Formula Systems (1985) Ltd. — FY 2015 Form 20-F
Reporting period: Fiscal year ended December 31, 2015; the filing is an annual report, not a standalone fourth-quarter report. Financial statements are prepared in U.S. dollars under U.S. GAAP. Formula is an IT-services and software holding company, with Matrix and InSync consolidated at year-end and Sapiens and Magic accounted for as affiliates after loss of accounting control during 2015 and 2014, respectively.
Key financial results
Amounts below are U.S. dollars in millions unless otherwise stated.
| Metric | 2014 | 2015 |
|---|---|---|
| Revenue | $636.4 | $750.6 |
| Gross profit / margin | $106.3 / 16.7% | $148.8 / 19.8% |
| Operating income / margin | $35.0 / 5.5% | $46.6 / 6.2% |
| Net income | $94.7 | $92.4* |
| Net income attributable to Formula shareholders | $80.8 | $73.7 |
| Basic / diluted earnings per share | $5.80 / $5.59 | $5.24 / $5.00 |
| Cash from operating activities | $16.7 | $54.4 |
| Cash used in investing activities | $(19.8) | $(58.5) |
| Cash from financing activities | $31.6 | $35.8 |
| Cash and cash equivalents at year-end | $107.4 | $132.6 |
| Bank and other financial-institution debt | $151.4 | $161.9 |
| Debentures outstanding | — | $58.3 |
| Total assets / equity | $1,125.1 / $656.7 | $1,066.9 / $542.3 |
*The audited income statement reports 2015 net income of $92.448 million; selected financial data and some narrative text give $92.488 million.
At year-end 2015, current assets were $357.5 million and current liabilities were $211.8 million. Cash, short-term deposits and marketable securities totaled approximately $143.6 million. Debt includes $161.9 million owed to banks and other financial institutions and $58.3 million of secured and convertible debentures. The filing separately presents $10.0 million of redeemable non-controlling interests outside permanent equity.
Material changes and drivers
- Reported revenue rose 18.0%, but the comparison is substantially affected by changes in which affiliates Formula consolidated. Proprietary software products and related services revenue rose to $136.6 million from $11.1 million, mainly because Sapiens was consolidated for nine months in 2015; software-services revenue declined to $614.0 million from $625.3 million.
- On a comparable pro forma basis assuming Sapiens and Magic were consolidated for all of both years, revenue increased 4.3%, to $971.5 million from $930.8 million, and operating income increased 6.9%, to $71.3 million from $66.7 million.
- Gross and operating margins improved on the reported basis. However, net income attributable to Formula shareholders declined 8.8%, and diluted EPS declined from $5.59 to $5.00.
- Equity in gains of affiliates was $65.1 million in 2015, including a $56.4 million net gain associated with Formula losing accounting control of Sapiens. This non-operating, non-recurring gain materially contributed to reported earnings.
- Cash from operations increased to $54.4 million. Investing outflows increased to $58.5 million, including $45.2 million related to Sapiens deconsolidation and $7.6 million for acquisitions. Financing cash inflows included approximately $58.6 million from the September 2015 debenture offering.
- Matrix remained the largest consolidated business, reporting approximately $584.0 million of revenue. Revenue from customers outside Israel reached 30.0% of the consolidated total, versus 16.5% in 2014; the filing attributes much of the mix change to consolidation differences.
Outlook, risks, contingencies and unusual items
- Management said available cash, subsidiary cash distributions and available credit should meet working-capital needs for at least the next 12 months at the then-current operating level. No specific revenue or earnings guidance was provided.
- Formula issued Series A secured debentures and Series B convertible debentures in 2015, with net proceeds of approximately $58.0 million. The instruments carry covenants and restrictions, including limits on dividends, debt, asset transfers and pledges; breach can accelerate repayment. Formula and Matrix reported compliance with their financial covenants as of the filing date.
- Formula paid approximately $12.9 million in dividends during 2015. A further $0.34-per-share dividend, approximately $5.0 million in total, was declared in January 2016. The debenture terms condition permitted distributions on specified equity, leverage, profit and default tests.
- In May 2016, after the reporting year, Formula and Israel Aerospace Industries each acquired 50% of TSG for approximately $25.8 million, subject to adjustments. TSG’s government and defense exposure, including dependence on the Israeli Ministry of Defense, adds contract-funding and export-approval risks.
- A Sapiens subsidiary faced a customer claim seeking contract termination, refunds and damages totaling approximately €21.5 million. Sapiens recorded a provision based on its current estimate, but the filing does not state the provision amount.
- Magic was ordered to pay damages in an arbitration over an alleged confidentiality-agreement breach; the filing reports a $0.7 million net impact in Formula’s affiliate-gain line. The claimant also pursued additional damages, and a further arbitration process was pending. A separate proposed Matrix shareholder class action was withdrawn and dismissed in January 2016, with immaterial fees and expenses.
- Principal risks include rapid technology shifts and competition, long and fixed-price projects, cybersecurity and privacy exposure, customer concentration, acquisitions and integration, foreign-exchange movements, Israeli political and security conditions, and changes in government and defense spending. The filing reports no material cyber incident to date.
- Management and the auditor concluded that internal control over financial reporting was effective at December 31, 2015; the auditor issued unqualified opinions on the consolidated statements and internal controls. The filing also notes previously discovered irregularities at a subsidiary affecting certain 2009–2013 income-statement items; they were corrected retroactively.
Investor verification priorities
- Reconcile reported growth and margins with the pro forma results and the timing of Sapiens and Magic deconsolidation; distinguish recurring operating performance from the $56.4 million Sapiens control-loss gain.
- Confirm the 2015 net-income discrepancy ($92.448 million in the audited statement versus $92.488 million elsewhere) and review the audited financial statements for any other presentation differences.
- Assess debt maturity, collateral, covenant headroom and dividend restrictions across Formula and Matrix, including the Series A and Series B terms and the effect of conversion or refinancing.
- Review the provision and potential exposure for the €21.5 million Sapiens customer claim and the status and possible costs of Magic’s arbitration matters.
- Evaluate the TSG acquisition’s funding, integration, government-customer concentration and export-license exposure, as a post-year-end transaction.