Formula Systems (1985) Ltd. — FY 2011 Form 20-F
Reporting period: Fiscal year ended December 31, 2011. This is an annual report, not a standalone fourth-quarter filing. Financial statements are consolidated, presented in U.S. dollars, and prepared under U.S. GAAP. Formula operates through Matrix IT, Magic Software, and Sapiens, with results affected by changes in which subsidiaries it controls.
Key financial metrics
Amounts below are in U.S. dollars; financial-statement amounts are in millions unless indicated otherwise.
| Metric | FY 2011 | FY 2010 | Change / context |
|---|---|---|---|
| Revenue | $640.6 | $549.7 | Up 16.5% |
| Gross profit | $147.7 | $137.2 | Up 7.7% |
| Gross margin | 23.1% | 25.0% | Down about 1.9 percentage points |
| Operating income | $49.5 | $47.0 | Up 5.2%; operating margin about 7.7%, versus 8.5% |
| Income before taxes | $43.0 | $42.6 | Up slightly |
| Net income | $63.1 | $35.0 | Includes a $25.8 gain related to Sapiens deconsolidation |
| Net income attributable to Formula shareholders | $43.0 | $18.4 | More than doubled; materially affected by the Sapiens gain |
| Diluted EPS | $3.11 | $1.36 | Continuing-operations EPS |
| Cash from operating activities | $25.8 | $50.9 | Down about 49%; receivables and other working-capital changes weighed on cash generation |
| Cash used in investing activities | $67.8 | $3.4 | Driven primarily by acquisitions and investment activity |
| Cash from financing activities | $20.3 | $(40.3) | Includes $45.4 of long-term loan proceeds and shareholder dividends |
- Liquidity: At year-end, cash and cash equivalents were $88.2 million, short-term marketable securities $14.3 million, and short-term deposits $5.2 million. Current assets were $307.0 million and current liabilities $181.2 million. The balance-sheet cash and investment figures differ from the “Current Outlook” narrative’s combined cash and short-term investments figure; the filing does not provide a clear reconciliation.
- Debt: Bank and other borrowings totaled $51.1 million, including $16.6 million current and $34.5 million long term. Matrix debentures totaled $46.7 million, including $31.5 million current and $15.2 million long term. These categories imply approximately $97.8 million of bank borrowings and debentures combined.
- Balance sheet: Audited statements report total assets of $669.2 million, total liabilities of $305.5 million, and total equity of $352.2 million, plus $11.5 million of redeemable non-controlling interest. A selected-financial-data table gives slightly different figures; the audited balance sheet is used here.
- Dividend: Formula paid approximately $10 million, or $0.71 per share, in June 2011. Its policy allows distributions of funds not expected to be used for near-term investment, subject to performance and Israeli law.
Material changes versus prior period
- Revenue growth was led by software services, up 21.7% to $549.3 million; proprietary software products and related services declined 7.3% to $91.3 million.
- Cost of revenue rose 19.5%, faster than revenue, and increased from 75.0% to 77.0% of revenue, reducing gross margin. Management cited growth in services costs and the stronger shekel’s impact on dollar-reported costs.
- Formula lost control of Sapiens on August 21, 2011 after Sapiens issued shares to acquire FIS and IDIT, reducing Formula’s interest from 75.6% to about 42%. Sapiens was deconsolidated and thereafter accounted for under the equity method. Formula regained control after year-end, increasing its interest to 52.1% on January 27, 2012.
- Formula recognized a $25.8 million gain on loss of control of Sapiens. The gain substantially elevated reported net income and EPS and is not an indication of recurring operating performance.
- Acquisitions expanded the group: Sapiens acquired FIS and IDIT; Magic acquired BluePhoenix’s AppBuilder activity for $13.5 million in December 2011, with its results to be consolidated from January 2012. Matrix and Magic also made other acquisitions. Acquisition integration and expected synergies remain execution risks.
- Cash from operations fell to $25.8 million from $50.9 million, with an increase in trade receivables of $21.8 million among the stated cash-flow pressures. Cash declined by $22.3 million during the year.
Outlook, risks, contingencies and unusual items
- Management said market recovery continued through 2011 and expected revenue growth to continue in 2012, partly reflecting acquisitions. It also cautioned that economic and financial uncertainty—including European sovereign-debt concerns, tighter credit, reduced spending, inflation, and energy costs—could weaken customer IT spending. No quantified earnings or revenue guidance was provided.
- Formula said available cash, subsidiary distributions, and existing credit facilities should cover working-capital needs for at least 12 months at the then-current operating level. Future acquisition financing may require additional equity, debt, or bank borrowing, which may not be available on favorable terms.
- Principal business risks include customer concentration, fixed-price project cost overruns or delays, competition and pricing pressure, acquisition integration, dependence on skilled personnel and partners, cybersecurity and intellectual-property claims, and volatility in subsidiary share prices. About 76% of 2011 revenue came from Israel; currency movements and Israeli political, economic, and military conditions are relevant exposures.
- Debt agreements contain financial and asset-related covenants; the filing says required financial ratios were met at December 31, 2011. Matrix debentures are linked to the Israeli CPI, bear 5.15% annual interest, and are repayable in installments through 2013. The filing also reports $13.5 million of customer-performance bank guarantees and $4.0 million of lease guarantees.
- Sapiens disclosed a contingent liability of approximately $6.3 million for royalties to Israel’s Office of the Chief Scientist, payable if revenue is generated from supported software. Contractual obligations totaled $164.0 million, including $92.9 million of long-term debt obligations, $39.6 million of lease obligations, and $17.7 million related to acquisitions; debt-obligation totals exclude interest.
- A Magic arbitration found breaches of a nondisclosure agreement; plaintiffs seek approximately $13.6 million. Magic said it could not estimate any probable loss because damages remain uncertain. A separate Sapiens customer arbitration was settled in 2011: Sapiens paid about $1.5 million and recovered $1.2 million from insurance. Other described claims were settled or assessed as not reasonably likely to result in material additional losses.
- Goodwill was approximately $166.6 million. No goodwill or other intangible-asset impairment was recorded in 2009–2011, but impairment remains a risk if future performance or valuations deteriorate. The 2011 marketable-securities impairment charge was $0.7 million.
- The independent auditor issued an unqualified opinion on the financial statements and on internal control over financial reporting; management also concluded disclosure controls and internal controls were effective at year-end.
Important facts for investors to verify
- Reconcile the balance-sheet liquidity figures with the “Current Outlook” narrative, and confirm the company’s unrestricted cash and available subsidiary-level cash.
- Separate recurring operating earnings and cash generation from the $25.8 million Sapiens deconsolidation gain; assess the implications of Sapiens’ year-end deconsolidation and January 2012 reconsolidation.
- Track receivables, collections, and operating cash flow as revenue grows, and compare cash conversion with reported net income.
- Review total debt, near-term maturities, CPI-linked debenture terms, collateral, and covenant headroom, including the effect of acquisition financing.
- Monitor integration, performance, and purchase-price allocation for FIS, IDIT, AppBuilder, and other acquisitions, as well as any contingent consideration and expected synergies.
- Follow the unresolved Magic arbitration, OCS royalty exposure, and customer or lease guarantees for changes in estimated liability or cash requirements.
- Assess gross-margin trends, revenue mix, foreign-exchange sensitivity, and the concentration of sales in Israel and selected large customers.