Annual Reports

  • 10-K (Mar 28, 2014)
  • 20-F (Apr 30, 2013)
  • 20-F (Apr 24, 2012)
  • 20-F (Apr 17, 2012)
  • 20-F (Mar 31, 2011)
  • 20-F (Mar 25, 2010)

 
8-K

 
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BluePhoenix Solutions 20-F 2011
zk1109680.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
F O R M 20 – F

o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2010
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
o
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Date of event requiring this shell company report……………………..

For the transition period from ________ to ________

Commission file number: 005-52583

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

Israel
(Jurisdiction of Incorporation or Organization)

8 Maskit Street, Herzliya 46733, Israel
(Address of Principal Executive Offices)

Nir Peles, CFO, 8 Maskit Street, Herzliya 46733, Israel
Tel: 972 9 9526110, Fax: 972 9 952611
(Name, Telephone, E-mail and/or Facsimile Number and Address of Company Contact Person)
_________________

Securities registered or to be registered pursuant to Section 12(b) of the Act:
 
 
Title of Each Class
 
Name of Each Exchange on Which Registered
 
 
Ordinary shares, NIS 0.01 par value
 
NASDAQ Global Select Market
 

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

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

 
 
23,720,191 Ordinary shares, NIS 0.01 per share

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

Yes o    No x
 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes o    No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes x    No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o    No o
 
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 o Accelerated filer o Non-accelerated filer x
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
 
U.S. GAAP x
 
International Financial Reporting Standards as issued by the International Accounting Standards Board o
 
Other o

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

Item 17 o    Item 18 o

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

Yes o    No x
 
 
 

 
 
TABLE OF CONTENTS
 
P A R T   I
 
1
2
2
2
A.   
Selected Financial Data
2
B.
Capitalization and Indebtedness
3
C.
Reasons for the Offer and Use of Proceeds
3
D.
Risk Factors
4
22
A.
History and Development of the Company
22
C.
Organizational Structure
38
D.
Property, Plants and Equipment
39
39
A.
Operating Results
48
B.
Liquidity and Capital Resources
54
C.
Research and Development, Patents and Licenses
61
D.
Trend Information
61
E.
Off-Balance Sheet Arrangements
61
F.
Tabular Disclosure of Contractual Obligations
62
62
A.
Directors and Senior Management
62
B.
Compensation
65
C.
Board Practices
68
D.
Employees
77
E.
Share Ownership
78
81
A.
Major Shareholders
81
B.
Related Party Transactions
82
C.
Interests of Expert and Counsel
84
84
A.
Consolidated Statements and Other Financial Information
84
B.
Significant Changes
85
86
A.
Offer and Listing Details
86
B.
Plan of Distribution
87
C.
Markets
87
D.
Selling Shareholders
87
E.
Dilution
87
F.
Expenses of the Issue
87
88
A.
Share Capital
88
B.
Memorandum and Articles of Association
88
C.
Material Contracts
91
D.
Exchange Controls
91
E.
Taxation
92
F.
Dividends and Paying Agents
99
G.
Statement by Experts
99
H.
Documents on Display
100
I.
Subsidiary Information
100
 
 
 

 
 
 
 
 

 
 


 
P A R T   I
 

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

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

The name BluePhoenix™ and the names BluePhoenix™ LogicMiner,  BluePhoenix™ LanguageMigrator, BluePhoenix™ AppBuilder and DSK2SMB™, appearing in this annual report are trademarks of our company. Other trademarks in this annual report are owned by their respective holders.

 
 

 
 
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 
 
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
 
Not applicable.
ITEM 3. KEY INFORMATION
 
A. 
Selected Financial Data
 
The following tables present selected information from our consolidated statement of operations and balance sheet data for the periods and as of the dates indicated. We derived the selected consolidated statements of operations data for each of the years ended December 31, 2008, 2009 and 2010 and the selected balance sheet data as of December 31, 2009 and 2010 from our consolidated financial statements included in Item 18 of this annual report, which have been prepared in accordance with generally accepted accounting principles as applied in the United States, or U.S. GAAP. Our consolidated financial statements have been audited by Ziv Haft, an independent registered public accounting firm and BDO member firm. The selected consolidated financial data as of December 31, 2006, 2007 and 2008 and for the years ended December 31, 2006 and 2007 is derived from our audited financial statements not included in this annual report, which have been prepared in accordance with U.S. GAAP. You should read the selected consolidated financial data set forth below together with our consolidated financial statements and notes thereto included elsewhere in this annual report. See “Item 5. Operating and Financial Review and Prospects.”
 
 
2

 
 
 
   
Year Ended December 31,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
    $  
 
 
(in thousands, except per share data)
 
Consolidated Statements of Operations Data:      
Revenues
  $ 57,120     $ 77,778     $ 91,745     $ 81,222     $ 61,375  
Cost of revenues
    42,212       44,885       46,032       36,529       26,066  
Gross profit
    14,908       32,893       45,713       44,693       35,309  
Research and development costs
    6,692       11,420       18,378       12,653       8,595  
Selling, general, and administrative expenses
    28,574       30,406       32,359       28,370       19,338  
Loss on sale of subsidiary
    3,989       -       -       -       -  
Goodwill impairment
    13,185       5,670       13,328       -       -  
Restructuring costs
    -       -       -       694       -  
Total operating expenses
    52,440       47,496       64,065       41,717       27,933  
Operating income (loss)
    (37,532 )     (14,603 )     (18,352 )     2,976       7,376  
Financial expenses, net
    (750 )     (779 )     (2,237 )     (4,343 )     (3,553 )
Other income, net
    -       -       398       892       282  
Income (loss) before taxes on income
    (38,282 )     (15,382 )     (20,191 )     (475 )     4,105  
Income tax (expense) benefit
    133       117       330       (68 )     407  
      (38,149     (15,265     (19,861     (543     4,512  
Equity in earnings (losses) of affiliated companies, net
    -       (10 )     (49 )     35       -  
Net profit (loss) from continued operation
    (38,149 )     (15,275 )     (19,910 )     (508 )     4,512  
Discontinued operation
    -       -       (8,512 )     (7,489 )     273  
Net income (loss)
    (38,149 )     (15,275 )     (28,422 )     (7,997 )     4,785  
Net income attributed to non-controlling interests
    (55 )     (295 )     (179 )     (199 )     (113 )
Net income (loss) attributed to BluePhoenix’ shareholders
  $ (38,204 )   $ (15,570 )   $ (28,601 )   $ (8,196 )   $ 4,672  
                                         
Total earning (loss) per share:
                                       
Basic
  $ (1.62 )   $ (0.72 )   $ (1.35 )   $ (0.48 )   $ 0.34  
Diluted
  $ (1.62 )   $ (0.72 )   $ (1.35 )   $ (0.48 )   $ 0.33  
Weighted average number of shares outstanding
    23,556       21,500       21,196       17,145       13,889  
Weighted average number of shares outstanding assuming dilution
    23,556       21,500       21,196       17,145       14,371  
 
    December 31,  
    2010     2009     2008    
2007
    2006  
    $  
Consolidated Balance Sheet Data:
  (in thousands)  
Working capital
  $ 647     $ 27,638     $ 32,360     $ 32,008     $ 31,401  
Total assets
  $ 78,999     $ 122,554     $ 139,987     $ 146,858     $ 127,466  
Total liabilities
  $ 32,957     $ 39,880     $ 46,665     $ 34,388     $ 66,961  
Net Assets
  $ 46,042     $ 82,674     $ 93,322     $ 112,470     $ 60,512  
 
B. 
Capitalization and Indebtedness
 
Not applicable.
 
C. 
Reasons for the Offer and Use of Proceeds
 
Not applicable.

 
3

 
 
D. 
Risk Factors
 
Our business, financial condition, and results of operations could be materially adversely affected by any of the following risks. Additional risks and uncertainties that we are not aware of or that we currently believe are immaterial may also adversely affect our business, financial condition, results of operations and our liquidity. The trading price of our ordinary shares could decline due to any of these risks, and you may lose all or part of your investment.

Risks Related to Our Business
 
Inthe past we have experienced significant losses and negative cash flows from operations. If these trends continue in the future, it would adversely affect our financial condition>.
 
We have incurred significant losses and negative cash flows from operations in the past. For the fiscal year ended December 31, 2010, we experienced a net loss of $38.2 million and negative cash flows from operations of $7.6 million. These results have had a negative impact on our financial condition, including our failure to meet certain covenants included in our existing credit facilities. There can be no assurance that our business will become profitable in the future, that additional losses and negative cash flows from operations will not be incurred, that we will be able to satisfy the covenants in our credit facilities, that we will be able to reduce operating expenses or that we will be able to find alternative financing if necessary. If these trends continue, we would encounter difficulties in funding our operations, which would have a material adverse affect on our business, financial condition and results of operations.
 
We failed to meet some of the covenants included in our existing credit facilities. If we are unable to restructure these credit facilities or find alternative financing, we would encounter difficulties in funding our operations, which would have a material adverse affect on our business, financial condition and results of operations.
 
As of March 25, 2011, we had an aggregate of $12.3 million of outstanding loans to banks under our credit facilities provided by four Israeli banks in the amounts of $5.8 million, $2.5 million, $2.25 million and $1.75 million.
 
Each loan agreement contains covenants regarding our maintenance of certain financial ratios, and based on our operating results for 2010, we failed to meet the covenants requiring that our accumulated earnings before interest, taxes, depreciation and amortization (EBITDA) for the last subsequent quarter not be less than $5 million and that our shareholders equity not be less than $50 million to $70 million (depending on the bank’s requirements). As a result, one of the banks requested that we accelerate repayment of our loan in the amount of $2.5 million. Accordingly, this loan is now payable in installments until full repayment in the original maturity date, in September 2011, rather than the whole amount being payable in September 2011. As a result of the foregoing, all of these loans are classified as short-term debt.
 
We are currently seeking to restructure the terms of our credit facilities and negotiating revised agreements with the banks. The revised agreements are expected to include an amended set of covenants and a floating charge on our assets and a fixed charge on our goodwill, as well as certain other fixed charges, in favor of the banks. However, we cannot assure you that we ultimately reach an agreement with the banks or that such agreements will be on favorable terms to us. Our ability to restructure or refinance our credit facilities depends on the condition of the capital markets and our financial condition. Any refinancing of our existing credit facilities could be at higher interest rates and may require us to comply with different covenants, which could restrict our business operations.
 
 
4

 
 
If we are unsuccessful in restructuring our credit facilities, the banks could accelerate all of our outstanding debt and we would encounter difficulties in funding our operations.  As a result, we could be required to dispose of material assets or operations or raise alternative funding through the issuance of debt or equity securities. There is no assurance that we would be able to consummate such dispositions or that we will be able to raise additional cash or obtain financing through the public or private sale of debt or equity securities in terms that are favorable to us or advantageous to our existing shareholders.
 
If we fail to restructure or otherwise repay our debt, or if we are required to use a significant portion or all of our cash and current assets to repay our debt, our business, financial condition and results of operations would be materially adversely affected.
 
In addition, our credit facilities contain a number of restrictive covenants that limit our operating and financial flexibility. These covenants restrict, among other things, our ability to pledge our assets, dispose of assets, make loans or give guarantees, make certain acquisitions, and engage in mergers or consolidations.
 
Unfavorable changes in economic conditions and decreases in capital expenditures by our customers, particularly in the financial services and banking sector, have had and could continue to have a material adverse effect on our business and results of operations.
 
Our revenue is dependent upon the strength of the worldwide economy. In particular, we depend upon our customers making continuing capital investments in information technology products, such as those marketed and sold by us. These spending levels are impacted by the worldwide level of demand for enterprise legacy IT modernization solutions and services. Demand for these is normally a function of prevailing global or regional economic conditions and is negatively affected by a general economic slow-down as consumers reduce discretionary spending on information technology upgrades.
 
Our results were particularly affected due to declines in our target market of the financial services industry. In 2010 and 2009, approximately 40% and 44% of our revenues, respectively, was derived from the financial services industry. We believe that the financial services industry continues to be adversely affected by difficult economic conditions. In addition, consolidation in the financial services industry has resulted in a significant reduction in the number of customers and overall spending on our products. These factors also contributed to a reduction in prices we obtain for our products and services.
 
Although there have been indications that the economy may be improving in many areas, this has not resulted in an increase in purchases by our customers. Our revenues decreased significantly from $91.7 million in 2008 to $77.8 million in 2009 and to $57.1 million in 2010. We expect our revenues to further decrease in 2011.
 
We have identified and continue to experience delays in purchase order placement by our customers and longer sales cycles. We believe that the significant downturn in the economy caused our customers to react by reducing their capital expenditures in general or by specifically reducing their spending on information technology. The negotiation process with our customers has developed into a lengthy and expensive process. In addition, many of our customers have delayed or cancelled information technology projects. Customers with excess information technology resources have chosen and may continue to choose to develop in-house software solutions rather than obtain those solutions from us. Moreover, competitors may respond to challenging market conditions by lowering prices and attempting to lure away our customers.
 
 
5

 
 
We cannot predict the timing, strength or duration of any economic slowdown or any subsequent recovery, particularly with respect to the financial services industry. If the conditions in the markets in which we operate remain the same or worsen from present levels, our business, financial condition and results of operations would be materially and adversely affected.
 
We had negative cash flows from operations in 2010 which, if we are not successful in implementing our restructuring plan in 2011, may continue.
 
We had negative operating cash flows of $7.6 million in 2010.The change in operating cash flow is primarily attributable to the significant decrease in revenues in 2010 compared to 2009 and 2008.
 
Based on the continuing decline in revenues in 2009 and 2010, we reduced our workforce during 2009 and 2010.  However, we performed most of our reductions in workforce in the latter half of 2010, since we had to keep our workforce for completion of ongoing projects. Due to this, as well as severance and other termination costs, our labor costs were not reduced commensurate with our reduction in revenues. As labor costs constitute a substantial majority of our costs of revenues, selling and administrative expenses and research and development expenses, we incurred significant losses and negative cash flow in 2010.
 
We intend to implement a further cost restructuring for 2011, which is expected to result in further severance and other termination costs. This planned restructuring, together with the cost saving plan conducted in 2009 and 2010, are intended to set our expenses at a level commensurate with expected revenue levels. There can be no assurance, however, that such plans will result in reduced expense levels commensurate with our reduced level of revenues. As a result, our business, financial condition and results of operations could be materially and adversely affected.
 
The loss of, or significant reduction or delay in, purchases by our customers could reduce our revenues and profitability.
 
A small number of customers has accounted for a substantial portion of our current and historical net revenues. In 2010, sales to Skandinavisk Data Center A/S (SDC) accounted for 15.9% of our revenues. In 2009, no individual customer accounted for more than 10% of our revenues. In 2008, sales to The Capita Group Plc accounted for approximately 10% of our revenues.
 
In 2010, we terminated the employment of 38 employees previously employed by us in Denmark. As a result, we anticipate a reduction of approximately $5 million to $6 million in our annual revenues.

 
6

 
 
The loss of any major customer or a decrease or delay in orders or anticipated spending by such customer could materially reduce our revenues and profitability. Our customers could also engage in business combinations, which could increase their size, reduce their demand for our products and solutions as they recognize synergies or rationalize assets and increase or decrease the portion of our total sales concentration to any single customer.
 
A significant portion of our revenues is derived from our product, BluePhoenix™ AppBuilder.  A reduction in number of our customers for this product could reduce our revenues and profitability.
 
In 2010, approximately 20% of our revenues were derived from our product BluePhoenix™ AppBuilder. The comparative high margin of this product causes our sales of this product to have a significant impact on our overall profitability. In recent years, there was a continuing trend of slight decrease in the number of customers for this product. In addition, BluePhoenix™ AppBuilder is a development environment based on the MDA (model driven architecture) approach, which has been considered in the past, as a main stream development architecture. However, as of today, there are newer methodologies that are more widely adopted (like extreme programming or agile development), utilizing development languages like JAVA and .Net. Our revenues from BluePhoenix™ AppBuilder in 2010 decreased 6.5% compared to our revenues from BluePhoenix™ AppBuilder in 2009. In 2009, those revenues decreased 7.2% compared to 2008.  If our revenues from this product continue to decrease, our business, financial condition and results of operations would be materially and adversely affected. For more information about BluePhoenix™ AppBuilder, see “Item 4.B. Our Business-AppBuilder.”

If we do not succeed in competing in the Israeli market for our information and communication technology services, our revenues may decreased.

One of our subsidiaries, Liacom Systems Ltd. (Liacom), provides consulting services, primarily to the Israeli market. Liacom’s revenues in 2008, 2009 and 2010 accounted for 8%, 11% and 17% of our consolidated revenues, respectively. Liacom’s revenues in 2009 increased by 11% compared to its revenues in 2008, and the revenues in 2010 increased by 18% compared to the revenues in 2009. The Israeli market is crowded with various companies offering information and communication technology services similar to those provided by us. We believe that we have an advantage of leadership, knowledge and experience, but our prices are not always competitive. Our consulting services include project management and additional services provided by us following the implementation of the project management. Accordingly, whenever we complete these types of projects, the customer has the option to use its internal resources for the ongoing activities, to continue working with us or use one of our competitors. If our customers select one of our competitors to provide these services, our revenues would decrease and as a result, our financial condition, results of operations and cash flows may be negatively affected.

Our failure to successfully integrate new businesses acquired by us could disrupt our business, dilute your holdings in us, and harm our financial condition and operating results.

In previous years, we acquired and increased our investment in several businesses.

For example, in 2007, we purchased the outstanding share capital of Amalgamated Software North America Inc. (ASNA) for total consideration of $7.0 million.  In December 2010, we sold our holdings in ASNA, including its holding interest in a Spanish affiliated company, for a consideration of $2.0 million. As a result of the sale, we recorded a capital loss of $ 4.0 million.

