Formula Systems (1985) Ltd. — FY2013 Form 20-F
Reporting period: Fiscal year ended December 31, 2013; filed April 30, 2014. This is an annual report, not a standalone fourth-quarter report, and the filing text does not provide clear standalone Q4 financial results. Figures are U.S. dollars unless noted; financial statements follow U.S. GAAP.
Business context
Formula is an IT-services and software holding company operating through Matrix, Magic Software and Sapiens. At December 31, 2013, it controlled Matrix and Magic and held 48.6% of Sapiens. Sapiens was deconsolidated on November 19, 2013 after a share offering diluted Formula’s ownership below 50%; its results thereafter were accounted for under the equity method. On March 5, 2014, a Magic offering reduced Formula’s ownership to 45.0%, and Magic became an affiliate rather than a subsidiary.
Key financial metrics
| Metric | FY2012 | FY2013 | Change / context |
|---|---|---|---|
| Revenue | $744.7 million | $796.7 million | Up 7.0% |
| Gross profit / margin | $179.9 million / 24.2% | $193.6 million / 24.3% | Margin broadly stable |
| Operating income / margin | $57.0 million / 7.7% | $61.5 million / 7.7% | Up 8.0%; margin stable |
| Income before taxes | $50.3 million | $55.3 million | Up 9.9% |
| Net income | $47.5 million | $107.1 million | Includes a material Sapiens deconsolidation gain |
| Net income attributable to Formula shareholders | $24.0 million | $81.0 million | 2013 diluted by non-controlling interests and lifted by the gain described below |
| Diluted earnings per share | $1.72 | $5.70 | Reflects the same unusual gain |
| Operating cash flow | $73.1 million | $68.6 million | Down $4.5 million |
| Cash and cash equivalents | $111.2 million | $82.1 million | Cash plus short-term investments and deposits was about $100.8 million in 2013 |
| Total assets / total liabilities / equity | $881.6 / $413.0 / $468.7 million | $877.5 / $395.6 / $481.8 million | Assets and liabilities declined slightly; equity increased |
| Bank and other indebtedness | $104.0 million | $98.1 million | 2013 includes $35.6 million current and $62.4 million long-term; no debentures remained |
2013 current assets were $338.9 million and current liabilities were $211.0 million. Cost of revenue was 75.7% of revenue, and net R&D expense was $14.2 million. The effective tax rate rose to 16.1% from 13.1% in 2012.
Material changes versus FY2012
- Software-services revenue increased 6.3% to $617.3 million; proprietary-software and related-services revenue increased 9.3% to $179.4 million.
- Revenue growth came from Matrix, Magic and Sapiens, but comparisons are affected by changes in consolidation and by currency movements. Management said NIS appreciation boosted the U.S.-dollar translation of Matrix revenue and operating income.
- Equity in gains of affiliates was $60.7 million in 2013, compared with $3.7 million in 2012. It included a $61.2 million gain from losing control of Sapiens after its November share offering. This accounting gain materially increased reported net income and should not be treated as recurring operating performance.
- Investing cash outflow increased to $63.3 million from $11.9 million, reflecting acquisitions, capitalized software development and the accounting effects of Sapiens deconsolidation. Financing cash outflow was $38.4 million, broadly unchanged from 2012.
- Formula paid a $5.4 million dividend in July 2013 and declared a further $4.6 million dividend in December, paid in February 2014.
Outlook, risks and unusual items
- Management said available cash, expected distributions from subsidiaries and available credit should meet working-capital needs for at least 12 months at the then-current operating level. It gave no specific revenue or earnings guidance.
- Formula finalized a NIS 200 million loan in January 2014 (about $57.6 million), with a fixed 5.5% annual rate and approximately four-year average duration, repayable over six years and secured by shares in its publicly traded holdings. The company said proceeds were intended to support investments and subsidiary holdings.
- Management noted seasonal softness in the first and third quarters of 2013 and a significantly stronger fourth quarter. It expected Jewish-holiday seasonality to affect the second and third quarters of 2014.
- A material arbitration claim against Magic remains unresolved. The arbitrator found a breach of a non-disclosure agreement; plaintiffs seek about NIS 52 million (approximately $15 million). The arbitrator has not ruled on damages, and Formula says it cannot estimate the probable loss or whether its accrual will be sufficient. A proposed additional claim was rejected for that proceeding; no separate action had been filed as of the report.
- Principal risks include project timing and fixed-price cost overruns, competition and technology shifts, acquisitions and integration, dependence on skilled personnel and key customers, currency and Israeli-market exposure, subsidiary share-price volatility, and debt covenants. The filing reports customer contract and rent bank guarantees of approximately $14.5 million and $4.4 million, respectively.
- The financial statements received an unqualified audit opinion; management and the auditor reported effective internal control over financial reporting as of year-end.
Important facts for investors to verify
- Reconcile the $81.0 million attributable net income and $5.70 diluted EPS to the $61.2 million Sapiens deconsolidation gain and other non-recurring items.
- Review cash conversion, receivables and acquisition-related commitments; operating cash flow declined while investing outflows increased.
- Confirm the terms, proceeds and use of the January 2014 NIS 200 million loan, and assess collateral, covenant headroom and debt maturities.
- Track Formula’s ownership and accounting treatment of Matrix, Magic and Sapiens after the subsequent offerings; loss of control can materially alter consolidated results.
- Monitor the Magic arbitration, including any damages ruling, accrual adequacy or separate proceedings.
- Assess how exchange rates, seasonality, acquisition integration and the high proportion of revenue generated in Israel affect future margins and cash flows.