

          We elected to record the effects of applying SAB 108 using the
          cumulative effect transition method.

          The following table summarizes the effects (up to January 1, 2006) of
          applying the guidance in SAB 108 (in thousands):

                                             PERIOD IN WHICH THE MISSTATEMENT ORIGINATED
                                                 --------------------------------
                                                            YEAR ENDED DECEMBER 31,
                                                 --------    --------------------
                                                CUMULATIVE                          ADJUSTMENT
                                                 PRIOR TO                         RECORDED AS OF
                                                JANUARY 1,                           JANUARY 1,
                                                   2004        2004        2005        2006
                                                 --------    --------    --------    --------
                                                              U.S $ IN THOUSANDS
                                                 --------------------------------------------

Accrued depreciation of land lease rights (1)         112          14          14         140
                                                 --------    --------    --------    --------
Impact on net income (loss)                           112          14          14
                                                 ========    ========    ========
accumulated deficit (2)                                                                   140
                                                                                     ========

          (1)  Prior to these financial statements the Company has not amortized
               its lease rights in land related to its headquarters in Or
               Yehuda, Israel. The accumulated amortization as at December 31,
               2005 of $140 has been recorded against accumulated deficit.

          (2)  Represents the net increase in the accumulated deficit recorded
               as of January 1, 2006 to record the initial application of SAB
               108.

     b.   In September 2006, the FASB issued Statement of Financial Accounting
          Standards (SFAS) 157, ``Fair Value Measurements.'' SFAS 157 defines
          fair value, establishes a framework for measuring fair value in
          generally accepted accounting principles (GAAP) and expands
          disclosures about fair value measurements. SFAS 157 is effective for
          fiscal years beginning after November 15, 2007 and interim periods
          within those fiscal years. The Company is currently evaluating the
          effect that the adoption of SFAS 157 will have on its financial
          position and results of operations.


                                     F - 22




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     c.   In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
          for Financial Assets and Financial Liabilities" (SFAS No. 159). SFAS
          No. 159 permits companies to choose to measure certain financial
          instruments and certain other items at fair value. The standard
          requires that unrealized gains and losses on items for which the fair
          value option has been elected be reported in earnings. SFAS No. 159 is
          effective for the Company beginning in the first quarter of fiscal
          year 2008, although earlier adoption is permitted. The Company is
          currently evaluating the impact that SFAS No. 159 will have on its
          consolidated financial statements

     RECLASSIFICATION:

     Certain amounts from prior years have been reclassified to conform to
     current period presentation.

NOTE 3:- MARKETABLE SECURITIES

     The Company invests in marketable debt securities, which are classified as
     available-for-sale. The following is a summary of marketable debt
     securities:

                                                                           DECEMBER 31,
                               ---------------------------------------------------------------------------------------------------
                                                    2005                                                 2006
                               ----------------------------------------------       ----------------------------------------------
                              AMORTIZED   UNREALIZED    UNREALIZED     MARKET      AMORTIZED   UNREALIZED    UNREALIZED     MARKET
                                COST        LOSSES        GAINS        VALUE         COST        LOSSES        GAINS        VALUE
                               ------       ------        ------       ------       ------       ------        ------       ------

AVAILABLE-FOR-SALE:

Governmental debentures        $1,662       $  (81)       $    -       $1,581       $1,641       $  (18)       $    3       $1,626
Commercial debentures           2,473         (125)            2        2,350        2,842          (56)            7        2,793
Equity funds                      486          (36)            -          450          249          (19)            -          230
                               ------       ------        ------       ------       ------       ------        ------       ------

TOTAL available-for-sale
   marketable securities       $4,621       $ (242)       $    2       $4,381       $4,732       $  (93)       $   10       $4,649
                               ======       ======        ======       ======       ======       ======        ======       ======

     During 2005 and 2006, the Company recorded proceeds from sales of
     marketable securities in the amount of $ 664 and $ 226, respectively and
     related losses of $ 68 and $ 10, respectively, in financial income, net.


                                     F - 23




                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 3:- MARKETABLE SECURITIES (CONT.)

     The amortized costs of available-for-sale debt securities at December 31,
     2006, by contractual maturities, are shown below:

                                                     UNREALIZED GAINS (LOSSES)
                                         ---------------------------------------------------
                                        AMORTIZED                                   ESTIMATED
                                          COST          GAINS         LOSSES        FAIR VALUE
                                         -------       -------        -------        -------

Due in one year or less                  $   928       $     -        $   (28)       $   900
Due between one year to five years         3,199            10            (59)         3,150
Due in more than five years                  605             -             (6)           599
                                         -------       -------        -------        -------

                                         $ 4,732       $    10        $   (93)       $ 4,649
                                         =======       =======        =======        =======

     The actual maturity dates may differ from the contractual maturities
     because debtors may have the right to call or prepay obligations without
     penalties.

     The unrealized losses in the Company's investments in available-for-sale
     marketable securities were caused by interest rate increases and
     devaluation of the Euro. It is expected that the securities would not be
     settled at a price less than the amortized cost of the Company's
     investment. Based on the partial recovery in the securities' market value
     after the balance sheet date and the ability and intent of the Company to
     hold these investments until recovery, the debentures were not considered
     to be other than temporarily impaired at December 31, 2006.