 
7

 
 
Acquisitions involve numerous risks, including:

 
·
problems combining the acquired operations, technologies, or products;
 
 
·
unanticipated costs or liabilities;
 
 
·
diversion of management’s attention;
 
 
·
adverse effects on existing business relationships with suppliers and customers;
 
 
·
risks associated with entering markets in which we have no or limited prior experience;
 
 
·
potential loss of key employees, particularly those of the acquired organizations; and
 
 
·
impairment of intangible assets related to acquisitions.

Further, products that we acquire from third parties often require significant expenditures of time and resources to upgrade and integrate with our existing product suite. We may not be able to successfully integrate any business, technologies or personnel that we have acquired or those we might acquire in the future, and this could harm our financial condition and operating results.

In addition, your holdings would be diluted if we issue equity securities in connection with any acquisition, as we did in the acquisition of CodeStream Software Ltd. For more information about these transactions, see “Item 4.B. Business Overview-Investments and Acquisitions.”

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

It is critical for us to appropriately align our cost structure with prevailing market conditions to minimize the effect of economic downturns on our operations and, in particular, to continue to maintain our customer relationships while protecting profitability and cash flow. However, we are limited in our ability to reduce expenses due to the ongoing need to maintain our worldwide customer service and support operations and to invest in research and development. In circumstances of reduced overall demand for our products, or if orders received differ from our expectations with respect to the product, volume, price or other items, our fixed cost structure could have a material adverse effect on our business and results of operations. If we are unable to align our cost structure in response to economic downturns on a timely basis, or if such implementation has an adverse impact on our business or prospects, then our financial condition, results of operations and cash flows may be negatively affected.
 
We experienced a significant decrease in revenues in 2010 compared to 2009 and 2008 based on adverse economic conditions. Based on the continuing decline in revenues in 2009 and 2010, we reduced our workforce during 2009 and 2010.  However, we performed most of our reductions in workforce in the latter half of 2010, since we had to keep our workforce for completion of ongoing projects. Due to this, as well as severance and other termination costs, our labor costs were not reduced commensurate with our reduction in revenues. As labor costs constitute a substantial majority of our costs of revenues, selling and administrative expenses and research and development expenses, we incurred significant losses and negative cash flow in 2010.

 
8

 
 
Conversely, adjusting our cost structure to fit economic downturn conditions may have a negative effect on us during an economic upturn or periods of increasing demand for our IT solutions. If we have too aggressively reduced our costs, we may not have sufficient resources to capture new IT projects, timely comply with project delivery schedules and meet customer demand. If we are unable to effectively manage our resources and capacity to capitalize on periods of economic upturn, there could be a material adverse effect on our business, financial condition, results of operations and cash flows.
 
If we are unable to accurately predict and respond to market developments or demands, our business will be adversely affected.
 
The IT modernization business is characterized by rapidly evolving technology and methodologies. This makes it difficult to predict demand and market acceptance for our modernization tools and services. In order to succeed, we need to adapt the tools and services we offer in order to keep up with technological developments and changes in customer needs. We cannot guarantee that we will succeed in enhancing our tools and services, or developing or acquiring new modernization tools and services that adequately address changing technologies and customer requirements. We also cannot assure you that the tools and services we offer will be accepted by customers. If our tools and services are not accepted by customers, our future revenues and profitability will be adversely affected. Changes in technologies, industry standards, the regulatory environment and customer requirements, and new product introductions by existing or future competitors, could render our existing solutions obsolete and unmarketable, or require us to enhance our current tools or develop new tools. This may require us to expend significant amounts of money, time, and other resources to meet the demand. This could strain our personnel and financial resources. Furthermore, modernization projects deal with customer mission critical applications, and therefore encapsulate risk for the customer. Therefore, customers are more cautious in entering into transactions with us, and accordingly, the process for approval and signing of deals may be a lengthy and expensive. We make efforts to mitigate such risks associated with legacy modernization projects but from time to time we encounter delays in the negotiation process.
 
We may experience significant fluctuations in our annual and quarterly results, which makes it difficult to make reliable period-to-period comparisons and may contribute to volatility in the market price of our ordinary shares.
 
Our quarterly and annual results of operations have fluctuated significantly in the past, and we expect them to continue to fluctuate significantly in the future. These fluctuations can occur as a result of any of the following events:

 
·
global economic trends;
 
 
·
global political trends, in particular, in the middle east and in countries in which we operate;
 
 
·
adverse economic conditions in various geographic areas where our customers and potential customers operate;
 
 
·
acquisitions and dispositions of companies;
 
 
·
timing of completion of specified milestones and delays in implementation;
 
 
9

 
 
 
·
timing of product releases;
 
 
·
timing of contracts;
 
 
·
increases in selling and marketing expenses, as well as other operating expenses; and
 
 
·
currency fluctuations and financial expenses related to our financial instruments.

In particular, we have experienced a significant decrease in our revenues over the last three fiscal years. Such decreases were primarily due to a decline in the number of our customers and a decrease in our prices, mostly in our legacy modernization projects. These decreases resulted from the continuing effects of the worldwide economic downturn and uncertainty, particularly in the financial services and banking sector which is our target market. As a result of market uncertainty, we identified delays in our customers’ placement of purchase orders and longer sales cycles. We expect revenues in 2011 to further decrease due to these factors, including a continuing decrease in the number of our legacy modernization projects.
 
We intend to implement a further cost restructuring for 2011, which is expected to result in further severance and other termination costs. However, there can be no assurance that such reduced expenses will be commensurate with our reduced level of revenues. As a result, our business, financial condition and results of operations could be materially and adversely affected.
 
In addition, unexpected events that do not occur on a regular basis and that are difficult to predict may cause fluctuations in our operating results. In 2010 and 2009, as a result of a delay in delivery of a large project, we charged additional $3.6 million and $2.8 million, respectively, of costs incurred by us. In 2010 and 2009, we had losses from continuing operations of approximately $38.1 million and $15.3 million, respectively. These losses were attributable to a number of factors described above, as well as impairment tests of goodwill performed by us on overall IT modernization reporting resulting in impairment losses of $13.2 million in 2010 and $5.7 million in 2009, and which were charged to operations. Additional losses in 2010 were attributable to costs incurred on the sale of one of our subsidiaries and changes in foreign currencies that affected our financial expenses.
 
As a result of the foregoing, we believe that period-to-period comparisons of our historical results of operations are not necessarily meaningful and that you should not rely on them as an indication for future performance. Also, it is possible that our quarterly and annual results of operations may be below the expectations of public market analysts and investors.
 
A delay in collecting our fees could result in cash flow shortages, which in turn may significantly impact our financial results.
 
Typical modernization projects which deploy our solutions are long-term projects. Therefore, payment for these projects or a substantial portion of our fees may be delayed until the successful completion of specified milestones. In addition, the payment of our fees is dependent upon customer acceptance of the completed work and our ability to collect the fees. Further, although the timing of receipt of our fees varies, we incur the majority of our expenses on a current basis. As a result, a delay in the collection of our fees could result in cash flow shortages. In order to improve our liquidity, we entered into sale of receivables’ agreements with a number of institutions, with regard to some of our customers, pursuant to which, control, credit risk and legal isolation of those trade receivables were fully transferred. If the scope of these transactions decreases, our cash flow during the quarter would be harmed and our revenues for the respective quarter will be delayed to the next quarter.
 
 
10

 
 
If we are unable to invest in new products and markets or to manage the effects of changes in our offering portfolio, our results will be adversely affected.
 
We specialize in the development and implementation of sophisticated software modernization and porting tools and products. We leverage our know-how, experience, and generic technologies to develop and introduce new software tools that enable the modernization of legacy systems. The need for our modernization solutions changes over time, and recent regulations or newly introduced technologies may create new needs for modernization solutions. As part of our growth strategy, as new needs evolve, we typically conduct a market analysis to qualify and quantify the market opportunity. If the results justify the investment required for the development of new products or tools, then we begin the development process of the new product. In order to maintain our position in the market, and our ability to address the constantly changing needs of the marketplace, we continually invest in the development of new products.
 
Due to a decline in our revenues, we have had to reduce our research and development expenditures. Our research and development costs were $6.7 million for 2010, compared to $11.4 million and $18.4 million for 2009 and 2008, respectively, which means a decrease of 41% in 2010 compared to 2009 and a 38% decrease in 2009 compared to 2008. These decreases resulted in large part from decreased head count in research and development.
 
There can be no assurances that our continued investment in research and development will result in us maintaining or increasing our market share. Such a failure to maintain market share could result in a further decline in our revenues and operating results.  Moreover, if we seek to increase our research and development expenses without a corresponding increase in revenues, it could have a material adverse effect on our operating results. We may not be able to successfully complete the development and market introduction of new products or product enhancements, in which case our revenues will decline and we may lose market share to our competitors.
 
Our failure to invest in new products and markets or to manage the effects of changes in our offering portfolio could result in our loss of market share, and our business, financial condition and results of operations could be materially and adversely affected as a result.
 
Our results have been adversely affected by the impairment of the value of certain intangible assets, and we may experience impairment charges in the future.
 
The assets listed in our consolidated balance sheet as of December 31, 2010, include, among other things, goodwill valued at approximately $37.0 million, research and development costs valued at approximately $5.6 million, intangible assets related to customers’ relations valued at approximately $1.6 million and other intangible assets valued at approximately $1.8 million. The applicable accounting standards require that:
 
 
·
goodwill is not amortized, but rather is subject to an annual impairment test. We perform an annual impairment test, as well as periodic impairment tests if impairment indicators are present. Intangible assets that are not considered to have an indefinite useful life are amortized using the straight-line basis over their estimated useful lives. The carrying amount of these assets is reviewed whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability of these assets is measured by comparison of the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value (usually discounted cash flow) of the impaired asset; and
 
 
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·
acquired technology and development costs of software that is intended for sale that were incurred after the establishment of technological feasibility of the relevant product, be capitalized and tested for impairment on a regular basis, and written down when capitalized costs exceed net realizable value.
 
In 2010 and 2009, we performed impairment tests and identified losses of $13.2 million and $5.7 million, respectively, related to goodwill of our overall IT modernization reporting unit which were charged to operations. The impairment of these assets was due, in part, a reduction in future expected cash flows from these reporting units and reduction in our market capitalization.
 
If we continue to experience reduced cash flows and our market capitalization stays below the value of our equity, or actual results of operations differ materially from our modeling estimates and related assumptions, we may be required to record additional impairment charges for our goodwill. If our goodwill or capitalized research and development costs were deemed to be impaired in whole or in part due to our failure to achieve our goals, or if we fail to accurately predict the useful life of the capitalized research and development costs, we could be required to reduce or write off such assets. Such write-offs could have a material adverse effect on our business and operating results.
 
If we are unable to attract, train, and retain qualified personnel, we may not be able to achieve our objectives and our business could be harmed.
 
In order to achieve our objectives, we hire from time to time software, administrative, operational, sales, and technical support personnel. The process of attracting, training, and successfully integrating qualified personnel can be lengthy and expensive. We may not be able to compete effectively for the personnel we need. Such a failure could have a material adverse effect on our business and operating results.
 
As part of our expansion strategy, we developed offshore centers in Romania and Russia. We hired professional consultants for these development centers, leveraging the lower employer costs that existed in these countries. In recent years, professional work in these countries became more expensive and professional fees may continue to increase in the future. The establishment of additional offshore facilities, if that occurs, may result in significant capital expenses, which may affect our cash position. We cannot assure you that our offshore facilities will continue to be cost effective. Our future success depends on our ability to absorb and retain senior employees and to attract, motivate, and retain highly qualified professional employees worldwide at competitive prices.
 
 
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If we fail to estimate accurately the costs of fixed-price contracts, we may incur losses.
 
We derive a substantial portion of our revenues from engagements on a fixed-price basis. We price these commitments based upon estimates of future costs. We bear the risk of faulty estimates and cost overruns in connection with these commitments. Our failure to accurately estimate the resources required for a fixed-price project, to accurately anticipate potential wage increases, or to complete our contractual obligations in a manner consistent with the project plan could materially adversely affect our business, operating results, and financial condition. In addition, we may agree to a price before the design specifications are finalized, which could result in a fixed price that is too low, resulting in lower margins or losses to us. For example, in 2010 and 2009, as a result of a delay in delivery of a large project, we incurred expenses of $3.6 million and $2.8 million, respectively. These costs constituted losses on these fixed-price contracts.
 
If our tools or solutions do not function efficiently, we may incur additional expenses.
 
In the course of providing our modernization solutions, the project team conducts testing to detect the existence of failures, errors, and bugs. If our modernization solutions fail to function efficiently or if errors or bugs are detected in our tools, we may incur significant expenditures in an attempt to remedy the problem. The consequences of failures, errors, and bugs could have a material adverse effect on our business, operating results, and financial condition.
 
If we fail to satisfy our customers’ expectations regarding our solutions, or if we fail to timely deliver our solutions to our customers, we may be required to pay penalties, our contracts may be cancelled and we may be the subject of damages claims.
 
In the event that we fail to satisfy our customers’ expectations from the results of the implementation of our solutions, or if we fail to timely deliver our solutions to our customers, these customers may suffer damages. When and if this occurs, we may be required under the customer agreement to pay penalties to our customers or pay their expenses (as occurred in 2009 and 2010) and our customers may have the ability to cancel our contracts. Payments of penalties or a cancellation of a contract could cause us to suffer damages. In addition, we might not be paid for costs that we incurred in performing services prior to the date of cancellation. In addition, from time to time we may be subject to claims as a result of not delivering our products on time or in a satisfactory manner. Such disputes or others may lead to material damages.
 
We are exposed to significant claims for damage caused to our customers’ information systems.
 
Some of the products, tools, and services we provide involve key aspects of our customers’ information systems. These systems are frequently critical to our customers’ operations. As a result, our customers have a greater sensitivity to failures in these systems than do customers of other software products generally. If a customer’s system fails during or following the provision of modernization solutions or services by us, or if we fail to provide customers with proper support for our modernization solutions, we are exposed to the risk of a claim for substantial damages against us, regardless of our responsibility for the failure. We cannot guarantee that the limitations of liability under our product and service contracts, if any, would be sufficient to protect us against legal claims. We cannot assure you that our insurance coverage will be sufficient to cover one or more large claims, or that the insurer will not disclaim coverage as to any future claim. If we lose one or more large claims against us that exceed available insurance coverage, it may have a material adverse effect on our business, operating results, and financial condition. In addition, the filing of legal claims against us in connection with contract liability may cause us negative publicity and damage to our reputation.
 
 
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If third parties assert claims of infringement against us, we may suffer substantial costs and diversion of management’s attention.
 
Substantial litigation over intellectual property rights exists in the software industry. Software products may be increasingly subject to third-party infringement claims as the functionality of products in different industry segments overlaps. We cannot predict whether third parties will assert claims of infringement against us. In addition, our employees and contractors have access to software licensed by us from third parties. A breach of the nondisclosure undertakings by any of our employees or contractors may lead to a claim of infringement against us.
 
Any claim, with or without merit, could be expensive and time-consuming to defend, and would probably divert our management’s attention and resources. In addition, such a claim, if submitted, may require us to enter into royalty or licensing agreements to obtain the right to use a necessary product or component. Such royalty or licensing agreements, if required, may not be available to us on acceptable terms, if at all.
 
A successful claim of product infringement against us and our failure or inability to license the infringed or similar technology could have a material adverse effect on our business, financial condition, and results of operations.
 
We may experience greater than expected competition that could have a negative effect on our business.

We operate in a highly competitive market. Competition in the modernization field is, to a large extent, based upon the functionality of the available automated tools and personnel expertise. Our competitors may be in a better position to devote significant funds and resources to the development, promotion and sale of their modernization tools and services, thus enabling them to respond more quickly to emerging opportunities and changes in technology or customer requirements. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase such competitors’ ability to successfully market their tools and services. We also expect that competition will increase as a result of consolidation within the industry. As we develop new tools and services, we may begin to compete with companies with which we have not previously competed. Our competitors include:

 
·
small vendors who provide specific solutions for a particular area of modernization, such as Ateras, Anubex, Migrationware, Alchemy solutions, HTWC, Speedware, Most and Clerity.

 
·
large system integrators such as IBM, HP,  Accenture and Cap Gemini, some of whom we also partner with;
 
 
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·
software houses such as Micro Focus and Metaware;

 
·
Indian system integrators such as TCS, WIPRO, Infosys and Patni;

 
·
Knowledge management (KM) competitors like eGain, Inquire, Right Now, Kana and Consona;

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

Many of our existing and potential competitors may have or acquire more extensive development, marketing, distribution, financial, technological and personnel resources than we do. This increased competition may result in our loss of market share and pricing pressure which may have a material adverse effect on our business, financial condition and results of operations. We cannot assure you that competition with both competitors within our industry and with the in-house IT departments of certain of our customers or prospective customers will not result in price reductions for our tools and services, fewer customer orders, deferred payment terms, reduced revenues or loss of market share, any of which could materially adversely affect our business, financial condition, and results of operations.

We may be unable to adequately protect our proprietary rights, which may limit our ability to compete effectively.
 
Our success and ability to compete are substantially dependent upon our internally developed technology. Our intellectual property consists of proprietary or confidential information that is not subject to patent or similar protection. Our employees and contractors have direct access to our technology. In general, we have relied on a combination of technical leadership, trade secret, copyright and trademark law, and nondisclosure agreements to protect our proprietary know-how. Unauthorized third parties may attempt to copy or obtain and use the technology protected by those rights. Any infringement of our intellectual property could have a material adverse effect on our business, financial condition, and results of operations. Policing unauthorized use of our products is difficult and costly, particularly in countries where the laws may not protect our proprietary rights as fully as in the United States.
 
