Formula Systems (1985) Ltd. — FY2014 Form 20-F
Reporting period: Year ended December 31, 2014; filed April 30, 2015. This is an annual report, not a standalone Q4 filing. Financial statements are audited and prepared under U.S. GAAP; amounts below are U.S. dollars unless stated otherwise.
Business context
Formula is an IT solutions and services holding company operating principally through Matrix, Sapiens and InSync, with Magic Software accounted for as an affiliate. The results are not directly comparable year to year: Formula lost control of Magic in March 2014 and regained control of Sapiens in December 2014. Accordingly, 2014 consolidated results include Magic only through March 5, InSync from April 1, and Sapiens from December 23.
Key financial metrics
| Metric | FY2014 | FY2013 | Change / context |
|---|---|---|---|
| Revenue | $636.4 million | $795.9 million | Down 20.0%; largely reflects changes in which subsidiaries were consolidated. |
| Gross profit / margin | $106.3 million / 16.7% | $192.8 million / 24.2% | Lower reported margin; software services made up 98.3% of 2014 revenue versus 77.5% in 2013. |
| Operating income / margin | $35.0 million / 5.5% | $60.7 million / 7.6% | Lower reported results, also affected by the consolidation changes. |
| Net income | $94.7 million | $106.5 million | Includes substantial equity-method and control-change gains. |
| Net income attributable to Formula shareholders | $80.8 million | $80.7 million | Broadly unchanged; basic EPS was $5.80 versus $5.88. |
| Cash from operating activities | $16.7 million | $68.6 million | Down sharply; 2014 included $13.6 million of increased trade receivables and significant noncash gains. |
| Cash and cash equivalents | $107.4 million | $82.1 million | Year-end cash increased. |
| Cash, short-term deposits and short-term marketable securities | $129.7 million | $100.8 million | Company-reported liquidity measure. |
| Debt to banks and others | $150.0 million | $98.1 million | $41.8 million current and $108.2 million long-term at year-end 2014. |
| Total assets / liabilities / equity | $1,120.7 million / $466.2 million / $654.6 million | $871.8 million / $395.6 million / $476.2 million | Assets and equity rose substantially, including from Sapiens’ reconsolidation. |
Material changes and unusual items
- Software-services revenue rose 1.4% to $625.3 million; proprietary-software and related-services revenue fell 93.8% to $11.1 million, mainly because Sapiens and Magic were not consolidated for most of 2014.
- Matrix revenue increased 10.0% in NIS, while InSync contributed from its April acquisition. Formula acquired InSync for $4.0 million; Sapiens also acquired Knowledge Partners International and related assets, and Matrix completed several acquisitions.
- Equity in gains of affiliated companies was $74.6 million in 2014, versus $60.7 million in 2013. The 2014 result includes gains associated with losing control of Magic and regaining control of Sapiens; these control changes make reported net income less indicative of recurring operations.
- Management presented pro forma comparisons assuming continued consolidation of Magic and Sapiens: revenue of $930.8 million versus $814.0 million, while also describing this as a 4.3% increase. Those figures do not arithmetically imply 4.3% growth and differ from another pro forma presentation in the notes; verify the figures and calculation.
- The company restated 2012 and 2013 results to correct Matrix revenue and receivables misstatements dating back to 2009. The filing describes the irregularities as insignificant; the restatement reduced reported 2013 revenue by $0.8 million and 2012 revenue by $1.8 million.
Liquidity, outlook, risks and contingencies
- Management said available cash, expected subsidiary distributions and existing credit facilities should cover working-capital needs for at least 12 months at the then-current operating level. It may seek additional financing for growth or acquisitions, with no assurance financing will be available on favorable terms.
- Formula’s NIS 200 million institutional loan carries fixed interest of 5.5% and is payable over six years. Formula and Matrix were reported in compliance with their financial covenants at the financial-statement date. Certain subsidiary shares are pledged; breaches can trigger repayment or enforcement. Contractual debt obligations were $134.3 million, excluding interest.
- Formula declared dividends of $0.48 per share paid in July 2014 and $0.535 per share payable in February 2015. The latter is also shown as a $7.9 million dividend payable at year-end; one passage in the filing gives an inconsistent payment year.
- Management noted a stronger-than-usual fourth quarter in 2014 and expects Jewish-holiday seasonality to affect the second and third quarters of 2015. No specific revenue or earnings guidance is provided.
- Key risks include rapid technology change and competition, fixed-price project cost and timing exposure, customer and personnel concentration, acquisition integration, foreign-exchange and Israeli economic/security conditions, cyber and data-security incidents, and dependence on retaining control of listed subsidiaries.
- An arbitrator ruled in January 2015 in a Magic-related nondisclosure dispute; the filing reports a $1.6 million net 2014 impact in one discussion, while the financial-statement note describes a $0.7 million impact in equity in affiliate gains. A Matrix-related class-action certification motion alleges misleading financial statements and seeks damages; Formula said the possible loss could not be estimated. Sapiens also disclosed contingent OCS royalty obligations of $7.6 million.
- The independent auditor issued unqualified opinions on the financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective as of December 31, 2014.
Most important facts for investors to verify
- Reconcile the pro forma revenue figures and stated growth rate, and distinguish them from reported consolidated results.
- Review the Matrix restatement, its effect on comparative results, and the related class-action allegations and any subsequent developments.
- Separate recurring earnings and cash generation from the large gains tied to changes in control of Magic and Sapiens; investigate the sharp decline in operating cash flow.
- Confirm debt maturities, covenant headroom, pledged subsidiary shares and the basis for management’s 12-month liquidity assessment.
- Resolve the inconsistent descriptions of the Magic arbitration impact and the payment date for Formula’s December 2014 dividend.