NOTE 4: - OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES

                                                            DECEMBER 31,
                                                        -------------------
                                                         2005         2006
                                                        ------       ------

Short-term deposits and other accounts receivable       $  968       $  890
Prepaid expenses                                           876          870
Government authorities                                     875          642
Employee loans                                              42           70
Related party receivables                                   71            -
                                                        ------       ------

                                                        $2,832       $2,472
                                                        ======       ======


                                     F - 24


                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 5:- PROPERTY AND EQUIPMENT

                                                  DECEMBER 31,
                                             ---------------------
                                              2005           2006
                                             -------       -------
Cost:
  Buildings and leasehold improvements       $ 6,910       $ 6,868
  Computers and peripheral equipment          10,688        11,116
  Office furniture and equipment               3,106         3,056
  Motor vehicles                                 446           356
  Software for internal use                    2,083         2,236
                                             -------       -------

                                              23,233        23,632
                                             -------       -------
Accumulated depreciation:
  Buildings and leasehold improvements         2,282         2,682
  Computers and peripheral equipment          10,208        10,608
  Office furniture and equipment               2,334         2,317
  Motor vehicles                                 228           215
  Software for internal use                    1,226         1,396
                                             -------       -------

                                              16,278        17,218
                                             -------       -------

Depreciated cost                             $ 6,955       $ 6,414
                                             =======       =======

     Depreciation expenses amounted to $ 1,430, $ 1,492 and $ 1,428 for the
     years ended December 31, 2004, 2005 and 2006, respectively. As for charges,
     see Note 15c.

NOTE 6:- OTHER INTANGIBLE ASSETS

     a.   Intangible assets:

                                           DECEMBER 31,
                                      ---------------------
                                       2005           2006
                                      -------       -------
Original amounts:
  Capitalized software costs          $31,508       $32,672
  Acquired technology and other         1,828         2,196
                                      -------       -------

                                       33,336        34,868
                                      -------       -------
Accumulated amortization:
  Capitalized software costs           21,348        22,606
  Acquired technology and other           789         1,399
                                      -------       -------

                                       22,137        24,005
                                      -------       -------

Amortized cost                        $11,199       $10,863
                                      =======       =======

     b.   Amortization expenses amounted to $ 3,219, $ 3,647 and $ 4,036 for the
          years ended December 31, 2004, 2005 and 2006, respectively.


                                     F - 25


                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 6:- OTHER INTANGIBLE ASSETS (CONT.)

     c.   Estimated acquired technology and other intangible assets amortization
          expenses for the years ended:

          DECEMBER 31,
          ------------

          2007                                                    $  119
          2008                                                       119
          2009 and thereafter                                         13

NOTE 7:- GOODWILL

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

Balance as of January 1, 2005                                          $ 21,684
  Foreign currency translation adjustments                                 (922)
  Acquisition of additional interest in subsidiaries (see Note 1)             -
                                                                       --------

Balance as of December 31, 2005                                          20,762
  Foreign currency translation adjustments                                  990
  Sale of Subsidiary's operations (see note 1d)                            (160)
  Acquisition of additional interest in subsidiary (see Note 1b)             32
                                                                       --------

Balance as of December 31, 2006                                        $ 21,624
                                                                       ========


                                     F - 26



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 8:- SHORT-TERM CREDIT AND CURRENT MATURITIES OF LONG-TERM LOANS

     a.   Classified by currency, linkage terms and interest rates, the credit
          and loans are as follows:

                                                    INTEREST RATE               DECEMBER 31,
                                                 -------------------        -------------------
                                                  2005         2006          2005         2006
                                                 ------       ------        ------       ------
                                                          %
                                                 -------------------
Short-term bank loans:
  In, or linked to, U.S. dollars                   6            -           $2,318       $    -
  In, or linked to, Euro                       3.75-5.68       5.5           1,405        3,184
  In other currencies                             1.63      2.13-6.75          341          975
                                                                            ------       ------

                                                                             4,064        4,159
                                                                            ------       ------
Short-term bank credit:
  In other currencies                               -           -                -          111
                                                                            ------       ------

                                                                                 -          111
                                                                            ------       ------

Short-term credit (1):
  In, or linked to, U.S. dollar                 5.6-6.6      5.6-6.6            66          185
                                                                            ------       ------

                                                                                66          185
                                                                            ------       ------
Current maturities of long-term loans                                           53           59
                                                                            ------       ------

                                                                            $4,183       $4,514
                                                                            ======       ======


          (1)  Financing arrangement in regard to the ERP system.

     b.   Contractual restrictions and financial covenants:

          For the purpose of obtaining credit and/or other bank services from
          banking institutions, the Company is committed towards the banking
          institutions as follow:

          1.   The Company is committed that the amount of cash and cash
               equivalents and short term investment will not be at any time
               below the amount of $ 6.5 million.

          2.   The Company is committed that at any time the rate of
               shareholders' equity of the Company will not drop below 45% of
               total balance sheet. In addition, shareholders equity will not
               drop at any time below the amount of $ 36 million.

          3.   The Company is committed that the total of its financial
               obligations (i.e., short and long terms from banking institutions
               or commitments due to debentures) will not exceed $7 million and
               10% of total balance sheet.

          4.   The Company is committed not to pledge under any form of general
               floating charge and for any purpose any of the Companies' assets
               and/or part of it in favor of any third party, without receiving
               the banking institutions' advance and written consent.


                                     F - 27



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 8:- SHORT-TERM CREDIT AND CURRENT MATURITIES OF LONG-TERM LOANS (CONT.)

          If the Company does not comply with all or part of the financial
          ratios, or upon the occurrence of certain events as specified in the
          agreement, the bank will be allowed to request the immediate repayment
          of the aforementioned credit.

          As of December 31, 2006, the Company was complied with some of the
          financial covenants and received a waiver from the banks for those
          financial covenants the Company did not comply with.

     c.   Credit line:

          As of December 31, 2006, the Company used $ 2.2 million of its credit
          facility with the First International Bank of Israel Ltd. and $ 3
          million with the Poalim Bank Ltd. As of December 31, 2006, the Company
          has an unutilized credit line of $ 0.3 million and $ 0.7 million in
          the First International Bank of Israel Ltd. and the Poalim Bank Ltd.,
          respectively.