Pursuant to agreements with certain of our customers, we have placed, and in the future may be required to place, in escrow, the source code of certain software. Under  the escrow arrangements, the software may, in specified circumstances, be made available to our customers. From time-to-time, we also provide our software directly to customers. These factors may increase the likelihood of misappropriation or other misuse of our software.
 
 
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We are exposed to litigation that could result in considerable financial liabilities.
 
In June 2003, a former Liraz shareholder filed an application with the Tel-Aviv-Jaffa District Court to approve a claim filed by him against us as a class action. The claim relates to the acquisition of Liraz shares, which we completed in March 2003. The shareholder alleges that the share price we paid to Liraz’s shareholders in the tender offer and in a subsequent mandatory purchase was lower than the fair price of Liraz shares. The maximum amount of the claim is approximately NIS 38.9 million ($10.8 million) in the aggregate. Under Israeli law, the court’s approval is required for the plaintiff to represent all of the shareholders of Liraz who sold their shares to us pursuant to the tender offer and the mandatory acquisition. The plaintiff has applied for such approval in the lawsuit. Since the critical issue in our case concerns the basis upon which the fair price of shares purchased within the context of a tender offer is to be determined, and due to the fact that this particular issue has come before the Supreme Court of Israel in an appeal concerning another separate case, the plaintiff in our claim has agreed to postpone the proceedings until the Supreme Court has given its decision in the appeal. In December 2009, the Supreme Court held that, as a general rule, the fair price of shares purchased within the context of a full tender offer shall be determined in accordance with the discounted cash flow method. The plaintiff in our case was supposed to notify the court whether he wishes to renew the proceedings. As of the date of this annual report, the plaintiff has not yet applied to the court. See also “Item 8.A. Consolidated Statements and Other Financial Information – Legal Proceedings.”

Based on our analysis of the statement of claim, including an evaluation of the fair value of the Liraz shares, and the price paid for Liraz in a previous transaction immediately prior to the tender offer, we believe that the allegations against us in this proceeding are without merit and we intend to vigorously defend the claim and contest the allegations made therein. If we are not successful in defending this claim, we could be exposed to considerable financial liabilities and, as a result, our financial condition could be materially adversely harmed.

Risks Relating to International Operations
 
Marketing our tools and solutions in international markets may cause increased expenses and greater exposure to risks that we may not be able to successfully address.
 
We have international operations, which require significant management attention and financial resources. In order to continue to expand worldwide sales, we need to establish additional marketing and sales operations, hire additional personnel, and recruit additional resellers internationally. Based on the significant decline in revenues, we sought to reduce our expenses during 2009 and 2010 by implementing a workforce reduction, including significant reductions to our marketing and sales department.
 
Risks inherent in our worldwide business activities generally include:
 
 
·
currency exchange fluctuations;
 
 
·
unexpected changes in regulatory requirements;
 
 
·
tariffs and other trade barriers;
 
 
·
costs of localizing products for foreign countries;
 
 
·
difficulties in operations of management;
 
 
·
potentially adverse tax consequences, including restrictions on the repatriation of earnings; and
 
 
·
the burdens of complying with a wide variety of local legislation.
 
We cannot assure you that these factors will not have a material adverse effect on our future international sales and, consequently, on our business, operating results, and financial condition.
 
 
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Inflation, devaluation, and fluctuation of various currencies may adversely affect our results of operations, liabilities, and assets.
 
Since we operate in several countries, we are impacted by inflation, devaluation and fluctuation of various currencies. We enter into transactions with customers and suppliers in local currencies, whereas the reporting currency of our consolidated financial statements and the functional currency of our business is the U.S. dollar. Fluctuations in foreign currency exchange rates in countries where we operate can adversely affect the reflection of these activities in our consolidated financial statements. For example, a large portion of our expenses, principally salaries and related personnel expenses, are paid in NIS, whereas most of our revenues are generated in U.S. dollars and Euros. During 2010, we witnessed a strengthening of the NIS against the U.S. dollar, which increased the dollar value of Israeli expenses. If the NIS continues to strengthen against the U.S. dollar, the value of our Israeli expenses will continue to increase. In addition, fluctuations in the value of our non-dollar revenues, costs, and expenses measured in dollars could materially affect our results of operations, and our balance sheet reflects non-dollar denominated assets and liabilities, which can be adversely affected by fluctuations in the currency exchange rates.  
 
Consequently, we are exposed to risks related to changes in currency exchange rates and fluctuations of exchange rates, any of which could result in a material adverse effect on our business, financial condition and results of operations. From time-to-time, we enter into forward currency exchange contracts or other arrangements in order to hedge our foreign currency exposure. Such arrangements may not always be effective or sufficient to offset the fluctuations in currency exchange rates.
 
For additional information relating to the impact of exchange rates between different relevant currencies, see “Item 5. Operating and Financial Review and Prospects–Our Reporting Currency.”
 
Fluctuations in foreign currency values affect the prices of our products and services, which in turn may affect our business and results of operations.
 
Most of our worldwide sales are currently denominated in U.S. dollars, British Pounds, Danish Kroner and Euros while our reporting currency is the dollar. A decrease in the value of the dollar relative to these foreign currencies would make our products more expensive and increase our operating costs and, therefore, could adversely affect our results and harm our competitive position in the markets in which we compete.
 
We are subject to multiple taxing jurisdictions. If we fail to estimate accurately the amount of income tax due in any of these jurisdictions, our net income will be adversely affected.
 
We operate within multiple taxing jurisdictions and are subject to taxation by these jurisdictions at various tax rates. In addition, we may be subject to audits in these jurisdictions. These audits can involve complex issues, which may require an extended period of time to resolve. We cannot assure you that the final tax outcome of these issues will not be different from management estimates, which are reflected in our income tax provisions. Such differences could have a material effect on our income tax provision and net income in the period in which such outcome occurs.
 
 
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Risks Relating to Operations in Israel
 
Political, economic, and military conditions in Israel could negatively impact our business.
 
Over the past several decades, a number of armed conflicts have occurred between Israel and its Arab neighbors. A state of hostility, varying in degree and intensity has led to security and economic problems for Israel. Since 2000, there have been ongoing hostilities between Israel and the Palestinians, which have adversely affected the peace process and at times have negatively influenced Israel’s economy as well as its relationship with several other countries. The taking of control by Hamas, an Islamist movement responsible for many attacks, including missile strikes against Israelis, of the entire Gaza Strip in 2007 further strained relations between Israelis and the Palestinians. The current political situation between Israel and its neighbors may not improve. The impact on Israel of the recent political changes in Egypt and other Arab countries is still unknown. Political, economic and military conditions in Israel could have a material adverse effect on our business, financial condition, results of operations and future growth. In addition, nonexempt male adult citizens of Israel, including some of our officers and employees, are obligated to perform military reserve duty until the age of 40 or 45 depending on their function in the army, and are subject to being called for active duty under emergency circumstances. We cannot predict the full impact of such conditions on us in the future, particularly if emergency circumstances occur. If many of our employees are called for active duty, our operations in Israel and our business may be adversely affected.

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

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

It may be difficult to serve process and enforce judgments against our directors and executive officers in Israel.

We are organized under the laws of the State of Israel. Most of our executive officers and directors are non-residents of the United States, and a substantial portion of our assets and the assets of these persons are located outside the United States. Therefore, it may be difficult to:
 
 
·
effect service of process within the United States on us or any of our executive officers or directors who are non-residents of the United States;
 
 
·
enforce court judgments obtained in the United States, including those predicated upon the civil liability provisions of the United States federal securities laws, against us or against any of our executive officers or directors that are non-residents of the United States, in the United States or Israel; and
 
 
·
bring an original action in an Israeli court against us or against any of our executive officers or directors to enforce liabilities based upon the United States federal securities laws.

 
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Risks Relating to Our Traded Securities
 
The market price of our ordinary shares has been and may be extremely volatile and our investors may not be able to resell the shares at or above the price they paid, or at all.
 
During the past years, the closing price of our ordinary shares experienced significant price and volume fluctuations. The high and low closing prices of our ordinary shares traded on the NASDAQ Global Market and the Tel Aviv Stock Exchange, or TASE, during each of the last three years, are summarized in the table below:
 
   
NASDAQ Global Market
   
TASE
 
   
In $
   
In NIS
 
   
High
   
Low
   
High
   
Low
 
2010
    2.94       1.20       10.99       4.50  
2009
    3.85       1.62       14.24       7.07  
2008
    20.66       1.40       74.83       5.25  

As of March 18, 2011, the exchange rate between the U.S. dollar and the New Israeli Shekel was NIS 3.554 to one dollar.

During the period between January 2008 and March 2011, the market price of our ordinary shares on the NASDAQ Global Market ranged from a high of $20.66 to a low of $1.20. As of March 18, 2011, the market price of our ordinary shares was $1.72. We cannot assure you that the market price of our ordinary shares will return to previous levels. The market price of our ordinary shares may continue to fluctuate substantially due to a variety of factors, including:

 
·
additional impairments of our intangible assets;
 
 
·
our continued operating losses and negative cash flows;
 
 
·
our continued non-compliance with our debt covenants;
 
 
·
our inability to secure funding;
 
 
·
any actual or anticipated fluctuations in our or our competitors’ quarterly revenues and operating results;
 
 
·
shortfalls in our operating results from levels forecast by securities analysts;
 
 
·
adverse consequences of litigation;
 
 
·
public announcements concerning us or our competitors;
 
 
·
the introduction or market acceptance of new products or service offerings by us or by our competitors;
 
 
·
changes in product pricing policies by us or our competitors;
 
 
·
changes in security analysts’ financial estimates;
 
 
·
changes in accounting principles;
 
 
·
sales of our shares by existing shareholders; and
 
 
·
the loss of any of our key personnel.

 
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In addition, global and local economic, political and market conditions, and military conflicts and, in particular, those specifically related to the State of Israel, may affect the market price of our shares.
 
Our ordinary shares are traded on more than one market which may result in price variations. 
 
Our ordinary shares trade on the NASDAQ Global Market and the TASE. Trading in our ordinary shares on these markets takes place in different currencies (dollars on the NASDAQ Global Market and NIS on the TASE), and at different times (resulting from different time zones, different trading days, and different public holidays in the United States and Israel). The trading prices of our ordinary shares on these two markets may differ due to these and other factors. 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.
 
Future sales of our shares to be registered for resale in the public market could dilute the ownership interest of our existing shareholders and could cause the market price for our ordinary shares to fall.
 
As of March 20, 2011, we had 24,054,774 ordinary shares outstanding and 2,562,496 ordinary shares reserved for issuance under our employee equity compensation plans, including 1,933,341 shares reserved for issuance upon the exercise of outstanding employee options, warrants and unvested restricted stock units. We also have the following commitments to issue our ordinary shares:
 
 
·
200,000 ordinary shares issuable upon exercise of warrants issued to institutional investors in connection with the $3 million private placement, completed in March 2006;

 
·
800,000 ordinary shares issuable upon exercise of warrants issued by us to institutional investors in connection with the $35 million private placement completed in November 2007;

 
·
818,745 ordinary shares issuable upon exercise of warrants issued by us to institutional investors in connection with the private placement consummated in October 2009; and

 
·
12,000 ordinary shares issuable upon exercise of warrants issued to Liolios Group, Inc., in connection with certain services provided to us.

We registered for resale the shares underlying the warrants issued to the institutional investors in March 2006, November 2007 and October 2009, pursuant to registration rights agreements entered into with such investors. For more information, see “Item 5.B - Liquidity and Capital Resources – Contractual Commitments and Guarantees.”
 
The exercise of options by employees and office holders, vesting of restricted stock units granted to employees and office holders and the exercise of warrants by investors would dilute the ownership interests of our existing shareholders. Any sales in the public market of our ordinary shares issuable upon exercise of options or warrants could adversely affect the market price of our ordinary shares. If a large number of our ordinary shares is sold in a short period, the price of our ordinary shares would likely decrease.
 
 
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Our U.S. investors could suffer adverse tax consequences if we are characterized as a passive foreign investment company.

Although we believe that we were not a passive foreign investment company, or PFIC, in 2010, we cannot assure you that the United States Internal Revenue Service will agree with our position. We would be a PFIC if (i) 75% or more of our gross income in a taxable year (including our pro rata share of the gross income of any company treated as a corporation for U.S. federal income tax purposes in which we are considered to own directly or indirectly 25% or more of the shares by value) is passive income, or (ii) the value of our assets averaged quarterly over the taxable year (including our pro rata share of the assets of any company treated as a corporation for U.S. federal income tax purposes in which we are considered to own directly or indirectly 25% or more of the shares by value) that produce, or are held for the production of, passive income is at least 50%. Passive income includes interest, dividends, royalties, rents and annuities. If we are or become a PFIC, our U.S. investors could suffer adverse tax consequences, including being taxed at ordinary income tax rates and being subject to an interest charge on gain from the sale or other disposition of our ordinary shares and on certain “excess distributions” with respect to our ordinary shares. For additional information regarding our PFIC status, see the discussion under “Item 10.E. Taxation — United States Federal Income Tax Considerations — Tax Consequences If We Are a Passive Foreign Investment Company.”.

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 listing requirements, which may not afford shareholders with the same protections that shareholders of domestic companies have.
 
As a foreign private issuer whose ordinary 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 Global Market. A foreign private issuer that elects to follow a home country practice instead of such requirements must submit to The NASDAQ Global Market 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 SEC each such requirement that it does not follow and describe the home country practice followed by the issuer instead of any such requirement. We follow home country practice with regard to distribution of annual reports to shareholders, meetings of independent directors in which only independent directors participate, approval of share compensation plans and changes in such plans and approval of share issuance or potential issuance which results in a change of control of the company.
 
 
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ITEM 4. INFORMATION ON THE COMPANY
 
A. 
History and Development of the Company
 
We were incorporated in Israel in 1987 under the name A. Crystal Solutions Ltd. In 1996, we changed our name to Crystal Systems Solutions Ltd. and in 2003, we changed our name to BluePhoenix Solutions Ltd. Our registered office is located at 8 Maskit Street, Herzliya, 46733, Israel and our telephone number is: 972-9-9526110.

For more information about our business and a description of our principal capital expenditures and divestitures that took place since the beginning of the last three financial years and that are currently in progress, see “Item 4.B. Business Overview,” “Item 5. Operating and Financial Review and Prospects” and “Item 18. Financial Statements.”

B. 
Business Overview
 
Our Business
 
We develop and market unique value driven enterprise legacy IT modernization solutions, provide professional services to selected customers and sell knowledge management solutions for contact centers.

IT Legacy Modernization Solutions

Our IT legacy modernization solutions enable companies to automate the process of modernizing and upgrading their mainframe and distributed IT infrastructure in order to more effectively compete in today’s business environment. The combination of our comprehensive tools and services with our unique methodology provides an efficient and cost-effective process for extending the return on investment of existing enterprise IT assets. Our complete modernization solutions consist of a combination of automated technologies and services that minimize the risk through the whole life cycle of the modernization process. Our solutions are based on technologies and services that support the following functionalities: Understanding and mapping an application; Migration of platforms, databases and languages, data and testing; and Remediation. The solutions allow companies to fully leverage their current systems and applications, speed up and reduce the cost of the renewal process, and effectively update their systems in order to be more agile when having to adapt to new business demands. In addition, by using our technologies our customers gain the added value of extending their systems to be ready for future demands, such as Service Oriented Architecture and Cloud computing. Our modernization solutions are offered to customers in all business market sectors, particularly financial services, automotive and governmental entities.

Our solution portfolio includes software products, software tools, and services that address the most pressing IT challenges which organizations and companies face today, including:

 
·
lack of agility and responsiveness to changing business needs;
 
 
·
difficulty in recruiting and retaining mainframe professionals;
 
 
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·
growing cost of infrastructure software licenses, maintenance and operations;
 
 
·
difficulties in complying with new regulations; and
 
 
·
use of old technologies which prevent access to modern tools and inhibit the ability to meet business expectations.
 
Our solutions enable companies to:

 
·
better understand and manage their IT systems and resources;
 
 
·
effectively plan and carry out strategic projects that provide real business value;
 
 
·
transformation to modern technology enables enterprises to recruit professional resources;
 
 
·
significantly decrease maintenance, human resource, and technology costs;
 
 
·
easily integrate packaged applications and build customized applications;
 
 
·
substantially transform applications and databases in order to address regulatory and business changes; and
 
 
·
directly gain access to cutting edge technology and new business channels.

Our comprehensive enterprise technologies span mainframe, midrange, and client/server computing platforms. We have enhanced our expertise through the successful completion of projects for many large organizations over the past two decades, establishing our credibility and achieving international recognition and presence. Based on our technology and that of our affiliates, we develop and market software products, tools, and related methodologies. We deliver our tools and methodologies together with training and support in order to provide enterprises with comprehensive solutions, primarily for the modernization of existing IT systems.
 
Market Background
 
Companies initiate IT modernization projects for a wide range of reasons, such as:

 
·
maintaining a competitive edge in the market;
 
 
·
addressing changing business needs;
 
 
·
complying with new regulations;
 
 
·
reducing maintenance, human resources, and technology costs; or
 
 
·
gaining access to cutting edge technology and new business channels.

Alternatives to modernization include, among others, renewing legacy systems, buying packaged software, or rebuilding entire applications. Enterprise IT modernization has proven to be the most efficient and lowest risk path for companies looking to protect their existing investments. We provide a range of solutions designed to efficiently address the challenge of retaining the business knowledge built into the application code while updating the system to reflect new requirements.

The enterprise legacy IT modernization market is divided into the following categories:

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

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

Our migration solutions provide numerous advantages, including:

 
·
significantly decreasing project costs, risk of errors and time;
 
 
·
preserving corporate business knowledge;
 
 
·
substantially reducing dependency on scarce legacy technology skill sets;
 
 
·
solving problematic maintenance issues;
 
 
·
enabling end-to-end project control and management;
 
 
·
directly supplying a full audit trail and documentation of all changes;
 
 
·
minimizing system freeze time with a unique “refresh” feature; and
 
 
·
comprehensively working with most mainframe and non-mainframe platforms.
 
Our solutions cover legacy databases modernization such as IDMS, ADABAS, IMS and VSAM, to relational databases, such as DB2, Oracle, and SQL Server. The tool performs automated conversions that provide companies with fully functional compliance for source and target applications and minimal application, functional, and logical program flow changes. Our solution leaves no residuals, emulation software, or translation procedures and allows system support to continue uninterrupted during the migration project. As a result of the conversion process, the migrated application operates more efficiently, is easier to maintain, and contains complete documentation of the customer’s knowledge base and guidelines.
 
Platform Modernization

A range of automated migration tools that convert a range of platforms, including IBM mainframe with operating systems such as VSE, MVS, in addition to Fujitsu ICL and Unisys, to Unix, Linux, Windows, and .Net. Our tools can be customized to fit the unique IT configuration and business rules of each customer site. The tool converts platforms to a pure, native installation so that programs are not required to run under emulation or through translation techniques. Our solutions assist companies with reducing IT costs maintaining service levels, setting and upgrading standards, implementing the new IT environment, training IT users, implementing new facilities such as a security system or a batch scheduler, and testing for functional equivalence.

Rehosting

Organizations implement mainframe rehosting in order to reduce the ongoing costs of existing legacy applications. Rehosting leverages the strength and investment of older COBOL and other languages applications while taking advantage of new, cost-efficient hardware and open operating system environments such as Linux, Unix, Windows, J2EE, and .NET.
 
 
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Using our various automated migration tools, and through cooperation with our partners, we offer COBOL migrations, System i and mainframe rehosting solutions. We formed the following alliances for providing these solutions:

 
·
an alliance with Clerity for assisting companies to rehost mainframe applications on more cost-efficient, open platforms;
 
 
·
a collaboration with Fujitsu for assisting companies to migrate COBOL/CICS applications into Fujitsu NetCOBOL and the Fujitsu NeoKicks and NeoBatch environments for handing CICS and batch/JCL;
 
 
·
a partnership with Oracle for assisting companies to migrate their legacy databases to the Oracle database;
 
 
·
advanced membership in IBM’s Partnerworld program to work together with IBM to modernize customers’ databases and applications on the mainframe platform; and
 
 
·
ongoing cooperation with SUN/Oracle that focuses on rehosting customers off of the mainframe and onto SUN’s UNIX platform.
 
LanguageMigrator

BluePhoenix™ LanguageMigrator is a set of automated migration tools for converting COBOL and 4GLs (fourth generation languages) such as ADSO, Natural, CA Gen (formerly COOL: Gen) to COBOL, Java/J2EE and C#/.Net. This reliable, time-efficient, and comprehensive solution enables site-wide installation, simultaneous testing, and implementation of batch programs. In addition, our tools identifies the compatibility of the code, converts it to the new standards required by customers, and analyzes converted programs to identify potential problems.

AppBuilder

In addition to our modernization tools, we develop, maintain and distribute a development environment called BluePhoenix™ AppBuilder. BluePhoenix™ AppBuilder has been used for managing, maintaining, and reusing the complicated applications needed by large businesses. It provides the infrastructure for enterprises worldwide, across several industries, with applications running millions of transactions daily on legacy systems. Enterprises using AppBuilder can build, deploy, and maintain large-scale custom-built business applications for years without being dependent on any particular technology. The deployment environments include IBM mainframe, Unix, Linux and Windows. BluePhoenix™ AppBuilder is intended to increase productivity and agility in the creation and deployment of enterprise class computing.

AppBuilder follows the 4GL development paradigm to help enterprises focus on the business needs and definition, and overlook  technical hurdles. AppBuilder developers define the business roles, and prior to deployment, the code is generated from the development environment to the required run time environment. Several large independent software vendors (ISVs) have built state of the art applications that are deployed through many customers.

We provide our customers new versions and features to the AppBuilder environment, allowing them to stay technological updated. We provide consulting, training, support and additional related services around this unique development environment.

 
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BluePhoenix™ AppBuilder implements a model driven architecture (MDA) approach to application development. It provides the ability to design an application at the business modeling level and generate forward to an application. AppBuilder has a platform-independent, business-rules language that enables generation to multiple platforms. It is possible to generate the client part of an application as Java and the server part as COBOL. As businesses change, the server part can be generated as Java without changing the application logic. Only a simple configuration option needs to be changed.

AppBuilder contains everything a development environment needs to create any type of simple or complex business application with platform-independent functionality, including:

 
System administration security controls for scope and permissions;
 
 
Migration, testing, and deployment functions;
 
 
Architecture-independent development;
 
 
An integrated toolset for designing, developing, and deploying applications;
 
 
Object-based components managed from host, server, or client repositories;
 
 
Support for Java/J2EE, COBOL, C#, and C programming languages;
 
 
An efficient, cross-platform code generation facility;
 
 
Ready-to-use business logic and libraries;
 
 
A remote prepare facility for mainframe development;
 
 
Multiple language user interface support; and
 
 
DBCS support.

Knowledge Management Solutions

The technology and products of BluePhoenix Knowledge Management, referred to as KMS, that we purchased in December 2009, known as KMS LightHouse and DSK2SMB, expand our ability to provide our customers with a whole package of management and upgrading organizational knowledge and computerization foundation. It expands our activity in the area of management and distribution of organizational knowledge in the international arena.

Our solution applies to contact centers and service oriented enterprises around the world. Our product line has proven experience in various market industries such as, telecom, media, Internet, shipment, logistic, tourism, banking, finance, insurance, Hi tech, government and health services.

In a service based organization, an informational worker constantly needs to find in numerous operational systems and repositories, a unique piece of information inside the huge mass of the organizational information. Seeking information is expensive and costly, especially in call centers where the CSRs (customer service representative) spends short amount of time with the organization and continues to other jobs. This is exactly where BluePhoenix's KMS has value and return on investment.

In the core of our methodology, we always think of “Rule 2 – 3 – 4”, meaning that within 2 or 3 seconds and not more then 3 or 4 mouse clicks, at least in 80% of the cases, the service provider will locate the exact piece of information that is needed to provide the best answer to the customer at his first call, with no escalation process.

 
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Our product helps organizing the needed knowledge, ahead of time, in a template and structure manner, to make the consumption of knowledge by the CSR (customer service representative) much easier. Compared to “content applications” or “Enterprise search” tools, KMS LightHouse does not return documents to the CSR, but the actual needed knowledge, in a very clear manner. This saves the CSR need to read documents and understand them while a customer is waiting on the other side of the line. The product has many significant features for contact centers like daily briefing mechanism, call scripts, picture scripts, decision trees, device simulator, management reports, test and surveys and many more. The large set of contact center tailored made features, ensures that companies utilizing KMS LightHouse will provide superb customer experience and higher efficiency in their contact center.

Professional Services

Our world-wide professional service activity is comprised of a high-end application and infrastructure development group. Our professional service activity specializes in enterprise application development, maintenance and system integration.

Our application maintenance services team assumes the daily IT activities involved in maintaining, troubleshooting, analyzing and assessing the application for enhanced efficiency and performance. We also supply software product development services for companies (independent software vendors or software publishers) to reduce significantly their cost of software product development while keeping control of the product architecture. These services enable easy ramping up and ramping down of product teams based on business priorities.

Our professional service team has the required knowledge in a wide range of technologies (legacy and modern) and can provide a competitive solution to enterprises in our region.

Our professional service team is divided between on site consultants and offshore activities. We run an offshore development center in Russia, leveraging the advanced technical resource available for lower cost. Especially to our customers in Europe, the Middle East and Africa, there is a clear advantage utilizing an offshore concept in East Europe over the alternative provided by companies in the Far East.

We are acting as the development force for many companies for their internal development needs alongside product development. Through the many years we are providing the professional services, we have established strong relationships with our customers and brought our joint working methodology to the highest results.

We also provide consulting and information and communication technology services for networking, information security and related software. Our activities focus on providing professional services in all aspects of telecommunications and information technology areas. Our services include development of strategy, preparation of master plans, economic analysis, engineering and regulatory compliance, definition of specifications, systems development, implementation of large networks and evaluation of proposals for tenders.

 
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Our specialists provide consultancy services to various networking technologies including Wireline, Wireless, Cellular, VoIP, RoIP, IPTV, Telephony and Internet. Our consultants have extensive technical, operational and commercial knowledge. Our approach combines different technological areas with an overall view of the diverse business requirements.

Investments and Acquisitions

In order to enhance our solutions and services portfolio, we have invested in certain complementary businesses as described below. The broad portfolio that we established, among others, through these acquisitions, contributes to our ability to penetrate new markets and to offer a complete set of solutions and professional services addressing the broad array of changing demands of our customers. We integrated the acquired businesses into our business and assimilate many of their functions, including, marketing, sales, finance and administration into our existing infrastructure. For more information about our capital expenditures, see “Item 5.B. Liquidity and Capital Resources- How We Have Financed Our Business-Capital expenditures.”

Following is a description of our principal investments and divestitures during the last three fiscal years, as well as those currently in progress:

Danshir Software Ltd. and Danshir Tmurot Ltd.> In January 2010, we acquired from two Israeli companies, Danshir Software Ltd. and Danshir Tmurot Ltd., through the temporary receiver appointed to the companies by the Israeli court, certain business activities in the field of professional services in Israel.  The companies are related to DSKnowledge Ltd., the business we purchased in December 2009. The total consideration paid for the activities of Danshir Software Ltd. and Danshir Tmurot Ltd. was $0.8 million, of which $0.1 million was paid in 2009 as an advance.

Knowledge Management Business.> In December 2009, we purchased the knowledge management business of DSKnowledge Ltd. The knowledge management product modernizes and transforms legacy data, information and content elements in enterprises into one knowledge management repository. Pursuant to the terms of the purchase agreement, we acquired the business for approximately $3.0 million. We committed to pay additional contingent consideration under the purchase agreement of up to $2,795,000 in the event that the purchased business’ net profit (as defined in the purchase agreement) reaches certain predefined targets in each of the years 2010, 2011 and 2012. No contingent consideration was accrued for 2010. As a result, our maximum commitment for contingent consideration under the purchase agreement has decreased to $2.5 million.

TIS Consultants Ltd>. In January 2008, we entered into the TIS purchase agreement for the purchase of the entire outstanding share capital of TIS Consultants Ltd., or TIS, a company incorporated in Cyprus, that wholly owns a subsidiary incorporated in India, TISA Software Consultants Private Limited. TIS provides consulting services, solutions and value added products to the banking industry, specializing in the market for Temenos GLOBUS/T24™.

Under the TIS purchase agreement, we paid to the selling shareholders an amount of $500,000 and an additional amount of $700,000 as a nonrefundable advance payment on account of contingent consideration described below. As part of the transaction, we undertook to pay the selling shareholders contingent consideration if certain conditions are met.

 
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In April 2009, the former shareholders of TIS filed a claim against us, following a dispute regarding the calculation of the consideration payable to them in connection with the TIS transaction. As part of the negotiated terms, in 2009 we paid to the former shareholders of TIS an advance payment of $3,070,000 and in September 2009, we entered into a settlement agreement with TIS pursuant to which we paid them an aggregate of $1,057,500 in January 2010 and $1,163,250 in January 2011. In addition, we issued to the former shareholders of TIS 813,461 ordinary shares of BluePhoenix. As part of the settlement, the parties agreed on a mutual release of their respective claims, and the former shareholders of TIS waived their right to any future contingent consideration.

JLC Russia. >In May 2008, in order to expand our off-shore center in Russia, we purchased the activity of an offshore professional outsourcing center in Nitzni (Russia), for total consideration of $1.18 million. Under the terms of the transaction, we agreed to pay to the selling shareholders of JLC Group Inc., or JLC, additional consideration if certain criteria are met, based on the revenue growth of JLC's activity in 2008 and 2009. Accordingly, we paid to the selling shareholders additional consideration of $406,000 for 2008. No additional consideration was accrued for 2009.

ASNA.> In August 2007, we entered into an agreement to purchase the entire outstanding share capital of Amalgamated Software North America Inc. (ASNA), a private company based in San Antonio, Texas, for total consideration of $7.0 million. The criteria for payment of additional contingent consideration were not met and therefore no additional consideration was accrued. In December 2010, we sold our holdings in ASNA, including its holding interest in a Spanish affiliated company, for a consideration of $2.0  million, $1.5 million of which were paid to us in December 2010 and the remaining $500,000 are payable in December 2012. As a result of the sale, we recorded capital loss of $4.0 million.

BridgeQuest.> Effective April 2007, we entered into an agreement to purchase the entire outstanding share capital of BridgeQuest Inc., a North Carolina corporation that manages and operates a professional outsourcing center in St. Petersburg, Russia. Through this large off-shore center, we offer services at a low cost. The consideration amounted to $2.0 million. Under the terms of the transaction, we committed to pay to the selling shareholders additional consideration computed based on BridgeQuest’s revenues and earnings before interest and taxes, during 2007-2009. For 2007, the contingent consideration amounted to $1.8 million and was recorded as goodwill in 2007. Under an amendment to the agreement entered into in January 2008, we granted to the selling shareholders warrants to purchase 200,000 BluePhoenix ordinary shares upon reaching a certain financial milestone. The warrants were valued at $2.5 million based on the Black-Scholes pricing model applied as of the commitment date, and such amount was recorded as additional goodwill in 2008. These warrants were exercised in 2008. On December 31, 2008, we signed an additional amendment to the purchase agreement, pursuant to which we paid to the selling shareholders in 2009 and 2010 additional aggregate consideration of $1.6 million. This amount was recorded as goodwill in 2008.

CodeStream Software Ltd. >In December 2006, we acquired from a company incorporated in the United Kingdom, CodeStream Software Ltd., certain business activities in the field of modernization of legacy databases, particularly IDMS and other mainframe platforms. Pursuant to the purchase agreement, we hired 18 persons previously employed by CodeStream and assumed all the obligations in respect of the purchased activities. In consideration therefor, we paid to CodeStream $10.2 million. Pursuant to the purchase agreement, as amended in December 2007, an additional amount of $2.5 million was paid in 2008. In addition, as contingent consideration for the purchased activity, we issued to the selling shareholders 400,000 ordinary shares of BluePhoenix in April 2008 valued at $3.8 million based on the share price on the commitment date, and paid an additional amount of $2.5 million in April 2009.

 
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BluePhoenix I-Ter S.p.A. (previously known as I-Ter/Informatica & Territorio S.p.A.). >In the second quarter of 2005, we entered into an agreement to purchase the entire outstanding share capital of I-Ter/Informatica & Territorio S.p.A., referred to as I-Ter. Pursuant to the purchase agreement, we paid to the selling shareholders of I-Ter $1.4 million. In addition, under the terms of the agreement, we paid to the selling shareholders additional consideration based on I-Ter’s average earnings before interest and taxes, for the years 2005 through 2007. Accordingly, we paid to the selling shareholders in 2008 and 2009, an aggregate amount of $6.2 million. In August 2010, I-Ter completed a spin-off, under which I-Ter business was split into two companies. Accordingly, the entire activity of the legacy modernization was transferred to BluePhoenix Legacy Modernization s.r.l, a new company wholly owned (through subsidiary) by BluePhoenix. I-Ter remained active in the field of IT services. In December 2010, I-Ter terminated the employment of certain employees previously employed by I-Ter in Italy and they began working for an Italian company.

Cicero Inc. >(formerly Level 8 Systems Inc.). Pursuant to an agreement signed in October 2007 with Cicero, we repaid $1.7 million on behalf of Cicero to cover a portion of Cicero's credit facility at Bank Ha'Poalim. In connection therewith, the bank released a $2.0 million bank guarantee previously provided by us to the bank to secure Cicero's bank loans. Accordingly, on the repayment date, an amount of $300,000 was charged to earnings. As consideration therefore, Cicero issued to us 2,546,149 ordinary shares of Cicero and a $1.0 million senior promissory note, bearing an annual interest rate of LIBOR + 1% (or in the event of any unpaid interest, LIBOR + 4%) payable in two installments, the first installment of $350,000 was paid in 2008, and the second installment of $671,000 is payable on December 31, 2011.  During 2009 and 2010, we sold all our shareholding in Cicero for an aggregate of $299,000.

Discontinued Operations

In January 2008, our board of directors announced our intent to sell our entire holdings in Mainsoft, in which we held a 58% controlling interest. This decision followed a strategic shift in Mainsoft's product development and marketing strategy outside of BluePhoenix's core business focus. In October 2008 we sold our stake in Mainsoft for consideration of $1.7 million. Mainsoft met the definition of a component. Accordingly the results of operation of Mainsoft are reported as discontinued operation in our 2008 statement of operations and prior periods’ results have been reclassified accordingly.

Customers

We provide our modernization solutions directly or through our strategic partners, such as IBM, HP (EDS), Clerity (Veryant) and Sun Micro Systems. Additionally, from time to time, other IT services companies license our technologies for use in modernization projects in various markets. Our partners include system integrators, as well as other software vendors such as Oracle and Microsoft, who assist us in increasing our penetration and exposure in the market. We provide solutions to our partners’ customers in collaboration with the system integrator’s team. In most cases, the partners provide related services to the customers. Our arrangements with our partners vary. We may enter into distribution agreements under which we grant license rights to our partners or to the partners’ customers or provide related services, or a combination of both. Alternatively, we may enter into subcontractor relationships with our strategic partners.