NOTE 9:- ACCRUED EXPENSES AND OTHER ACCOUNTS PAYABLE

                                            DECEMBER 31,
                                       -------       -------
                                        2005           2006
                                       -------       -------

Employees and payroll accruals         $ 4,019       $ 4,351
Accrued expenses                         2,287         2,109
Deferred revenues                        3,442         4,132
Government authorities and other           948           807
                                       -------       -------

                                       $10,696       $11,399
                                       =======       =======

NOTE 10:- LONG-TERM LOANS

     Long-term loans are composed as follows:

                                     INTEREST RATE             DECEMBER 31,
                                  ------------------        ------------------
                                  2005          2006        2005          2006
                                  -----        -----        -----        -----
                                          %
                                  ------------------

In U.S. dollar                  5.6-6.6       5.6-6.6       $  94        $  95
In Yens                           4.37          3.70           85          169
In euros                          9.35           -              6
In other currencies              10.97          14             33           28
Less - current maturities                                     (53)         (59)
                                                            -----        -----

                                                            $ 165        $ 233
                                                            =====        =====


                                     F - 28


                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 11:- TAXES ON INCOME

     a.   Tax benefits under the Law for the Encouragement of Capital
          Investments, 1959 (the "Law"):

          Seven expansion programs of the Company have been granted "Approved
          Enterprise" status under the Law. For these expansion programs, the
          Company has elected the alternative benefits track, waiving grants in
          return for tax exemptions. Pursuant thereto, the income of the Company
          derived from the following "Approved Enterprise" expansion programs is
          tax-exempt for the periods stated below and will be eligible for
          reduced tax rates thereafter (such reduced tax rates are dependent on
          the level of foreign investments in the Company), as described below.

          1.   The period of the benefits for the first program and its four
               extensions has already ended as of December 31, 2006.

          2.   The fifth program entitles the Company to a tax exemption for a
               four-year period ended December 31, 2000, and is subject to a
               reduced tax rate of 25% for an additional period of six years.
               The period of benefits for this program has not yet commenced.

          3.   In each of January 1998, November 1998 and November 2002, the
               Company received approvals for other expansions of its "Approved
               Enterprise" status, which entitles the Company to a two-year tax
               exemption period for each expansion and to a reduced tax rate of
               25% for an additional period of five to eight years. The period
               of benefits for those expansions has not yet commenced.

               The tax benefit periods provided by the fifth, sixth, seventh and
               eighth programs end at the earlier of 12 years from the
               commencement of production, or 14 years from receipt of the
               approval. As the Company currently has no taxable income, these
               benefits have not yet commenced.

               The benefits available to an enterprise are conditional upon the
               fulfillment of conditions stipulated in the Law and its
               regulations and the criteria set forth in the specific letters of
               approval. In the event that the Company does not meet these
               conditions, it would be required to refund the amount of tax
               benefits, with the addition of interest and linkage adjustment to
               the Israeli Consumer Price Index ("CPI"). In the opinion of the
               Company's management, the Company has been in full compliance
               with the conditions of the above programs through December 31,
               2006, and with respect to the first eight programs, has received
               written confirmation to this effect from the Investment Center.

               If dividends were to be distributed out of tax-exempt profits
               deriving from an "Approved Enterprise", the Company would be
               liable for corporate tax at a rate of 25%. The Company does not
               anticipate paying dividends in the foreseeable future.


                                     F - 29



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 11:- TAXES ON INCOME (CONT.)

               Income from sources other than the "Approved Enterprise" during
               the benefit period will be subject to tax at the regular
               corporate tax rate (see Note 11d below).

               On April 1, 2005, an amendment to the Investment Law came into
               effect ("the Amendment") and has significantly changed the
               provisions of the Investment Law. The Amendment limits the scope
               of enterprises which may be approved by the Investment Center by
               setting criteria for the approval of a facility as an Approved
               Enterprise, such as provisions generally requiring that at least
               25% of the Approved Enterprise's income will be derived from
               export. Additionally, the Amendment enacted major changes in the
               manner in which tax benefits are awarded under the Investment Law
               so that companies no longer require Investment Center approval in
               order to qualify for tax benefits.

               As a result of the April 2005 amendment, tax-exempt income
               generated under the provisions of the new law will subject us to
               taxes upon distribution of the tax-exempt income to shareholders
               or liquidation of the company, and we may be required to record a
               deferred tax liability with respect to such tax-exempt income.

               However, the Investment Law provides that terms and benefits
               included in any certificate of approval already granted will
               remain subject to the provisions of the law as they were on the
               date of such approval. Therefore, the Company's existing Approved
               Enterprise will generally not be subject to the provisions of the
               Amendment. As a result of the amendment, tax-exempt income
               generated under the provisions of the new law, will subject the
               Company to taxes upon distribution or liquidation and the Company
               may be required to record deferred tax liability with respect to
               such tax-exempt income. As of December 31, 2006, the Company did
               not generate income under the provision of the new law.

     b.   Tax benefits under the Law for the Encouragement of Industry (Taxes),
          1969 ("the Encouragement Law"):

          The Company is an "industrial company", as defined by the
          Encouragement Law and, as such, is entitled to certain tax benefits,
          mainly accelerated depreciation of machinery and equipment, as
          prescribed by regulations published under the Inflationary Adjustments
          Law, the right to deduct public issuance expenses and patents and
          other intangible property rights for tax purposes, and the right to
          file, under specified conditions, a consolidated tax return with
          additional related Israeli "industrial companies".

     c.   Measurement of taxable income under the Income Tax (Inflationary
          Adjustments) Law, 1985:

          Results for tax purposes in Israel are measured and reflected in real
          terms in accordance with the change in the CPI. As explained in Note
          2b, the consolidated financial statements are presented in dollars.
          The differences between the change in the Israeli CPI and in the
          NIS/dollar exchange rate causes a difference between taxable income or
          loss and the income or loss before taxes reflected in the consolidated
          financial statements. In accordance with paragraph 9(f) of SFAS No.
          109, "Accounting for Income Taxes" ("SFAS No. 109"), the


                                     F - 30



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 11:- TAXES ON INCOME (CONT.)