 
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Our customers for our consulting services in Israel include telecommunications service providers governmental offices, public and private entities.

Some of our agreements are fixed price contracts. These projects bear some risks and uncertainties as we price these contracts based on estimates of future costs, duration of the project, and the impact of potential changes in the scope of the work. We also enter into other types of contracts, including annual maintenance contracts, license agreements, and arrangements on a time and materials basis.
 
In 2010, SDC accounted for 15.9% of our revenues. In 2009, no individual customer accounted for 10% or more of our revenues. In 2008, Capita Group Plc, accounted for 10% of our revenues.

In 2010, we terminated the employment of 38 employees previously employed by us in Denmark. As a result, we anticipate a reduction of approximately $5 million to $6 million in our annual revenues. In addition, in 2010, we entered into an agreement with SDC pursuant to which we licensed to SDC certain software. During 2010, we also entered into an agreement with SDC pursuant to which we shall provide to SDC maintenance and other related services. The aggregate amount paid to us by SDC in 2010, together with software license fees and services fees, was $9.1 million, constituting 15.9% of our consolidated revenues in 2010.

The following table summarizes the revenues from our tools and services by geographic regions based on the location of the end customer for the periods indicated:
 
   
Year ended December 31,
 
   
2010
2009
2008
 
   
(in thousands)
 
                   
North America
  $ 14,432     $ 27,897     $ 22,660  
Europe (other than Denmark)
    18,106       26,091       40,044  
Denmark
    8,998       9,975       11,096  
Israel
    13,457       10,320       10,679  
Other
    2,127       3,495       7,266  
    $ 57,120     $ 77,778     $ 91,745  

 
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Research and Development

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

We continue to reinvest in our company through our investment in technology and process improvement. In addition, we invest in businesses that develop software tools that are complementary to our existing portfolio. We also invest in a skilled and specialized workforce. In 2010, our investment in research and development amounted to $6.7 million, as compared to $11.4 million in 2009 and $18.4 million in 2008. This decrease is attributable to the reallocation of human resources from research and development to delivery of turn-key projects, termination of employment of a significant number of employees as part of the continued implementation of our cost saving plan and reallocation of research and development activities to our Romanian subsidiary. Accordingly, we reduced our investment in certain of our databases modernization tools and IT Discovery. In addition, we ceased development of LogicMiner.

Enterprise IT Understanding

BluePhoenix™ IT Discovery—By further refining our existing understanding technology, IT Discovery provides the basis for legacy understanding needed by the other modernization solutions and projects.

Enterprise IT Automated Migration

Language Migration—In the area of automated language migration, we continue to build on our COBOL and 4GL migration solutions. Our assets in the migration area cover COBOL, JCL, COOL:Gen, ADSO, Natural, CSP, PL/I and other transformations. We continue to extend the support target platform of these transformations to include J2EE and .NET platforms.

BluePhoenix™ LogicMiner—A comprehensive solution for discovery that mines COBOL and extracts business rules from the legacy code, thus providing IT departments with the ability to begin a modernization process based on techniques that preserve the functionality of the legacy code. This tool retains past investments in software assets by producing reusable code objects or descriptive data that can later be used for improving the quality of the legacy code, rewriting the legacy application, or building a full modernization plan. LogicMiner increases a system’s manageability, while eliminating rules that no longer apply to current business procedures.

Chief Scientist Grants

PowerText—We received through a subsidiary, an aggregate of approximately $300,000 in grants from the Office of the Chief Scientist, or the OCS, for the development of PowerText. PowerText is a software solution for automated electronic document mining, management and presentment. Royalties of 3% are payable to the OCS on all sales of PowerText up to 100% of the dollar-linked grant received.

 
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Knowledge Management Systems for Call Centers—We received through a subsidiary, an aggregate of approximately $90,000 in grants from the OCS, for the development of knowledge management system for call centers. Royalties of 3% are payable to the OCS on all sales of PowerText up to 100% of the dollar-linked grant received.

The balance of the contingent liability relating to the royalties payable by our subsidiaries to the OCS, at December 31, 2010, amounted to approximately $330,000.

Other Grants

During 2007, our subsidiary, I-Ter, received an amount of $585,000 from the Ministry of Production in Italy for I-Ter's Easy4Plan product. Easy4Plan is a workflow management tool designed for ISO9000 companies. 36.5% of the funds received constitute a grant, and the remaining 63.5%, is a 10-year loan to be repaid by I-Ter in annual installments until September 2018. The loan bears a minimal annual interest of 0.87% and is linked to the euro. As of March 20, 2011, the remaining loan balance was $330,000.

Intellectual Property

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

Challenges and Opportunities
 
Legacy Modernization
 
In connection with our legacy IT modernization solutions, we encounter challenges associated with driving constant revenue growth while continually improving profit margins. In a market that continues to innovate and evolve, new technologies and practices, by definition, render existing technology deployments out-of-date - or legacy. By the same measure, however, in order for us to capitalize on the constant source of legacy solutions, we must evolve our solutions portfolio to deal with the changing definition of what constitutes “leading edge” technologies and the growing set that is deemed to be “legacy.” Over time, as one legacy set of technologies is gradually replaced, we must be capable of addressing the modernization needs of the next set of aging technologies.
 
 
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The fact that the modernization needs of the market are evolving on a constant basis, necessitates that we be capable of tracking and predicting changes in technologies. Anticipating the needs of the IT modernization market and delivering new tools and services that satisfy the emerging needs is a critical success factor.

However, even if we develop modernization solutions that address the evolving needs of the legacy IT modernization market, we cannot assure you that there will be a predictable demand for our offerings. Vagaries ranging from the macro-economic climate, to the competitive landscape, to the perceived need that the enterprise market has for a specific modernization solution, will all have an impact such as a longer sales cycle and increased pricing pressure.

In addition to our ability to foresee the needs of the market and develop appropriate modernization solutions, our growth is predicated, in part, on the acquisition of companies with services, tools, and technologies that extend or complement our existing business. We may face increased competition for choice acquisition targets or difficulties in identifying and locating new tools and technologies, which may inhibit our ability to complete suitable acquisitions on favorable terms. The successful integration of acquired businesses, technologies, and products into our existing portfolio of solutions will continue to be a significant challenge.

To keep up with the anticipated growing demand for our tools and services, we must retain our highly skilled personnel in the fields of project management, legacy systems, and leading modern technologies. Maintaining and growing the requisite skill base can be problematic; personnel with an understanding of legacy technologies is a finite resource and the market for recruiting and retaining such skills can be highly competitive.
 
Knowledge Management
 
Organizations have done many activities around CRM technologies in recent years, and accordingly, there is a viable opportunity for knowledge management application which extends and completes the CRM application. While CRM applications provide the personal information of the enterprise customer (address, products, invoices and so on), the knowledge management application contains the enterprise general offering and knowledge (products, campaigns, procedures, competition and so on). The combination of the two applications provides comprehensive information to the CSR and the ability to provide customers with adequate service.

There are direct competitors in the KM arena, and in addition, there is the challenge that CRM vendors will add KM capabilities to their applications and will offer the customers a unified suit. Currently, we do not believe that it is a trend, but it is a challenge.
 
AppBuilder
 
AppBuilder MDA (model driven architecture) concept is considered today as legacy. Though there are many benefits to this approach and it was proven all over the world, new development methodologies are taking over. Methodologies like agile programming of extreme programming are challenging the veteran MDM paradigm. Computer sciences graduates get acquainted with the new paradigm in the universities while the MDA and SDLC (system development life cycle) are being neglected.
 
 
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There is a very interesting opportunity within our existing install base, and ability to recruit new customers, but the recruiting of new customers is becoming more challenging and expensive.
 
Professional Services
 
Organizations understand that outsourcing their IT service has meaningful cost saving benefits. There is a lot of potential to continue and grow our professional service practice. We have unique capabilities in legacy modernization consulting and we can offer EMEA customers a cost effective development in their own time zone. Furthermore, we have growth potential from our existing customers to whom we are developing software products and the option to expand and work on additional line of products.

The main challenges of our professional service team is the competition from new Eastern European offshore companies and the traditional competition with offshore companies in the Far East (like India, China and more).
 
Competition
 
Legacy Modernization
 
We face competition for our tools and services from various entities operating in the market. At the highest level, the legacy IT modernization market competes with two other approaches that can be employed to evolve the operating capabilities of a business: re-building business systems from scratch or buying a commercially available application package that can be configured to serve the specific needs of a particular business. The benefits of each approach have been widely documented by major research firms such as Gartner and Forrester. It is typically understood that legacy IT modernization provides several key advantages over the other two, including:

 
·
Lowest risk – existing tried and tested information technology is leveraged directly and translated into a version of itself based on a newer technology platform;
 
 
·
Least cost and time; and
 
 
·
Least impact on the business and professional skill set.

However, some enterprises still choose to abandon legacy technologies and invest in the redevelopment of new business systems.

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

 
·
the ability to offer automated solutions for legacy IT modernization;
 
 
·
the range and number of languages, operating systems and databases supported by said tools;
 
 
·
tool functionality, performance, and reliability;
 
 
·
the extent and range of ancillary professional services that can be offered in conjunction with the actual modernization services;
 
 
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·
availability of experienced personnel and with appropriate modernization subject matter expertise;
 
 
·
solution pricing;
 
 
·
local geographic presence in customer’s territory;
 
 
·
credibility in the market place, customer references and perceived financial stability;
 
 
·
the ability to respond in a timely manner to changing customer needs; and
 
 
·
the quality of operational support and maintenance for any delivered solution.
 
Competition in the legacy IT modernization field is, to a large extent, based upon the functionality of the available tools and personnel expertise. Vendors in this market address the modernization of legacy systems in different ways, and therefore do not always compete directly with the others. Many small vendors, those that possess just a few niche modernization technologies or a focused set of skills, are only capable of addressing a small portion of the overall modernization market. Selected few others are able to offer comprehensive suites of integrated tools and solutions and are able to address the broad set of needs encountered by businesses.

Our principal competitors consist of system integrators, offshore outsourcers, and tool vendors, including leading software developers, who enable the replacement or modernization of legacy systems.

Major system integrators in the market include IBM, HP, Accenture and Cap Gemini, some of whom we also partner with. IBM has established legacy modernization as a strategic aspect of its long-term application development strategy. Major system integrators have a specific and dominant advantage in the underlying application development infrastructure associated with many legacy environments (predominantly IBM mainframes) and a large service delivery capability. In some cases, we cooperate with some of these system integrators in providing specific solutions or portions of comprehensive projects. Major offshore outsourcers in the market include TCS, WIPRO, Infosys and Patni. Both systems integrators and offshore outsourcers have vertical market groups offering consulting and professional services. Although system integrators and offshore outsourcers often have the advantage of brand recognition and depth of resources, their ability to compete with purely automatic tool-based modernization techniques is still limited. Modernization approaches that use relatively inexpensive offshore manual labor to conduct migration projects are still more expensive than those conducted using automated tools and are more prone to project risks and delays.

We also face competition from niche tools and solutions companies operating in the enterprise IT modernization continuum.

Examples of businesses that address specific sub-segments of the market include MicroFocus, Meta Ware, Ateras, Anubex, Migrationware, Alchemy Solutions, HTWC, Speedware and Clerity.

In addition, enterprises themselves represent one of the largest categories of competition. For a variety of reasons, many businesses choose to execute legacy IT modernization projects using their own internal IT resources. The rationale for a company to attempt to conduct modernization activities using in-house resources varies. Reasons include wanting to justify the existence of available resources, the belief that using internal resources will be quicker or cheaper, and decision makers underestimating the complexity of modernization projects or failing to appreciate the benefits that can result by using experienced personnel and built-for-purpose tools.
 
 
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AppBuilder
 
AppBuilder is an MDA (model driven architecture) product. There are similar products in the market utilizing the MDA approach. Companies like CA and IBM, have tools that compete directly with AppBuilder. Furthermore, new development paradigm have become very popular in IT software development and developers today have many alternatives like different Java IDEs (integrated development environment) or Visual Studio.

Knowledge Management

KMS Lighthouse is focused primarily on knowledge management for call centers. We identify four types of competitors for our knowledge management solution:

 
·
Internal knowledge initiatives based on documents or internal portals. Utilizing portal technology for contact center knowledge repository is extremely challenging, as this method does not solve the real problems of the contact center;

 
·
Content management\document management\enterprise search vendors. Some customers fail to understand the difference between knowledge management and different manners of document management or retrieval of documents utilizing smart search engines. CSRs (customer service representatives) cannot read and retrieve knowledge from a document while there is a customer on the other side of the phone line. The main players in this segment are Microsoft Sharepoint as a content management application and Google appliance for enterprise search;

 
·
CRM vendors – as knowledge management is the natural extension to a CRM application, some CRM vendors are adopting KM features into their solution. Companies like eGain and RightNow offer integrated suite of CRM and KM;

 
·
KM niche players – we have identified several companies that compete with our solution directly. There are differentiators but we are aiming to the same type of customers. Our direct competitors include Inquira, Kana, Consona, Talisma  Kaidara and PegaSystems.
 
Professional Services
 
The markets for professional services and offshore services are extremely crowded. There are big global system integrators like TCS, Cap Gimini, Infosys and Wipro. There are numerous professional service and system integrators worldwide, some are more local focused and some operate internationally. The customer decision is based on relationship, success history and cost.

 
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C. 
Organizational Structure
 
We run our worldwide operations through several wholly owned and controlled subsidiaries, named below:

Name of Subsidiary
 
Country of Incorporation
BluePhoenix Solutions USA Inc.
 
United States
BridgeQuest Inc.
 
United States
BluePhoenix Solutions Nordic, AS
 
Denmark
BluePhoenix Solutions U.K. Limited
 
United Kingdom
Blue Phoenix I-Ter S.p.A.
 
Italy
Bluephoenix Legacy Modernization s.r.l.
 
Italy
BluePhoenix Solutions B.V.
 
The Netherlands
BluePhoenix Solutions Ltd.
 
Cyprus
BluePhoenix Solutions Srl.
 
Romania
Liacom Systems Ltd.
 
Israel
Zulu Software Inc.
 
United States
TIS Consultants Ltd.
 
Cyprus
BluePhoenix Knowledge Management Systems Ltd. (formerly known as BluePhoenix Technologies Ltd.)
 
Israel
 
 
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D. 
Property, Plants and Equipment
 
We, together with our subsidiaries and affiliates, currently occupy approximately 6,182 square meters of office space. The aggregate annual rent we paid for these facilities in 2010 was $1.7 million. The following table presents certain information about these facilities and the terms of lease of these facilities.
Country and State
 
City
 
Sq. Meters
 
Expiration
 
Annual anticipated rental fees in 2011(*)
in thousands $
 
Israel
 
Herzliya
    1,220  
December  2012
    389  
Israel
 
Holon
    571  
December 2015
    89  
USA, North Carolina
 
Cary
    730  
April 2012
    135  
USA
 
Virginia
    235  
November 2012
    47  
Denmark
 
Ballerup
    120  
November 2011
    21  
Romania
 
Bucharest
    933  
August 2015
    188  
United Kingdom
 
Buckinghamshire
    15  
April 2011
    8  
United Kingdom
 
Buckinghamshire
    20  
November 2011
    20  
Cyprus
 
Nicosia
    1,152  
April 2011
    10  
Italy
 
Riccione
    200  
December 2013
    31  
Russia
 
St. Petersburg
    698  
 November 2011
    227  
Russia
 
Irkutsk
     78  
 September  2011
    18  
Russia
 
Nizhny Novgorod
    160  
December 2011
    44  
Russia
 
Petrozavodsk
    50  
January 2012
    13  
Total
        6,182         1,240  
________________________
(*) Includes related fees such as management fees, parking, etc.

If, in the future, we determine that we need additional space to accommodate our growth, we believe that we will be able to obtain this additional space without difficulty and at commercially reasonable prices. We do not own any real property.
ITEM 4A. UNRESOLVED STAFF COMMENTS
 
Not applicable.
 
 
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ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
 
Overview
 
We engage in the IT modernization solutions business and provide professional services and knowledge management solutions.

2010 Highlights. We have experienced a significant decline in our revenues over the past three years, from $91.7 million in 2008 to $77.8 million in 2009 and to $57.1 million in 2010. The decline in our revenues has resulted from the general economic recession and, in particular, its impact on the financial services and banking sector which is our largest market. Approximately 40% of our revenues in 2010 were derived from financial institutions, compared to 44% of revenues in 2009 and 60% in 2008.
 
Economic conditions in our target markets have experienced a significant prolonged downturn and remain uncertain, particularly with respect to the financial services industry. Challenging economic times have caused, among other things, a general tightening in the credit markets, lower levels of liquidity, increases in the rates of default and bankruptcy, and reduced corporate profits and capital spending, all of which have had and continue to have a negative effect on our business, results of operations and financial condition. Our services, particularly in modernization projects, deal with customer mission critical applications and encapsulate risk for the customer. Therefore, our customers are more cautious when in entering into these types transactions with us, and consequently, the process for approval and signing of deals may be lengthy and expensive.
 
In response to these market conditions, we are focusing on providing customers with legacy modernization solutions that have a cost effective impact on the customers’ information technology spending, which is particularly important during difficult economic environment. Our knowledge management solution is an example of our ability to deliver cost effective tools to our customers, improving their employees’ productivity.

We sought to offset the decrease in our revenues by instituting initiatives to reduce costs, improve working capital and mitigate the effects of the different related economic conditions on our business. The number of our employees has decreased from approximately 800 in 2008 to 730 in 2009 and to 550 in 2010. However, we were unable to control our costs in relation to the decline in revenues. Although we sought to reduce our costs during 2010, we performed most of our reductions in workforce in the latter half of 2010, after it had become apparent that revenues were not going to increase based on improvements in the economy generally. Due to this, as well as severance and other termination costs, our labor costs were not reduced commensurate with our reduction in revenues. As labor costs constitute a substantial majority of our costs of revenues, selling and administrative expenses and research and development expenses, we incurred significant losses and negative cash flow in 2010. In addition, a significant portion of the workforce reduction was in our marketing and sales department. We believe such reductions were a factor that contributed to the decrease in our revenues, and our business, operating results, and financial condition may be further adversely affected by the reduction in this portion of our workforce.

 
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In 2010, we entered into an agreement with SDC, one of our customers, pursuant to which we terminated 38 employees previously employed by us in Denmark. As a result, we anticipate a decrease of approximately $5 million to $6 million in our annual revenues resulting from a decrease in revenues from SDC. The aggregate amount paid to us by SDC in 2010, together with software license fees and services fees, was $9.1 million, constituting 15.9% of our consolidated revenues in 2010.
 
In addition, we sold our holdings in ASNA, including its interest in a Spanish affiliated company, in December 2010, for consideration of $2.0 million.  Of this amount, $1.5 million was paid to us in December 2010, with the remaining $0.5 million being payable in December 2012. As a result of the sale, we recorded a capital loss of $4.0 million.

As a result of a delay in delivery of a large project, we recorded an additional charge of $3.6 million and $2.8 million in 2010 and 2009, respectively.

Our investment in research and development in 2010 amounted to $6.7 million, compared to $11.4 million in 2009 and $18.4 million in 2008. The decrease in software development costs was attributable to the reallocation of human resources from research and development costs to cost of sales and termination of employment of a significant number of employees as part of the continued implementation of our cost savings plan. The decrease in software development costs in 2009 compared to 2008 results from shifting of some of our professionals who focused on research and development in 2008 to turn-key projects in 2009. In the first quarter of 2011, we approved a restructuring plan to be implemented in 2011 which, among other things, is expected to further reduce the number of our employees, including those engaged in research and development activities.

We have also incurred significant chares related impairment losses on our goodwill.  Pursuant to impairment tests performed in 2010, 2009 and 2008, impairment losses of $13.2 million, $5.7 million and $13.3 million, respectively, related to goodwill of our overall IT modernization reporting unit were identified and charged to income. These impairment losses are attributed mainly to the decrease our in revenues and the decline in our stock price.

2010 Adjusted EBITDA. In evaluating our results, we focus on the following key financial and operating data: revenues, gross margin, recurring revenues, cash flow and adjusted EBITDA.

Recurring revenues are analyzed in terms of revenues from products, revenues from professional services based on our tools, revenues based on geography and revenues from maintenance and long term service contracts. We had negative operating cash flow of $7.6 million in 2010. The change in operating cash flow is primarily attributable to the significant decrease in revenues in 2010 compared to 2009 and 2008, while the adjustment to the level of expenses (mainly workforce) lagged behind. We performed most of our reductions in workforce in the latter half of 2010, after it had become apparent that revenues were not going to increase based on improvements in the economy generally. Due to this, as well as severance and other termination costs, our labor costs were not reduced commensurate with our reduction in revenues. As labor costs constitute a substantial majority of our costs of revenues, selling and administrative expenses and research and development expenses, we incurred significant losses and negative cash flow in 2010. Cash flow from operating activities is targeted to be positive, inter alia, by implementing our recently approved restructuring plan, and the reflection of the impact of the cost saving plan implemented during 2009 and 2010. For more information, see “Item 5.B. Liquidity and Capital Resources.”

 
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The non-GAAP measure of “adjusted EBITDA” serves as an additional indicator of our operating performance and not as a replacement for other measures such as cash flows from operating activities and operating income in accordance with GAAP. We believe that adjusted EBITDA is useful to investors as a measure of forward-looking cash flows as it excludes depreciation and amortization, goodwill impairment, stock based compensation and non-recurring charges, such as termination costs and one-time expenses and losses. Stock-based compensation is an incentive for certain individuals who are part of the executive management. They are affected by historical stock prices which are irrelevant to forward-looking analyses and are not necessarily linked to the operational performance. We also believe that adjusted EBITDA is commonly used by analysts and investors in our industry and enables shareholders and potential investors to apply multiples on adjusted EBITDA in making investment decisions with respect to our company. Our management uses the non-GAAP measure of adjusted EBITDA as the main indicator to evaluate operational performance and future cash flow of our business, and to assist management in allocating financial resources and workforce as well as to determine strategic targets and executive management remuneration.

Adjusted EBITDA does not take into account certain items and therefore it has inherent limitations. We obtain our adjusted EBITDA measurement by adding to net earnings (net loss), financial expenses, amortizations, income taxes, financial expenses, results attributed to non-controlling interests and losses on exchange incurred during the year. We exclude from our adjusted EBITDA calculation the effects of non-monetary transactions recorded, such as stock-based compensation, goodwill impairment, one-time charges (like the one-time expenses related to a large project ended during the fourth quarter of 2010, a loss related to the sale of ASNA and employees’ termination expenses related to our cost saving plan. These expenses do not reflect our on-going future operation. To compensate for these limitations, we analyze adjusted EBITDA in conjunction with other GAAP measures and other operating performance measures. Adjusted EBITDA should not be considered in isolation or as a substitute for a GAAP measure. Investors should carefully consider the specific items included in adjusted EBITDA. While adjusted EBITDA has been disclosed to permit a more complete comparative analysis of our operating performance relative to other companies, investors should be cautioned that adjusted EBITDA as reported by us may not be comparable in all instances to adjusted EBITDA as reported by other companies.

 
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The following table provides a reconciliation of net income (loss) to adjusted EBITDA for the periods indicated:

   
2010
   
2009
   
2008
 
Net income (loss)
    (38,204 )     (15,570 )     (28,601 )
Amortization of intangible assets
    7,002       7,926       9,094  
Goodwill impairment
    13,185       5,670       13,328  
Stock-based and non-cash compensation
    1,506       2,031       2,824  
Cost saving expenses and one-time charges
    14,481       6,167       2,339  
Loss on sale of subsidiary
    3,989       0       0  
Net loss from discontinued operation
    0       -       8,512  
Net income attributed to non-controlling interests
    55       305       228  
Income tax expenses (benefit)
    (133 )     (117 )     (330 )
Financial expenses, net
    750       779       1,839  
Adjusted EBITDA
    2,631       7,191       9,233  
 
The following table provides a reconciliation of cash flow provided by operating activity to adjusted EBITDA for the periods indicated:
 
   
2010
   
2009
   
2008
 
Cash flow provided by operating activity
    (7616     966       902  
Financial expenses and other income paid in cash
    1,195       802       592  
Restructuring expenses and one-time charges paid in cash
    14,218       7,213       2,019  
Increase (decrease) in trade receivable
    (6,990     (3,017     4,702  
Increase (decrease) other current assets
    (442     (568     407  
Decrease (increase) in trade payables
    858       (981     (992
Decrease in other accounts payables
    945       2,429       744  
Income tax paid in cash
    463       347       859  
Adjusted EBITDA
    2,631       7,191       9,233  

Consolidation of the Results of Operations of Our Subsidiaries and Acquired Activity

Following is information regarding the consolidation of the results of operations of certain of our subsidiaries and acquired activity during 2008, 2009 and 2010. We began to consolidate the results of operations of each of these subsidiaries and acquired activity when we acquired control in them.

Name of Subsidiary/purchased activity
 
Beginning Consolidation
TIS Consultants Ltd.
 
First quarter of 2008
JLC Group business
 
Second quarter of 2008
Knowledge Management business
 
Fourth quarter of 2009
Danshir Software Ltd. and Danshir Tmurot Ltd.
 
First quarter of 2010

Following our board of directors' decision to sell our holdings in our subsidiary, Mainsoft in January 2008, we included Mainsoft’s results in our financial statements as a discontinued operation. Accordingly, all figures in this annual report exclude Mainsoft's results. See Note 15 to our financial statements.

 
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Critical Accounting Policies
 
We prepare our consolidated financial statements in conformity with U.S. GAAP. Accordingly, we are required to make certain estimates, judgments, and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies that we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

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

Revenues derived from direct software license agreements are recognized in accordance with FASB ASC Topic 985 “Software” (“ASC 985”), upon delivery of the software, when collection is probable, the license fee is otherwise fixed or determinable, and persuasive evidence of an arrangement exists.

We typically sell our software products and services in stand-alone contracts for software product licenses, services, or maintenance and support. A relatively small portion of our arrangements includes multiple elements. These arrangements are usually arrangements in which we sell a software product license and post-contract support, referred to as PCS.

We allocate the total fee arrangement to the software and the PCS undelivered element based on vendor-specific objective evidence, referred to as VSOE, under which “The fair value of the PCS should be determined by reference to the price the customer will be required to pay when it is sold separately.” The fair value of the PCS is calculated by the consistent renewal rate of the PCS stated in the relevant contract. The portion of the fee arrangement allocated to the PCS is recognized as revenues ratably over the term of the PCS arrangement.

In some agreements with our customers, the customers have the right to receive unspecified upgrades on an if-and-when available basis (we do not provide specific upgrades). These upgrades are considered post-contract support (PCS). Revenue allocated to the PCS is recognized ratably over the term of the PCS.

Long term contracts accounted for pursuant to FASB ASC Topic 605-35-25 (prior authoritative literature: SOP 81-1, “Accounting for Performance of Construction-Type Contracts”) are contracts in which we sell our software framework, on which material modifications, developments and customizations are performed, to provide the customer with a new and modern IT application with enhanced capabilities that were unavailable in its former legacy system. The services are essential to the functionality of the software and to its compliance with customers’ needs and specifications. Under this method, estimated revenue is generally accrued based on costs incurred to date, as a percentage of total updated estimated costs. Changes in our estimates may affect the recognition of our long-term contract revenues. We recognize contract losses, if any, in the period in which they first become evident. Some of our contracts include client acceptance clauses. In these contracts, we follow the guidance of ASC 985-605-55 (formerly TPA 5100.67) and SAB 104. In determining whether revenue can be recognized, when an acceptance clause exists, we consider our history with similar arrangements, the customer’s involvement in the negotiation process, and the existence of other service providers and the payment terms.

 
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We present revenues from products and revenues from services in separate line items. The product revenues line item includes revenues generated from (i) stand-alone software products; and (ii) software products that were included in multiple-element arrangements and were separated pursuant to ASC 985 as aforementioned.

In the services revenue line item, we include (i) revenues generated from stand-alone consulting services; (ii) revenues generated from stand alone PCS; (iii) revenues accounted for pursuant to ASC 605-35-25; and (iv) revenues generated from PCS included in multiple-element arrangement and were separated pursuant to ASC 985 as aforementioned. We have included all long term contracts arrangements in the service revenue line item since we can not establish VSOE of fair value to neither the service element nor the software element. Our software framework and these kinds of modifications and customizations are not sold separately. Therefore, we can not appropriately justify reflecting the product portion separately in our statement of operations.

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

In accordance with FASB ASC Topic 350 “Intangible – goodwill and other,” indefinite life intangible assets and goodwill are not amortized but rather subject to periodic impairment testing.

Goodwill and intangible assets are tested for impairment by comparing the fair value of the reporting unit with its carrying value. Fair value is generally determined using discounted cash flows, market multiples, and market capitalization. Significant estimates used in the fair value methodologies include estimates of future cash flows, future short-term and long-term growth rates, weighted average cost of capital and estimates of market multiples of the reportable unit. If these estimates or their related assumptions change in the future, we may be required to record additional impairment charges for our goodwill and intangible assets. These write downs may have an adverse affect on our operating results. Future events could cause us to conclude that impairment indicators exist and that additional intangible assets associated with our acquired businesses are impaired. In addition, we evaluate a reporting unit for impairment if events or circumstances change between annual tests, indicating a possible impairment. Examples of such events or circumstances include: (i) a significant adverse change in legal factors or in the business climate; (ii) an adverse action or assessment by a regulator; (iii) a more likely than not expectation that a portion of the reporting unit will be sold; (iv) continued or sustained losses at a reporting unit; (v) a significant decline in our market capitalization as compared to our book value; or (vi) the testing for recoverability of a significant asset group within the reporting unit.

 
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The process of evaluating the potential impairment of goodwill is subjective and requires significant judgment at many points during the analysis. In estimating the fair value of the reporting unit for the purpose of our periodic analysis, we make estimates and judgments about the future cash flows of the reporting unit. Although our cash flow forecasts are based on assumptions that are consistent with our plans and estimates we are using to manage the underlying businesses, there is significant exercise of judgment involved in determining the cash flows attributable to a reporting unit over its estimated remaining useful life. In addition, we make certain judgments about allocating shared assets to the estimated balance sheets of our reporting unit. Changes in judgment on these assumptions and estimates could result in a goodwill impairment charge. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.

We have one operating segment and one reporting unit related to overall IT modernization. We utilize a two-step method to perform a goodwill impairment review in the fourth quarter of each fiscal year or when facts and circumstances indicate goodwill may be impaired. In the first step, we determine the fair value of the reporting unit using expected future discounted cash flows and estimated terminal values. If the net book value of the reporting unit exceeds the fair value, we would then perform the second step of the impairment test which requires allocation of the reporting unit's fair value of all of its assets and liabilities in a manner similar to a purchase price allocation, with any residual fair value being allocated to goodwill. The implied fair value of the goodwill is then compared to the carrying value to determine impairment, if any. In 2010, 2009 and 2008, we performed impairment tests, and identified impairment losses of $13.2 million, $5.7 million and $13.3 million, respectively, related to goodwill of our overall IT modernization reporting unit, which were charged to operations. We attribute this impairment primarily to the decline in revenues and the decline in prices.

We determine the fair value of a reporting unit using the Income Approach, which utilizes a discounted cash flow model, as we believe this approach best approximates the unit’s fair value. We corroborated the fair values using the Market Approach. Judgments and assumptions related to revenue, gross profit, operating expenses, future short-term and long-term growth rates, weighted average cost of capital, interest, capital expenditures, cash flows, and market conditions are inherent in developing the discounted cash flow model. Additionally, we evaluated the reasonableness of the estimated fair value of the reporting unit by reconciling to its market capitalization. This reconciliation allowed us to consider market expectations in corroborating the reasonableness of the fair value of the reporting unit. Following such reconciliation, we found that there was no material difference (approximately 1.4%) between the fair value of the reporting unit and its market capitalization as of December 31, 2010. If our market capitalization stays below the value of our equity, or actual results of operations differ materially from our modeling estimates and related assumptions, we may be required to record additional impairment charges for our goodwill. We will continue to monitor market trends in our business, the related expected cash flows and our calculation of market capitalization for purposes of identifying possible indicators of impairment. Should our book value per share continue to exceed our market share price or we have other indicators of impairment, as previously discussed, we will be required to perform an interim step one impairment analysis, which may lead to a step two analysis resulting in goodwill impairment. Additionally, we would then be required to review our remaining long-lived assets for impairment.

 
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Stock Based Compensation>. We account for stock-based compensation to employees in accordance with FASB ASC Topic 718 “Compensation - Stock Compensation.” In the past three years, most of the awards were of restricted stock units (“RSUs”).  RSUs are valued based on the market value of the underlying stock at the date of grant. A small portion of the awards are share options. We measure and recognize compensation expense with respect to share options based on estimated fair values on the date of grant using the Black-Scholes option-pricing model. This option pricing model requires that we make several estimates, including the option’s expected life and the price volatility of the underlying stock.

Income taxes.> As a multinational corporation, we are subject to taxation in many jurisdictions, and the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in various taxing jurisdictions. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty.  Accounting for uncertainty in income taxes requires that tax benefits recognized in the financial statements must be at least more likely than not of being sustained based on technical merits. The amount of benefits recorded for these positions is measured as the largest benefit more likely than not to be sustained. Significant judgment is required in making these determinations. As of December 31, 2010, there are no unrecognized tax benefits. Deferred taxes are determined utilizing the “asset and liability” method, whereby deferred tax asset and liability account balances are determined based on differences between financial reporting and the tax basis 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. We provide a valuation allowance, when it is more likely than not that deferred tax assets will not be realized in the foreseeable future. In calculating our deferred taxes we are taking into account various estimations, which are examined and if necessary adjusted on a quarterly basis, regarding our future utilization of future carry forward losses.

Accounts receivable and Allowances for Doubtful Accounts.> Our trade receivables include amounts due from customers. We perform ongoing credit evaluations of our customers’ financial condition and we require collateral as deemed necessary. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make payments. In judging the adequacy of the allowance for doubtful accounts, we consider multiple factors including the aging of our receivables, historical bad debt experience and the general economic environment. Management applies considerable judgment in assessing the realization of receivables, including assessing the probability of collection and the current credit worthiness of each customer. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

 
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Derivative Instruments. Under the provisions of FASB ASC Topic 815 “Derivatives and hedging,” all derivatives are recognized on the balance sheet at their fair value.

We use foreign currency options, forward exchange contracts and forward interest rate contracts to assist in managing financial risks. We do not use derivative financial instruments for speculative purposes. These instruments are recognized at fair value, with all changes in fair value recorded in current period earnings, as these transactions have not been designated as hedging instruments under ASC 815.

Recently Issued Accounting Pronouncements
 
In December 2010, the FASB issued amendments to the disclosure of pro forma information for business combinations. These amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010 (early adoption is permitted). The amendments clarify the acquisition date that should be used for reporting the pro forma financial information disclosures when comparative financial statements are presented. The amendments also improve the usefulness of the pro forma revenue and earnings disclosures by requiring a description of the nature and amount of material, nonrecurring pro forma adjustments that are directly attributable to the business combination. We believe that the adoption will not have a material impact on our consolidated financial statements.
 