          Company has not provided deferred income taxes on this difference
          between the reporting currency and the tax bases of assets and
          liabilities.

     d.   Tax rates:

          Until December 31, 2003, the regular tax rate applicable to income of
          companies (which are not entitled to benefits due to "approved
          enterprise", as described above) was 36%. In June 2004, an amendment
          to the Income Tax Ordinance (No. 140 and Temporary Provision), 2004
          was passed by the "Knesset" (Israeli parliament) and on July 25, 2005,
          another law was passed, the amendment to the Income Tax Ordinance (No.
          147) 2005, according to which the corporate tax rate is to be
          progressively reduced to the following tax rates: 2004 - 35%, 2005 -
          34%, 2006 - 31%, 2007 - 29%, 2008 - 27%, 2009 - 26%, 2010 and
          thereafter - 25%.

     e.   The Company received final tax assessments for the 1997 to 2002 tax
          years. As of today, the Company filed an appeal with the court on one
          issue left open. The issue is being deliberated in the Tel - Aviv
          district court. The next hearing was set to September 2008. Since the
          Company's management, based on the opinion of its legal advisors,
          believes that the probability of an unfavorable outcome for the
          Company on this matter is remote, no provision was recorded in the
          financial statements in respect of this matter (all other items
          determined by the tax authorities as increasing the Company's taxable
          income, were offset against net operating loss carryforward). In the
          remote case that the tax authorities position will be accepted, the
          Company will lose most of its carryforward losses as of December 31,
          2002, and as a result, will have to pay approximately $ 700.

     f.   Net operating losses carryforward:

          Through December 31, 2005 and 2006, the Company and its Israeli
          subsidiaries had operating loss carryforwards of approximately $
          23,102 and $ 26,438, respectively, which can be carried forward and
          offset against taxable income in the future for an indefinite period.

          Through December 31, 2005 and 2006, Magic Software Enterprises Inc.,
          CoreTech Consulting Inc. and AAOD had federal net operating tax loss
          carryforward of approximately $ 14,497, and $ 11,796, respectively
          which can be carried forward and offset against taxable income for
          15-20 years and will expire from 2011 to 2026.

          The Company's subsidiaries in Europe and Japan had estimated total
          available tax loss carryforward of $ 10,847 and $ 1,119 respectively
          in 2005 and $ 15,695 and $ 2,358, in 2006 respectively, in 2006 to
          offset against future taxable income for 15-20 years and 5 years,
          respectively.


                                     F - 31



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 11:- TAXES ON INCOME (CONT.)

     g.   Income (loss) before taxes on income:

                      YEAR ENDED DECEMBER 31,
               -------------------------------------
                2004           2005            2006
               -------        -------        -------

Domestic       $ 3,069        $(6,379)       $(2,414)
Foreign          1,145          2,476         (2,339)
               -------        -------        -------

               $ 4,214        $(3,903)       $(4,753)
               =======        =======        =======

     h.   Taxes on income:

          Taxes on income consist of the following:

                        YEAR ENDED DECEMBER 31,
                      --------------------------
                      2004       2005       2006
                      ----       ----       ----
Current:
   Domestic           $ 99       $ 63       $  1
   Foreign             182        428        324
                      ----       ----       ----

Taxes on income       $281       $491       $325
                      ====       ====       ====

     i.   Deferred income taxes:

          Deferred income taxes reflect the net tax effects of temporary
          differences between the carrying amounts of assets and liabilities for
          financial reporting purposes and the amounts used for income tax
          purposes. Significant components of the Company and its subsidiaries
          deferred tax assets are as follows:

                                             DECEMBER 31,
                                      ------------------------
                                        2005            2006
                                      --------        --------

Net Operating Loss carryforward       $ 15,938        $ 16,716
Allowances and reserves                    812             872
                                      --------        --------

                                        16,750          17,588
Less: valuation allowance              (16,750)        (17,588)
                                      --------        --------

Net deferred tax assets               $      -        $      -
                                      ========        ========

          The Company and its subsidiaries provided a 100% valuation allowance
          against the deferred tax assets in respect of its tax losses
          carryforward and other temporary differences due to uncertainty
          concerning its ability to realize these deferred tax assets in the
          foreseeable future.


                                     F - 32



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 11:- TAXES ON INCOME (CONT.)

     j.   Reconciliation of the theoretical tax expense to the actual tax
          expense:

          Reconciliation between the theoretical tax expense, assuming all
          income is taxed at the statutory rate applicable to the income of
          companies in Israel and the actual tax expenses is as follows:

                                                                     YEAR ENDED DECEMBER 31,
                                                             ----------------------------------------
                                                              2004             2005           2006
                                                             -------         -------         -------
Income (loss) before taxes on income,
  as reported in the consolidated
  statements of operations                                   $ 4,214         $(3,903)        $(4,753)
                                                             =======         =======         =======

Statutory tax rate                                                35%             34%             31%
                                                             =======         =======         =======

Theoretical tax expense (benefit)                            $ 1,475         $(1,327)        $(1,473)


Utilization of tax losses carryforward for which
  a valuation allowance was provided                          (1,544)         (1,121)           (810)
Deferred taxes assets for which valuation
  allowance was provided                                           -           2,647           2,448
Non-deductible expenses and other                                113             120              63
Tax in respect of previous years                                 281             138             114
Tax adjustment in respect of inflation in Israel
  and other                                                      (44)             34             (17)
                                                             -------         -------         -------