In April 2010, the FASB issued an amendment to the accounting and disclosure for revenue recognition—milestone method. This amendment, effective for fiscal years beginning on or after June 15, 2010 (early adoption is permitted), provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research and development transactions. We believe that the adoption of the amendment will not have a material impact on our consolidated financial statements.
 
In January 2010, the FASB updated the “Fair Value Measurements Disclosures”. More specifically, this update requires (a) an entity to disclose separately the amounts of significant transfers in and out of Levels 1 and 2 fair value measurements, and to describe the reasons for the transfers; and (b) information about purchases, sales, issuances and settlements to be presented separately (i.e. present the activity on a gross basis rather than net) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3 inputs). This update clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at fair value, and requires disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. As applicable to us, this became effective as of the first interim or annual reporting period beginning after December 15, 2009, except for the gross presentation of the Level 3 roll forward information, which is required for annual reporting periods beginning after December 15, 2010 and for interim reporting periods within those years. As applicable to us, the adoption of the new guidance did not have a material impact on our consolidated financial statements.

In October 2009, the FASB issued amendments to the accounting and disclosure for revenue recognition. These amendments, effective for fiscal years beginning on or after June 15, 2010 (early adoption is permitted), modify the criteria for recognizing revenue in multiple element arrangements and require companies to develop a best estimate of the selling price to separate deliverables and allocate arrangement consideration using the relative selling price method. Additionally, the amendments eliminate the residual method for allocating arrangement considerations. We believe that the adoption will not have a material impact on our consolidated financial statements.

 
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Our Reporting Currency

The currency of the primary economic environment in which the operations of BluePhoenix and most of its subsidiaries are conducted is the U.S. dollar. In addition, a substantial portion of our revenues and costs are incurred in dollars. Thus, the dollar is our functional and reporting currency.

We follow FASB ASC Topic 830 “Foreign currency translation” and accordingly non monetary transactions denominated in currencies other than the dollar are measured and recorded in U.S. dollar at the exchange rates prevailing at transaction date. Monetary assets and liabilities denominated in currencies other than the dollar are translated at the exchange rate on the balance sheet date. Exchange gain or losses on foreign currency translation are recorded in income.

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

For the year ended December 31,
 
Inflation rate in Israel
   
Revaluation of NIS against the US$
   
Devaluation of euro against the US$
 
   
%
   
%
   
%
 
2008
    3.8       1.1       5.6  
2009
    3.9       0.7       (3.3 )
2010
    2.7       6.0       (8.0 )
 
A. 
Operating Results
 
The following table presents the percentage relationships of certain items from our consolidated statement of operations, as a percentage of total revenues for the periods indicated:

Statement of Operations Data as a Percentage of Revenues:
 
     
Year ended December 31,
 
   
2010
   
2009
   
2008
 
   
%
   
%
   
%
 
                   
Revenues
    100.0       100.0       100.0  
Cost of revenues
    73.9       57.7       50.2  
Gross profit
    26.1       42.3       49.8  
Research and development costs
    11.7       14.7       20.0  
Selling, general, and administrative expenses
    50.0       39.1       35.3  
Loss on sale of subsidiary
    7.0                  
Goodwill impairment
    23.1       7.3       14.5  
Operating income (loss)
    (65.7 )     (18.8 )     (20.0 )
Financial expenses, net
    1.3       (1.0 )     (2.4 )
Other income, net
    -       -       0.4  
Income (loss) before taxes on income
    (67.0 )     (19.8 )     (22.0 )
Income tax (expense) benefit
    0.2       0.2       0.4  
      (66.8 )     (19.6 )     (21.6 )
Equity in earnings of affiliated companies, net
    -       -       (0.1 )
Net loss from continued operation
    (66.8 )     (19.6 )     (21.7 )
Loss from discontinued operation
    -       -       (9.3 )
Net loss
    (66.8 )     (19.6 )     (31.0 )
Net results attributable to non-controlling interests
    (0.1 )     (0.4 )     (0.2 )
Net loss attributable to BluePhoenix’ shareholders
    (66.9 )     (20.0 )     (31.2 )

Years Ended December 31, 2010 and 2009

Revenues. Revenues decreased 27% from $77.8 million in 2009 to $57.1 million in 2010. The decrease is mainly attributable to the decline in the number of our customers, as well as the decrease in prices, mostly in our legacy modernization projects.
 
Our revenue is dependent upon the strength of the worldwide economy. In particular, we depend upon our customers making continuing capital investments in information technology products. These spending levels are impacted by the worldwide level of demand for enterprise legacy IT modernization solutions and services. Demand for these is normally a function of prevailing global or regional economic conditions and is negatively affected by a general economic slow-down as consumers reduce discretionary spending on information technology upgrades. Although there have been indications that the economy may be improving in many areas, this has not resulted in an increase in purchases by our customers. Our results were particularly affected due to declines in our target market of the financial services industry. In 2010 and 2009, approximately 40% and 44% of our revenues, respectively, was derived from the financial services industry. We believe that the financial services industry continues to be adversely affected by difficult economic conditions.

We have identified delays in purchase order placement and longer sales cycles from our customers.  The negotiation process with our customers in the financial services industry has developed into a lengthy and expensive process. In addition, some of our customers have delayed or cancelled information technology projects or are seeking to lower their costs which has resulted in reduced prices being paid for our products. Customers with excess information technology resources have chosen and may continue to choose to develop in-house software solutions rather than obtain those solutions from us.
 
Revenues generated from our products (software licenses) were $7.9 million in 2010 and $6.8 million in 2009. Revenues generated from our services decreased by 31%, from $71.0 million in 2009 to $49.2 million in 2010.

Our revenues are generated from long term services and maintenance contracts, and from legacy systems modernization (turn-key projects, products and related maintenance). We continued to suffer from a decrease in the revenues generated from legacy systems modernization in 2010, which decreased from $34.6 million in 2009 to $14.7 million in 2010. As a percentage of revenues, revenues from legacy modernization decreased from 44% of revenues in 2009 to 26% of revenues in 2010, most of which is attributable to a decrease in revenues from turn-key projects.

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

   
2010
   
2009
   
2008
 
   
%
   
%
   
%
 
North America
    25       36       25  
Europe (other than Denmark)
    32       34       44  
Denmark
    16       13       12  
Israel
    23       13       12  
Other
    4       4       7  
                         
Total
    100       100       100  

Revenues from customers located in North America decreased in 2010 compared to 2009 due to a decrease in revenues from legacy system modernization. The increase in the percentage of revenues from customers located in Israel was attributed to, among others, our purchase of the KM business.

Gross Profit. As a percentage of revenues, gross profit was 26% in 2010 compared to 42% in 2009. The decrease is attributable to:

 
·
a significant decrease in revenues in 2010 compared to 2009;
 
 
·
a reduction in our cost of revenues lagging behind the decrease in our revenues, which was due to our workforce reductions occurring in the latter half of 2010, after it had become apparent that revenues were not going to increase based on improvements in the economy generally, and our incurring severance and other termination costs in connection with the workforce reduction;
 
 
·
an additional expense of $3.6 million incurred during 2010 relating to a delay in delivery of a large project;
 
 
·
pricing pressures in attracting new customers; and
 
 
·
a reallocation of human resources from research and development costs to cost of sales.

Cost of revenues. Cost of revenues consists of salaries, amortization of intangible assets, fees paid to independent subcontractors and other direct costs. Cost of revenues decreased by 6% from $45.0 million in 2009 to $42.0 million in 2010. This decrease resulted from the reduction in our workforce. The number of our technical expert employees decreased from approximately 430 in 2009 to 385 in 2010. Cost of revenues as a percentage of revenues increased from 58% in 2009 to 74% in 2010. This increase was attributable to the significant decrease in revenues in 2010 compared to 2009. Although we sought to reduce our costs during 2010, we performed most of our reductions in workforce in the latter half of 2010, after it had become apparent that revenues were not going to increase based on improvements in the economy generally. Due to this, as well as severance and other termination costs, our labor costs were not reduced commensurate with our reduction in revenues. In addition, we incurred $3.6 million of costs during 2010 due to a delay in delivery of a large project and costs associated with the reallocation of human resources from research and development costs to cost of sales.

 
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Research and development costs. Research and development costs consist of salaries and consulting fees that we pay to professionals engaged in the development of new software tools and related methodologies. Our development costs are allocated among our modernization suite of tools and are charged to operations as incurred. Research and development costs decreased by 41% from $11.4 million in 2009 to $6.7 million in 2010, mainly as a result of reduction in our research and development activities, shifting of our research and development activities to our cost-effective off-shore centers, reallocation of professional human resources from research and development to the delivery of turn key projects and termination of employment of a significant number of employees. The number of employees in research and development has been decreased from approximately 190 in 2009 to 85 in 2010. As a percentage of revenues, research and development costs decreased from 15% in 2009 to 12% in 2010.

Selling, general, and administrative expenses. Selling, general, and administrative expenses consist primarily of wages and related expenses, travel expenses, sales commissions, selling expenses, marketing and advertising expenses, rent, insurance, utilities, professional fees, depreciation and amortization. Selling, general, and administrative expenses decreased by 6% from $30.4 million in 2009 to $28.6 million in 2010. This decrease is attributable to the dismissal of employees in connection with our cost savings plan which we continued to implement in 2010. The number of employees employed by us in selling, general, and administrative has been decreased from approximately 115 in 2009 to 80 in 2010. As a percentage of revenues, selling, general and administrative expenses increased from 39% in 2009 to 50% in 2010 as a result of the significant decline in revenues in 2010 and the high costs of our cost saving plan relating to the severance pay for dismissed employees. Expenses for doubtful accounts increased from $0.9 million in 2009 to $2.0 million in 2010, based on a quarterly reassessment.

Goodwill impairment. Our intangible assets are tested for impairment on an annual basis or whenever events or circumstances indicate impairment may have occurred. In 2010 and 2009, we performed impairment tests. An impairment loss of $13.2 million was identified in 2010 and attributed to goodwill of our overall IT modernization reporting unit, which was charged to operations, compared to an impairment loss of $5.7 million identified in 2009. We attribute this impairment to the decline in the number of modernization projects performed by us and the decline in prices for our products, resulted from the continuing effect of the global economic and financial downturn and market uncertainty, which caused a significant decrease in our revenues.

Loss on sale of subsidiary. Loss on sale of our subsidiary, ASNA, in 2010 was $4.0 million, mostly derived from the realization of goodwill in the amount of $2.2 million and other intangible assets of $2.1 million. ASNA was a non-core activity and we had not successfully integrated its business into ours.

Financial expenses, net. Financial expenses decreased from $779,000 in 2009 to $750,000 in 2010. The decrease in financial expenses is mostly attributable to adjustment to foreign currency translation that was offset by a decrease in interest expenses and expenses related to derivative financial instruments and realized gain on marketable securities. The derivative is presented at fair value and all changes in fair value are recorded as non cash financial income/expenses, as applicable. Financial income attributed to the warrants issued by us in recent years was similar to 2009 at $1.5 million. This financial income attributed to the warrants is treated under ASC 815-40-15, under which as of January 1, 2009, the warrants (ratchet down of exercise price based upon lower exercise price in future offerings), which are not indexed to our own stock and therefore are a derivative financial liability, are bifurcated and separately accounted for and being recorded.

 
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Income tax benefit. In 2010, we had income tax benefits of $133,000 compared to $117,000 in 2009. The tax benefits for 2010 are compounded from $133,000 current tax expenses offset by $87,000 deferred taxes (which represent our estimated tax benefits for future years) and $179,000 tax benefits related to previous years. We have net operating losses carried forward for tax purposes in the amount of $70 million. We have deferred tax asset at an amount of $1.8 million.

Net income attributable to non-controlling interests. Non-controlling interest in earnings in 2010 was $55,000 compared to $295,000 in 2009, and represented the non-controlling share in the net profit of our subsidiaries, Liacom Systems Ltd. and Zulu Software Inc. The decrease in non-controlling interest results from the decrease in the net profit of these subsidiaries.

Years Ended December 31, 2009 and 2008

Revenues. Revenues decreased by 15% from $91.7 million in 2008 to $77.8 million in 2009. The decrease was mainly attributable to the global economic and financial crisis which caused a decrease in demand from existing customers for our consulting services and pricing pressure in attracting new customers for our legacy modernization projects. The majority of our projects are specifically tailored and negotiated separately, and therefore, the lack of uniform rates and price lists makes us unable to quantify the decrease in pricing.

Revenues generated from our services decreased by 16%, from $84.9 million in 2008 to $71.0 million in 2009. This decrease was attributable to a decrease in demand by existing customers for consulting services. Revenues generated from our products (software license) were $6.8 million in each of 2009 and 2008.

Our revenues are generated from long term services and maintenance contracts, and from legacy systems modernization (turn-key projects, products and related maintenance). Revenues generated from legacy modernization decreased from $37.6 million in 2008 to $34.6 million in 2009. As a percentage of revenues, revenues from legacy modernization increased from 41% of revenues in 2008 to 44% of revenues in 2009. Approximately 44% of our revenues in 2009 were derived from financial institutions compared to 60% of revenues in 2008.

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

   
2009
   
2008
   
2007
 
   
%
   
%
   
%
 
North America
    36       25       22  
Europe (other than Denmark)
    34       44       39  
Denmark
    13       12       19  
Israel
    13       12       10  
Other
    4       7       10  
                         
Total
    100       100       100  

Gross Profit. As a percentage of revenues, gross profit was 42% in 2009 compared to 50% in 2008. The decrease is attributable to: additional expense of $2.8 million incurred during the fourth quarter of 2009 with regard to a large project; pricing pressures in attracting new customers for our legacy modernization projects; and the reallocation of human resources from research and development costs to cost of sales. Some of our professionals, who focused on research and development during 2008, were shifted in 2009 to our turn-key projects.

Cost of revenues. Cost of revenues decreased by 2% from $46.0 million in 2008 to $45 million in 2009. This decrease is a direct result of the decrease in revenues. Cost of revenues as a percentage of revenues increased from 50% in 2008 to 58% in 2009. This increase was attributable to $2.8 million of unexpected costs during the end of 2009 due to a delay in delivery of a large project, pricing pressures in attracting new customers for our legacy modernization projects and the reallocation of human resources from research and development costs to cost of sales.

Research and development costs. Research and development costs decreased by 38% from $18.4 million in 2008 to $11.4 million in 2009, mainly as a result of reallocation of professional human resources from research and development to the delivery of turn key projects. As a percentage of revenues, research and development costs decreased from 20% in 2008 to 15% in 2009.

Selling, general, and administrative expenses. Selling, general, and administrative expenses decreased by 6% from $32.4 million in 2008 to $30.4 million in 2009. This decrease is attributable to the dismissal of employees in connection with our cost savings plan implemented at the end of 2008, offset by increased acquisition related expenses and by provision for termination costs in connection with our cost savings plan implemented in 2009. In 2009, our acquisition related expenses were allocated to general and administrative expenses as a result of a new pronouncement which became effective in 2009. As a percentage of revenues, selling, general and administrative expenses increased from 35% in 2008 to 39% in 2009 as a result of a decrease in revenues in 2009.

Goodwill impairment. In 2009 and 2008, we performed impairment tests. An impairment loss of $5.7 million was identified in 2009 attributed to goodwill of our overall IT modernization reporting unit, which was charged to operations, compared to an impairment loss of $13.3 million identified in 2008. We attribute this impairment to the global economic and financial market crisis, which had a negative effect on our business primarily as a result of the negative equity market conditions which caused a material decline in industry market multiples starting the second half of 2008.

 
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Financial expenses, net. Financial expenses decreased from $2.2 million in 2008 to $779,000 in 2009. The decrease in financial expenses is attributable to $1.5 million of financial income attributed to the warrants issued by us in recent years. This financial income attributed to the warrants is treated under ASC 815-40-15, under which as of January 1, 2009, the warrants (ratchet down of exercise price based upon lower exercise price in future offerings), which are not indexed to our own stock and therefore are a derivative financial liability, are bifurcated and separately accounted for and being recorded. The derivative is presented at fair value and all changes in fair value are recorded as non cash financial income/expenses as applicable. This decrease in financial expenses was offset by fluctuations in foreign currency exchange rates of certain foreign currencies, which had a negative effect on our financial charges.

Other income, net. Other income, net, in 2008, consisted of a $350,000 loan repayment by Cicero Inc. There was no other income, net, in 2009.

Income tax expense. In 2008, we had income tax benefits of $330,000 compared to an income tax benefit of $117,000 in 2009. The tax expenses for 2009 are compounded from $422,000 current tax expenses offset by $493,000 deferred taxes which represent our estimated tax benefits for future years.

Net income attributable to non-controlling interests. Non-controlling interest in earnings in 2009 was $295,000 compared to $179,000 in 2008, and represented the non-controlling share in the net profit of our subsidiaries, Liacom Systems Ltd. and Zulu Software Inc. The increase in non-controlling interest results from an increase in the net profit of these subsidiaries. There was no change in the non-controlling interest.

Discontinued operation. We had a loss from discontinued operation of $8.5 million in 2008 related to Mainsoft.
 
B. 
Liquidity and Capital Resources
 
How We Have Financed Our Business

Public Offerings

In 1997, we consummated two public offerings, and received net proceeds of $33.9 million after deducting underwriting discounts and commissions and offering expenses.

In February 2006, we completed an underwritten public offering in Israel of series A convertible notes in an aggregate principal amount of NIS 54.0 million that were equal at the time of the transaction to approximately $11.5 million (the dollar amount was calculated based on the exchange rate at the date of the transaction). All of the notes have been converted into shares.