Actual tax expense                                           $   281         $   491         $   325
                                                             =======         =======         =======


                                     F - 33



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)

NOTE 12:- SHAREHOLDERS' EQUITY

     a.   The Ordinary shares of the Company are traded on both the Nasdaq
          National Market in the United States and the Tel-Aviv Stock Exchange
          in Israel.

     b.   Treasury shares

          The Company's Board of Directors resolved to authorize and empower the
          Company to repurchase its shares from time to time on the open market.
          Accordingly, through the end of 2006, the Company repurchased
          1,275,368 of its shares for an aggregate amount of $6,772.

     c.   Stock Option Plan:

          Under the Company's 1991 and 2000, Stock Option Plans ("the plans"),
          as amended, options may be granted to employees, officers, directors
          and consultants of the Company and its subsidiaries.

          Pursuant to the plans, the Company reserved for issuance 6,750,000 and
          4,600,000 Ordinary shares, respectively. As of December 31, 2006, an
          aggregate of 2,258,753 Ordinary shares of the Company are still
          available for future grant.

          Each option granted under the plans is exercisable until the earlier
          of 10 years from the date of the grant of the option or the expiration
          dates of the respective option plans. The 1991 plan expired on July
          31, 2001 and the 2000 plan will expire on November 5, 2010. The
          exercise price of the options granted under the plans may not be less
          than 65% of the market price of such shares on the grant date of the
          award. The Company grants options to its employees at an exercise
          price that is equal to the share market price at the grant date. The
          options vest primarily over three years. Any option, which is
          forfeited or canceled before expiration, becomes available for future
          grants.

          On December 29, 2005, the Company has adopted an amendment to 2000
          Employee Stock Option Plan to provide for the issuance hereunder of an
          additional 600,000 Ordinary shares.

          As of December 29, 2005, all of the unvested out-of-the-money options,
          which amounted to 611,517, with an average exercise price of $ 3.46
          per share with related vesting period from January 1, 2006 through
          March 2009 had been accelerated. The shares which may be purchased by
          exercise of the accelerated options shall be subject to a holding
          period according to which the employees shall only be entitled to sell
          a monthly fraction of such numbers of shares (1/36 per month).

          The Company's decision to accelerate the vesting of those options and
          to grant fully vested options was based primarily upon the issuance of
          SFAS No. 123R, which requires the Company to treat all unvested stock
          options as compensation expense effective January 1, 2006. The Company
          believes that the acceleration of vesting of those options will enable
          the Company to avoid recognizing stock-based compensation expense
          associated with these options in future periods. Additional purposes
          of the fully vested grant and for the acceleration were to make the
          options more attractive to the recipients, and to avoid discrimination
          between groups of option holders, respectively.


                                     F - 34



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)

NOTE 12:- SHAREHOLDERS' EQUITY (CONT.)

          The acceleration had no impact on the Company's statement of
          operations, however the impact of vesting accelerating on proforma
          stock-based compensation required to be disclosed in the financial
          statement footnotes under the provisions of SFAS No. 123, was to
          increase such disclosed compensation cost by approximately $ 1,021.

          A summary of the Company's stock option activity and related
          information for the year ended December 31, 2006, is as follows:

                                                                  WEIGHTED-
                                                                   AVERAGE
                                                      WEIGHTED-   REMAINING
                                                       AVERAGE   CONTRACTUAL    AGGREGATE
                                       NUMBER OF       EXERCISE     TERM        INTRINSIC
                                        OPTIONS         PRICE     (IN YEARS)      VALUE
                                        -------         -----     ----------      -----

Outstanding at January 1, 2006         3,061,216        $2.62
Granted                                   62,000        $1.69
Exercised                               (253,346)       $1.11
Forfeited                               (517,238)       $3.41
                                      ----------

Outstanding at December 31,2006        2,352,632        $2.52       6.67       $    1,405
                                      ==========        =====       ====       ==========

Vested and expected to vest            2,336,982        $3.20       6.65       $    1,396
                                      ==========

Exercisable at December 31,2006        2,290,032        $5.24       6.60       $    1,370
                                      ==========        =====       ====       ==========

          The weighted-average grant-date fair value of options granted during
          the twelve months ended December 31, 2006 was $ 0.98. The aggregate
          intrinsic value in the table above represents the total intrinsic
          value (the difference between the fair market value of the Company
          ordinary shares on December 31, 2006 and the exercise price,
          multiplied by the number of in-the-money options) that would have been
          received by the option holders had all option holders exercised their
          options on December 31, 2006. This amount is changed based on the fair
          market value of the Company's shares. Total intrinsic value of options
          exercised for the twelve months ended December 31, 2006 was $ 161. As
          of December 31, 2006, there was $ 7,052 of total unrecognized
          compensation cost related to non-vested share-based compensation
          arrangements granted under the Company's stock option plans. That cost
          is expected to be recognized over a period of approximately 3 years.
          Total grant-date fair value of vested options for the twelve months
          ended December 31, 2006 $ 0 as a result of the acceleration in
          December 29, 2005.


                                     F - 35



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)

NOTE 12:- SHAREHOLDERS' EQUITY (CONT.)