 
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Private Placements

In 2004, we completed a $5 million private placement of convertible debentures and warrants to institutional investors. Pursuant to our agreement with the institutional investors, in March 2006, the institutional investors exercised their right to purchase from us, for an aggregate purchase price of $3 million, additional convertible debentures due in 2009. In 2008, the institutional investors converted the entire principal amount of the debentures into 1,620,790 of our ordinary shares. As of March 20, 2011, warrants exercisable into 200,00 ordinary shares were outstanding. These warrants are exercisable until September 2011, at an adjusted exercise price of $6.31 (the exercise price was adjusted pursuant to anti dilution provisions triggered by the private placement that took place in October 2009).

In November 2007, we completed a $35 million private placement of ordinary shares and warrants issued to institutional investors. The warrants are exercisable for 800,000 ordinary shares until November 2012 at an adjusted exercise price of $18.80 (the exercise price was adjusted pursuant to anti dilution provisions triggered by the private placement that took place in October 2009). The net proceeds from the offering were mainly used for repayment of debt.

In October 2009, we completed a $4.2 million private placement of ordinary shares and warrants issued to institutional investors. Under the Securities Purchase Agreement entered into with the institutional investors, we sold to the investors 1,364,575 ordinary shares at a purchase price of $3.05 per share. The investors were also granted 818,745 Series A Warrants exercisable until October 2014, at an exercise price of $3.95. Other warrants issued to the investors already expired.  As agreed with the investors, we registered the shares purchased by the investors and those underlying the warrants for resale under an effective registration statement.

Other Financing Arrangements

In order to improve our liquidity, we entered into sale of receivables’ agreements with a number of institutions, with regard to some of our customers, pursuant to which, control, credit risk and legal isolation of those trade receivables were fully transferred. This facility enables us to receive short term financing from time to time, as the related costs of the financing are similar to the costs of credit lines from banks, and no covenants are required. The balance of sold receivables as at the end of each fiscal quarter in 2010 was $9.7 million, $8.2 million, $6.2 million and $5.6 million. The balance of sold receivables as at the end of each fiscal quarter in 2009 was $6.6 million, $8.8 million, $8.2 million and $9.9 million. In 2010, $24.7 million of receivables were sold. Of this amount, $23.6 million was collected by the financial institutions as of March 20, 2011. 

 
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We have entered into credit facilities with Bank Discount Le’Israel Ltd., Bank Ha’Poalim Ltd., the First International Bank Ltd. and Bank Leumi Le’Israel Ltd. The aggregate amount outstanding under these credit facilities as of December 31, 2010 and as of March 25, 2011, was $14.3 million and $12.3 million, respectively. We use these credit facilities to finance ongoing operations and to make contingent consideration payments. In connection with these credit facilities, we are committed to the banks for certain covenants related to our operations, such as

 
·
maintaining a minimum level of shareholders’ equity of not less than a rate  between 40% to 60% of our total assets and not less than $50 million to $70 million;
 
 
·
maintaining a minimum level of tangible shareholders’ equity not to exceed a deficit of between $30 million and $12 million;
 
 
·
maintaining a cash balance of $10 million;
 
 
·
maintaining a level of EBITDA in four sequential quarters of not less than $5 million;
 
 
·
maintaining  maximum amount of financial debt of no more than $35 million and no more than 40% of our total assets; and
 
 
·
maintaining a ratio of our bank liabilities to current assets, excluding other current assets, of no more than 40%.

Based on our operating results for 2010, we failed to meet the covenants that require our accumulated EBITDA for the last subsequent quarter to be not less than $5 million and that our shareholders’ equity be not less than $50 million to $70 million (depending on the bank's requirements). As a result, one of the banks requested that we accelerate the repayment of our loan in the amount of $2.5 million. Accordingly, this loan is payable in installments until full repayment in the original maturity date, in September 2011, rather than the whole amount payable in September 2011.

We are currently in the process of negotiating a revised set of covenants with the other banks, which will reflect our current level of operations. In addition, as part of our new arrangements with the banks, we have been requested to provide the banks a floating charge on our assets and a fixed charge on our goodwill, as well as certain other fixed charges. However, we cannot assure you that we will be able to reach an agreement with the banks, and if we enter into such agreement, that it would be on favorable terms to us. Our ability to restructure or refinance our credit facilities depends on the condition of the capital markets and our financial condition. Any refinancing of our existing credit facilities could be at higher interest rates and may require us to comply with different covenants, which could restrict our business operations.

If we are unsuccessful in restructuring our credit facilities, the banks could accelerate all of our outstanding debt and we would encounter difficulties in funding our operations.  As a result, we could be required to dispose of material assets or operations or raise alternative funding through the issuance of debt or equity securities. There is no assurance that we would be able to consummate such dispositions or that we will be able to raise additional cash or obtain financing through the public or private sale of debt or equity securities in terms that are favorable to us or advantageous to our existing shareholders.
 
If we fail to restructure or otherwise repay our debt, or if we are required to use a significant portion or all of our cash and current assets to repay our debt, our business, financial condition and results of operations would be materially adversely affected.

 
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Cash and Cash Equivalents

As of December 31, 2010, we had cash and cash equivalents of $12.3 million and working capital of $647,000. As of December 31, 2009, we had cash and cash equivalents of $22.3 million and working capital of $27.6 million. The working capital decreased primarily due to the reclassification of long-term loans as short-term loans as result of the failure to meet the financial covenants and the decrease in the trade receivables.

Net cash used in operating activities in 2010 was $7.6 million. Net cash provided by operating activities in 2009 was $966,000 and in 2008, $902,000. The change is primarily attributable to the significant decrease in revenues in 2010 compared to 2009 and 2008, while the adjustment of the level of expenses (mainly workforce) lagged behind. We performed most of our reductions in workforce in the latter half of 2010, after it had become apparent that revenues were not going to increase based on improvements in the economy generally. Due to this, as well as severance and other termination costs, our labor costs were not reduced commensurate with our reduction in revenues. As labor costs constitute a substantial majority of our costs of revenues, selling and administrative expenses and research and development expenses, we incurred significant losses and negative cash flow in 2010. The negative change in cash flow was partially offset due to changes in operating assets and liabilities that provided $5.7 million in 2010 compared to $2.2 million in 2009. Trade receivables decreased by $7.0 million, due to the decrease in the revenues and the collection of account receivables. This was partially offset by a decrease in trade payables and other payables at an amount of $1.8 million. Other receivables decreased by $400,000.

Net cash used for investment activities was $1.6 million in 2010 compared to $11.9 million in 2009. Cash used for investment activities includes investments in fixed assets of $358,000 in 2010 compared to $589,000 in 2009, investments in newly consolidated activity of $702,000 in 2010 compared to $2.5 million in 2009, contingent consideration for previously purchased subsidiaries and activities of $1.9 million in 2010, compared to $8.9 million in 2009and proceeds from sale of subsidiary of $1.2 million in 2010.
 
Net cash used in financing activities was $773,000, in 2010, representing repayment of net loans to banks. Net cash provided by financing activities in 2009 was $2.9 million, representing $4.1 million received from the private placement consummated in October 2009, offset by $1.2 million which consist from $1.1 million repayment of net loans to banks and $0.1 million other payments.
 
Capital Expenditures
 
Our capital expenditures include the consideration paid for acquired activities and technologies. For more information about our investments and acquisitions, see “Item 4.B. Business Overview–Investments and Acquisitions.”

In 2010, we paid $702,000 for the purchase of certain business activities of Danshir Software Ltd. and Danshir Tmurot Ltd. and $1.9 million as additional consideration with regard to the acquisition of BridgeQuest, TIS and KMS acquired in previous years.

 
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In addition, we received proceeds from a sale of a subsidiary in an amount of $1.2 million.

In 2009, we paid an aggregate of $8.9 million as contingent consideration with regard to the acquisition of BridgeQuest, TIS, Codestream, I-Ter and JLC, and $2.5 million for the newly acquired knowledge management business.

In January 2011, we paid the final payment with regard to the TIS contingent consideration settlement in the amount of $1.2 million.

Investment in property and equipment required to support our software development activities was comprised mainly of computers and peripheral equipment and was $358,000 in 2010 and $589,000 in 2009. The decrease in 2010 was primarily the result of the implementation of our cost savings plan.

In 2009, we repurchased 44,994 of our shares for an aggregate amount of $83,000. In 2010, we did not repurchase any of our shares. The repurchases in 2009 were made in accordance with the resolution of our board of directors adopted in March 2008 authorizing the repurchase of our shares, subject to market conditions, under our existing buy-back programs. As of December 31, 2010, we had repurchased an aggregate of 2,371,240 of our ordinary shares under our buy-back programs, for an aggregate of approximately $15.2 million. Some of the repurchased shares were allotted to employees and consultants in connection with the exercise of options and vesting of RSUs under our option and award plans. Under our buy-back programs, we may purchase our shares from time to time, subject to market conditions and other relevant factors affecting us. Under the Israeli Companies Law, 1999, referred to as the Companies Law, the repurchased shares held by us do not confer upon their holder any rights. The first buy-back program adopted in May 1998 enables us to purchase our shares, utilizing up to $5 million. Under the second buy-back program adopted in September 1998, and amended in May 1999, we may purchase, up to an additional 2,000,000 ordinary shares. We do not currently intend to make any additional repurchases under these two buy-back programs. The closing price of our ordinary shares as quoted on the NASDAQ Global Market on March 21, 2011 was $1.76.

Following our failure to meet certain of our financial covenants included in our credit facilities, we are currently seeking to restructure the terms of our credit facilities and negotiate revised agreement the banks. See “Liquidity and Capital Resources – How We Have Financed Our Business – Other Financing Arrangements.”

Contractual Commitments and Guarantees

2006 Warrants

In connection with a private placement to institutional investors consummated in 2004, in March 2006, the institutional investors exercised their right to purchase from us additional debentures (already fully converted into our shares) and received warrants, exercisable until September 2011, for 200,000 ordinary shares at an exercise price of $6.31 per share (the exercise price was adjusted pursuant to anti dilution provisions triggered by the private placement that took place in October 2009).

 
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As of March 22, 2010, none of these warrants have been exercised. As agreed upon by the investors, we registered the shares underlying the warrants for resale under an effective registration statement.

2007 Warrants

In November 2007, as part of a $35 million private placement, we issued to institutional investors warrants to purchase an aggregate of up to 800,000 BluePhoenix ordinary shares at an exercise price of $21.88 per share, subject to certain adjustments. The exercise price was adjusted to $18.80 per share pursuant to anti dilution provisions triggered by the private placement that took place in October 2009. These warrants may be exercised during a 5-year period, which commenced in November 2007. As agreed upon by the investors, we registered the shares underlying the warrants for resale under an effective registration statement.

2009 Warrants

In October 2009, as part of a $4.2 million private placement, we issued to institutional investors 818,745 Series A Warrants exercisable until October 2014, at an exercise price of $3.95.  The exercise price of the warrants is subject to adjustment in certain events. Other warrants issued to the investors already expired.

As agreed with the investors, we registered the shares underlying the warrants for resale under an effective registration statement.

Registration Rights Agreement

In October 2002, we granted certain registration rights to Formula Systems (1985) Ltd., or Formula, our former controlling shareholder, Mr. Arie Kilman and another shareholder of Liraz, in a Share Exchange Agreement with those shareholders. Under this registration rights agreement, if we propose to register our ordinary shares under the Securities Act, each of these holders may request that we register his shares as well, subject to certain limitations. We shall bear all expenses in connection with the registration, provided that all underwriting commissions shall be paid by the holders selling shares with respect to their shares sold. In 2007, Formula waived its rights under this agreement in connection with the sale of its shares of BluePhoenix.

Chief Scientist
 
Two of our subsidiaries have entered into agreements with the Office of the Chief Scientist, or OCS. These subsidiaries are obliged to pay royalties to the OCS at a rate of 3% on sales of the funded products, up to 100% of the dollar-linked grant received in respect of these products from the OCS. As of December 31, 2010, the contingent liability amounted to $330,000.

Ministry of Production in Italy

During 2007, our subsidiary, I-Ter, received an amount of $585,000 from the Ministry of Production in Italy for I-Ter's Easy4Plan product. Easy4Plan is a workflow management tool designed for ISO9000 companies. 36.5% of the funds received constitute a grant, and the remaining 63.5%, is a 10-year loan to be repaid by I-Ter in annual installments until September 2018. The loan bears a minimal annual interest of 0.87% and is linked to the euro. As of March 20, 2011, the remaining loan balance was $330,000.

 
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Customers’ Bank Guarantees

Under agreements between us and certain of our customers, we undertook to provide these customers with bank guarantees for the assurance of performance of our obligations under our agreements with such customers. As of December 31, 2010, there were outstanding bank guarantees on our behalf for our customers in the aggregate amount of $178,000.

Operating Leases

We are committed under operating leases for rental of office facilities, vehicles, and other equipment for the years 2011 until 2015. Annual rental fees under current leases are approximately $ 1.24 million. In connection with the office leases, we issued bank guarantees of $152,000 in the aggregate.

Indemnification of Office Holders

We entered into an undertaking to indemnify our office holders in specified limited categories of events and in specified amounts, subject to certain limitations. For more information, see “Item 7.B. Related Party Transactions – Indemnification of Office Holders.”

Effective Corporate Tax Rates

Following the tax reform enacted in 2003, an Israeli company is subject to tax on its worldwide income. An Israeli company that is subject to Israeli taxes on the income of its non-Israeli subsidiaries will receive a credit for income taxes paid by the subsidiary in its country of residence, subject to certain conditions. Israeli tax payers are also subject to tax on income from a controlled foreign corporation, according to which an Israeli company may become subject to Israeli taxes on certain income of a non-Israeli subsidiary, if such subsidiary’s primary source of income is a passive income (such as interest, dividends, royalties, rental income, or capital gains)

On January 1, 2006, an additional tax reform was passed relating primarily to profits from investments. The main goal of the reform was to unify the tax rates applicable to profits from investments, such as interest, capital gains, and dividends. Under the reform, the tax rates applicable to companies were reduced to 25% in 2010 and 24% in 2011. The corporate tax rate is scheduled to be further reduced to 23% in 2012, 22% in 2013, 21% in 2014, 20% in 2015 and 18% in 2016. There is a bill of legislation, not yet effective, pursuant to which the reduction in corporate tax rate would be postponed for one year, beginning 2012, such that  the corporate tax rate would be 24% in 2012, 23% in 2013, 22% in 2014, 21% in 2015, 20% in 2016 and 18% in 2017.

Our international operations are taxed at the local effective corporate tax rate in the countries of our subsidiaries’ residence.
 
 
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C. 
Research and Development, Patents and Licenses
 
For a description of our research and development activities, see “Item 4.B. Business Overview – Research and Development.”
 
D. 
Trend Information
 
As discussed above, we have incurred significant losses and negative cash flows from operations in the past. These results have had a negative impact on our financial condition, including our failure to meet certain covenants included in our existing credit facilities. There can be no assurance that our business will become profitable in the future, that additional losses and negative cash flows from operations will not be incurred, that we will be able to satisfy the covenants in our credit facilities, that we will be able to reduce operating expenses or that we will be able to find alternative financing if necessary.

Our revenue is dependent upon the strength of the worldwide economy. In particular, we depend upon our customers making continuing capital investments in information technology products, such as those marketed and sold by us. These spending levels are impacted by the worldwide level of demand for enterprise legacy IT modernization solutions and services. Demand for these is normally a function of prevailing global or regional economic conditions and is negatively affected by a general economic slow-down as consumers reduce discretionary spending on information technology upgrades.
 
Our results were particularly affected due to declines in our target market of the financial services industry. In 2010 and 2009, approximately 40% and 44% of our revenues, respectively, was derived from the financial services industry. We believe that the financial services industry continues to be adversely affected by difficult economic conditions.
 
We have identified and continue to experience delays in purchase order placement by our customers and longer sales cycles. We believe that the significant downturn in the economy caused our customers to react by reducing their capital expenditures in general or by specifically reducing their spending on information technology. The negotiation process with our customers has developed into a lengthy and expensive process. In addition, many of our customers have delayed or cancelled information technology projects. Customers with excess information technology resources have chosen and may continue to choose to develop in-house software solutions rather than obtain those solutions from us. Moreover, competitors may respond to challenging market conditions by lowering prices and attempting to lure away our customers.
 
In addition, our customers may face issues gaining timely access to sufficient credit, which could result in an impairment of their ability to make timely payments to us. If that were to occur, we may be required to increase our allowance for doubtful accounts and our results would be negatively impacted.
 
E. 
Off-Balance Sheet Arrangements
 
None.
 
 
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F. 
Tabular Disclosure of Contractual Obligations
 
The following table summarizes our contractual obligations and commitments as of December 31, 2010:
 
   
Payment due by period
 
Contractual Obligations
 
Total
   
Less than 1 year
   
1–2 years
   
3-5 years
   
More than 5 years
 
   
In thousands $
 
                               
Contingent Consideration
    1,483       1,483       -       -       -  
                                         
Operating Lease Obligations
    4,395       2,160       1,744       491       -  
                                         
Loans from Banks
    14,629       14,363       82       122       62  
                                         
Total
    20,507       18,006       1,826       613       62  

The above table does not include royalties that we may be required to pay to the OCS and that may reach, in the aggregate, as of December 31, 2010, $330,000. For more information about grants received from the OCS, see “Item 4.B. Business Overview – Research and Development.” We are unable to reasonably estimate the amounts that we will eventually be required to pay to the OCS, if at all, and the timing of such payments, since these payments depend on our ability to sell products based on the OCS-funded technologies and the timing of such sales, if any.