          The following table is a summary of the Company's stock option
          activity during 2004, 2005 and 2006:

                                                  YEAR ENDED              YEAR ENDED                YEAR ENDED
                                               DECEMBER 31, 2004       DECEMBER 31, 2005        DECEMBER 31, 2006
                                             ----------------------  ----------------------  ----------------------
                                                          WEIGHTED                WEIGHTED               WEIGHTED
                                                          AVERAGE                 AVERAGE                 AVERAGE
                                               NUMBER     EXERCISE     NUMBER     EXERCISE     NUMBER    EXERCISE
                                             OF OPTIONS    PRICE     OF OPTIONS    PRICE     OF OPTIONS    PRICE
                                             ----------  ----------  ----------  ----------  ----------  ----------

Outstanding at the beginning
   of the year                                3,346,406  $     2.26   2,513,237  $     2.95   3,061,216  $     2.62
Granted                                         406,601  $     4.84     820,028  $     1.70      62,000  $     1.69
Exercised                                      (973,551) $     1.28     (80,604) $     1.04    (153,346) $     1.11

Forfeited                                      (266,219) $      3.6    (191,445) $     3.54    (617,238) $     3.41
                                             ----------              ----------              ----------
Outstanding at the end of
  the year                                    2,513,237  $     2.95   3,061,216  $     2.62   2,352,632  $     2.52
                                             ==========  ==========  ==========  ==========  ==========  ==========

Exercisable at the end of
  the year                                    1,423,970  $     2.28   3,061,216  $     2.62   2,290,632  $     2.54
                                             ==========  ==========  ==========  ==========  ==========  ==========

Weighted average fair value of
  options granted during the year                        $      2.2              $      1.1              $      1.7
                                                         ==========              ==========              ==========

          The options outstanding as of December 31, 2006, have been separated
          into ranges of exercise price categories, as follows:

                       OPTIONS         WEIGHTED                         OPTIONS        WEIGHTED
                      OUTSTANDING      AVERAGE           WEIGHTED     EXERCISABLE       AVERAGE
                         AS OF         REMAINING         AVERAGE         AS OF       EXERCISE PRICE
                      DECEMBER 31,  CONTRACTUAL LIFE     EXERCISE     DECEMBER 31,   OF EXERCISABLE
     EXERCISE PRICE      2006           (YEARS)            PRICE          2006          OPTIONS
        ---------      ---------       ---------         ---------     ---------       ---------

          0-1            214,355               6         $    0.83       214,355       $    0.83
          1-2          1,253,793               7         $    1.37     1,191,793       $    1.36
          2-3             15,600               3         $    2.48        15,600       $    2.48
          3-4            466,333               7         $    3.82       466,333       $    3.82
          4-5            230,840               7         $    4.13       230,840       $    4.13
          5-6            135,500               7         $    5.95       135,500       $    5.95
          6-7                711               3         $    6.14           711       $    6.14
         10-11            26,500               3         $   10.16        26,500       $   10.16
         18-19             9,000               3         $   18.79         9,000       $   18.79
                       ---------                                       ---------

                       2,352,632               7         $    2.52     2,290,632       $    2.54
                       =========       =========         =========     =========       =========

          The fair value on grant date of options which became vested during the
          year ended December 31, 2006 amounted to $ 0 as there was no vesting
          of options during the year.

     d.   Warrants to service providers:

          In April 2003, the Company issued 110,000 warrants as a consideration
          of the purchase of its distribution activity in Switzerland.


                                     F - 36



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)

NOTE 12:- SHAREHOLDERS' EQUITY (CONT.)

          The warrants were exercisable into the Company's Ordinary shares for a
          period of four years, at an exercise price of $ 0.6565 per share.
          These warrants were exercised in April 2004.

          During the year ended December 31, 2006, 50,000 warrants were granted
          to Peter Gyenes, a consultant of the Company. Those warrants were not
          exercised or forfeited.

          The fair value of warrants which became vested during the year ended
          December 31, 2006 amounted to $ 24 thousand.

          The fair value for the warrants to service providers was estimated on
          the date of grant using Black-Scholes option pricing model, with the
          following weighted-average assumptions for the year ended December 31,
          2006 weighted average volatility of 58.3% risk-free interest rates of
          4.7% dividend yields of 0% and a weighted average life of the options
          of 3 years.

     e.   Dividends:

          The Company does not intend to pay cash dividends in the foreseeable
          future.

     f.   Accumulated other comprehensive loss

                                                YEAR ENDED DECEMBER 31,
                                                ----------------------
                                                  2005           2006
                                                -------        -------

Accumulated unrealized loss on
  available-for-sale securities                    (240)           (83)
Accumulated foreign currency
  translation adjustments                        (1,274)        (1,254)
                                                -------        -------

Total other comprehensive loss                  $(1,514)       $(1,337)
                                                =======        =======

                                     F - 37



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 13:- GEOGRAPHIC INFORMATION

     Summary information about geographic areas:

     The Company manages its business on the basis of one reportable segment
     (see Note 1 for a brief description of the Company's business). The
     Company's business is divided into the following geographic areas: Israel,
     Europe, the U.S.A., Japan and other regions. Total revenues are attributed
     to geographic areas based on the location of the customers.

     This data is presented in accordance with SFAS No. 131, "Disclosures about
     Segments of an Enterprise and Related Information" ("SFAS No. 131").

     The following table presents total revenues classified according to
     geographical destination for the years ended December 31, 2004, 2005 and
     2006:

                   YEAR ENDED DECEMBER 31,
             -----------------------------------
              2004           2005         2006
             -------       -------       -------

Israel       $ 3,354       $ 4,013       $ 4,307
Europe        25,698        23,186        21,887
U.S.A.        21,090        20,435        23,236
Japan         11,450        10,107        10,223
Other          3,575         3,249         2,072
             -------       -------       -------

             $65,167       $60,990       $61,725
             =======       =======       =======

     The Company's long-lived assets are as follows:

                 DECEMBER 31,
             -------------------
              2005         2006
             ------       ------

Israel       $5,239       $4,990
Europe          751          679
U.S.A.          561          467
Japan           280          313
Other           124          105
             ------       ------

             $6,955       $6,554
             ======       ======


                                     F - 38



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 14:- SELECTED STATEMENTS OF OPERATIONS DATA

     a.   Research and development costs:

                                               YEAR ENDED DECEMBER 31,
                                        -------------------------------------
                                          2004          2005           2006
                                        -------        -------        -------

Total costs                             $ 7,317        $ 7,642        $ 7,477
Less - capitalized software costs        (3,472)        (3,909)        (3,535)
                                        -------        -------        -------

Research and development, net           $ 3,845        $ 3,733        $ 3,942
                                        =======        =======        =======

     b.   Financial income (expenses), net:

Interest and bank charges               $  (157)       $  (117)       $   (49)
Gain (loss) arising from foreign
  currency transactions                   1,069           (694)           459
                                        -------        -------        -------

Financial income (expenses),net         $   912        $  (811)       $   410
                                        =======        =======        =======

NOTE 15:- COMMITMENTS AND CONTINGENTIES

     a.   Lease commitments:

          Certain of the facilities, motor vehicles and equipment of the Company
          and its subsidiaries are rented under long-term operating lease
          agreements. Future minimum lease commitments under non-cancelable
          operating leases as of December 31, 2006, are as follows:

          2007                      2,670
          2008                      2,298
          2009                      1,751
          2010 and thereafter       1,064
                                    -----

                                    7,783
                                    =====

          Rent expenses for the years ended December 31, 2004, 2005 and 2006,
          were approximately $ 1,844, $ 1490 and $ 1,585, respectively.

     b.   Guarantees:

          The Company has provided two of its clients with bank guarantees
          totaling $ 41, which is linked to the NIS and valid through July 2007.


                                     F - 39



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 15:- COMMITMENTS AND CONTINGENCIES (CONT.)

     c.   Charges:

          As collateral for a subsidiary's line of credit, a charge was recorded
          on the subsidiary's trade receivables.

          In respect of a lease agreement, the Company placed a lien on the
          leased computer equipment.

     d.   Legal proceedings:

          Lawsuits have been lodged against the Company in the ordinary course
          of business in insignificant amounts. The Company intends to defend
          itself vigorously against those lawsuits. Management cannot predict
          the outcome of the lawsuits nor can they make any estimate of the
          amount of damages; therefore, no provision has been made for the
          lawsuits.

          1.   In June 2004, an Israeli Company has filed a lawsuit against the
               Company in the Tel-Aviv District Court in the amount of NIS 8
               million (approximately $ 1,840), with a possibility to increase
               the lawsuit's amount to approximately NIS 17 million
               (approximately $ 3,900), for recovery of damages caused to
               plaintiff by the Company's failure to integrate a software
               system. During the last three years, the parties tried to settle
               the case with an external mediator. This attempt failed recently
               and the parties returned to the court to proceed with the court
               proceedings. Preliminary court proceedings have commenced, such
               as disclosure of documents and questionnaires. As of December 31,
               2006, the Company's management, based on its legal advisors
               opinion, cannot predict the outcome of the lawsuit nor can they
               make any estimate of the amount of damages; therefore, no
               provision has been made for the lawsuit.

          2.   In February 2006, a client of the Company's subsidiary, CarPro
               Systems Ltd., has filed in the Magistrate's court in Tel Aviv,
               Israel, a lawsuit against the subsidiary, claiming an alleged
               breach of the agreement between the parties, in the amount of $
               257. The claim had been moved to arbitration, which will commence
               in August 2007. The lawsuit is in its initial stages, therefore
               the Company's management, based on its legal advisors opinion,
               cannot predict the outcome of the lawsuit nor can they make any
               estimate of the amount of damages; therefore, no provision has
               been made for the lawsuit.

          3.   In May 2005, a client of the Company's subsidiary, Magic Software
               Enterprises (Israel) Ltd., filed a lawsuit against the subsidiary
               claiming an alleged breach of the agreement between the parties.
               The plaintiff is seeking damages in the amount of $ 336. The
               claim was moved to arbitration. The Company's management, due to
               the preliminary stage of this litigation and based on its legal
               advisors opinion, cannot predict the outcome of the lawsuit nor
               can they make any estimate of the amount of damages; therefore,
               no provision has been made for the lawsuit.


                                     F - 40



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 15:- COMMITMENTS AND CONTINGENCIES (CONT.)

          4.   In March 2006, a client of the Company's subsidiary, Magic
               Software Enterprises France, filed a lawsuit against the
               subsidiary in the commercial court in Paris claiming an alleged
               breach of the agreement between the parties. The plaintiff is
               seeking damages in the amount of (euro) 548,000 (approximately $
               708). The Company's management, due to the preliminary stage of
               this litigation and based on its legal advisors opinion, cannot
               predict the outcome of the lawsuit nor can they make any estimate
               of the amount of damages; therefore, no provision has been made
               for the lawsuit.

     e.   Royalty commitments:

          1.   The Government of Israel, through the Fund for the Encouragement
               of Marketing Activities ("the Fund"), awarded the Company grants
               for participation in its foreign marketing expenses. The Company
               received an aggregate amount of grants of $ 1,526 for the years
               up to and including 2005. The Company is committed to pay
               royalties at the rate of 3% of the increase in exports, up to the
               amount of the grants. As of December 31, 2006, the remaining
               contingent obligation of the Company amounted to $ 442.

          2.   The Company is committed to pay royalties to Enformia Software
               Ltd. ("Enformia") in the amount of 40% regarding any sale of
               products related to the IP purchased from Enformia and to comply
               with all of the terms required by the Office of the Chief
               Scientist ("OCS") in connection with its grants to Enformia.

               As of December 31, 2005 and 2006, the aggregate contingent
               liability to the OCS, in regard to Enformia products, amounted to
               $ 52 and $ 42, respectively. Through December 31, 2005 and 2006,
               the Company has paid and accrued royalties to Enformia, in regard
               to sales of its product, in the amount of $ 114 and $ 84,
               respectively.

          3.   The Company is committed to pay royalties of 1.75% of gross sales
               of the Hermes application, including license fees and all
               services fees for a period of 5 years until end of 2008. Through
               December 31, 2006, the Company has paid and accrued royalties to
               Hermes, in regard to sales of the product, in the amount of $9
               (see Note 1e).


                                     F - 41



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 16:- NET EARNINGS (LOSS) PER SHARE

     The following table sets forth the computation of basic and diluted net
     earnings (loss) per share:

                                                                     YEAR ENDED DECEMBER 31,
                                                            -------------------------------------------
                                                              2004             2005              2006
                                                            --------       ------------        --------

Numerator for basic and diluted earnings (loss)
   per share - net income (loss)
   available to shareholders                                $  4,090       $     (4,607)       $ (5,006)
                                                            ========       ============        ========

Weighted average shares outstanding:

Denominator for basic net earnings (loss) per share           31,029             31,124          31,184
Effect of dilutive securities                                  1,397               *) -            *) -
                                                            --------       ------------        --------

Denominator for diluted net earnings (loss) per share         32,426             31,124          31,184
                                                            ========       ============        ========

Basic and diluted net earnings (loss) per share             $   0.13       $      (0.15)       $  (0.16)
                                                            ========       ============        ========

     *)   Anti dilutive.

NOTE 17:- RELATED PARTIES

     In July 2005, the Company signed a memorandum of understanding with a
     related party, to implement the ERP system in a total consideration of $
     670. In 2005 and 2006, the Company performed only part of the project in
     the amount of $ 235 and $ 263, respectively.

NOTE 18:- SUBSEQUENT EVENTS (NOT AUDITED)

     In July 2006, the FASB issued FASB Interpretation No. 48 "Accounting for
     Uncertainty in Income Taxes an Interpretation of FASB Statement No. 109"
     ("FIN 48"). FIN 48 clarifies the accounting for income taxes by prescribing
     the minimum recognition threshold a tax position is required to meet before
     being recognized in the financial statements. FIN 48 utilizes a two-step
     approach for evaluating tax positions. Recognition (step one) occurs when
     an enterprise concludes that a tax position, based solely on its technical
     merits, is more-likely-than-not to be sustained upon examination.
     Measurement (step two) is only addressed if step one has been satisfied
     (i.e., the position is more-likely-than-not to be sustained). Under step
     two, the tax benefit is measured as the largest amount of benefit,
     determined on a cumulative probability basis that is more-likely-than-not
     to be realized upon ultimate settlement.


                                     F - 42



                                                 MAGIC SOFTWARE ENTERPRISES LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 18:- SUBSEQUENT EVENTS (NOT AUDITED) (CONT.)

     FIN 48 applies to all tax positions related to income taxes subject to the
     Financial Accounting Standard Board Statement No. 109, "Accounting for
     income taxes" ("FAS 109"). This includes tax positions considered to be
     "routine" as well as those with a high degree of uncertainty.

     FIN 48 has expanded disclosure requirements, which include a tabular roll
     forward of the beginning and ending aggregate unrecognized tax benefits as
     well as specific detail related to tax uncertainties for which it is
     reasonably possible the amount of unrecognized tax benefit will
     significantly increase or decrease within twelve months. These disclosures
     are required at each annual reporting period unless a significant change
     occurs in an interim period.

     FIN 48 is effective for fiscal years beginning after December 15, 2006. The
     cumulative effect of applying FIN 48 will be reported as an adjustment to
     the opening balance of retained earnings. The Company does not expect that
     the adoption of FIN 48 will have a significant impact on the Company's
     financial position and results of operations.

                                     F - 43

MAGIC SOFTWARE ENTERPRISES LTD.
AND ITS SUBSIDIARIES
--------------------------------------------------------------------------------

DETAILS OF SUBSIDIARIES AND AFFILIATE

Details of the percentage of control of the share capital and voting rights of
subsidiaries and an affiliated company as of December 31, 2006:

PERCENTAGE OF PLACE OF
NAME OF COMPANY OWNERSHIP AND CONTROL INCORPORATION
--------------- --------------------- -------------
%
---------------------

Magic Software Japan K.K. 100 Japan
Magic Software Enterprises Inc. 100 U.S.A.
Magic Software Enterprises (UK) Ltd. 100 U.K.
Hermes Logistics Technologies Limited 100 U.K.
Magic Software Enterprises Spain Ltd. 100 Spain
Coretech Consulting Group Inc. 100 U.S.A
Coretech Consulting Group LLC 100 U.S.A
MSE Holdings, INC 100 U.S.A
Magic Software Enterprises (Israel) Ltd. 100 Israel
Magic Software Enterprises Italy S.r.l. 100 Italy
Magic Software Enterprises Netherlands B.V. 100 Netherlands
Magic Software Enterprises France 100 France
Magic Beheer B.V. 100 Netherlands
Magic Benelux B.V. 100 Netherlands
Magic Software Enterprises GMBH 100 Germany
Magic Software Enterprises India Pvt. Ltd. 100 India
Onyx Magyarorszag Szsoftverhaz*) 100 Hungary
CarPro Systems Ltd. *) 90.48 Israel
Advanced Answers On Demand Holding Corp. *) 100 U.S.A
Nextstep Infotech Prt. Ltd. 40 India

*) See Note 1.

F - 44




                               S I G N A T U R E S

     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.

                                             MAGIC SOFTWARE ENTERPRISES LTD.


                                             By: /s/ David Assia
                                             -------------------
                                             David Assia
                                             Chairman of the Board of  Directors
                                             and Acting Chief Executive Officer

Dated: June 26, 2007


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