FORM 20-F/A
(Amendment No. 2)
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[ ] 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, 2004;
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
Commission File Number: 0-29442
FORMULA SYSTEMS (1985) LTD.
---------------------------
(Exact name of registrant as specified in its charter)
Israel
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(Jurisdiction of incorporation or organization)
3 Abba Eban Boulevard, Herzlia 46725, Israel
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(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
None
Securities registered or to be registered pursuant to Section 12(g) of the Act:
American Depositary Shares
Ordinary Shares, NIS 1 par value
--------------------------------
(Title of class)
Securities for which there is a reporting obligation pursuant to Section 15(d)
of the Act:
American Depositary Shares
Ordinary Shares, NIS 1 par value
--------------------------------
(Title of Class)
As of December 31, 2004, the registrant had 10,800,000 outstanding ordinary
shares, NIS 1 par value, of which 412,472 were represented by American
depositary shares as of such date.
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 ___
Indicate by check mark which financial statement item the registrant has elected
to follow:
Item 17 Item 18 X
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.
Beginning with the fiscal year ended December 31, 2002, we prepare our
consolidated financial statements in accordance with accounting principles
generally accepted in the United States, commonly referred to as U.S. GAAP.
Prior to 2002, we prepared our consolidated financial statements in accordance
with accounting principles generally accepted in Israel, referred to as Israeli
GAAP. Israeli GAAP and U.S. GAAP vary in certain respects. As a result, we have
restated certain figures in our financial statements relating to prior periods.
In accordance with U.S GAAP, we use the United States dollar as our reporting
currency. Prior to 2002, we presented our consolidated financial statements in
New Israeli Shekels, or NIS, that have been adjusted to reflect changes in the
Israeli consumer price index, referred to as the Israeli CPI.
As used in this annual report, references to dollar refer to the United
States dollar and references to NIS refer to New Israeli Shekels.
As used in this annual report, references to "we", "our", "ours" and "us"
refer to Formula Systems (1985) Ltd. and its subsidiaries, unless otherwise
indicated. References to "Formula" refer to Formula Systems (1985) Ltd.
All trademarks appearing in this annual report are the property of their
respective holders.
The purpose of this 20F/A is to provide additional disclosure in response
to comments from the Securities and Exchange Commission. This amendment does not
reflect events occurring after the origional filing of the Form 20-F or modify
or update thoes disclosures in Form 20-F, expect to reflect the addional
disclosure described above.
TABLE OF CONTENTS
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS.................3
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE...............................3
ITEM 3. KEY INFORMATION.......................................................3
ITEM 4. INFORMATION ON THE COMPANY...........................................17
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS.........................47
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES...........................63
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS....................74
ITEM 8. FINANCIAL INFORMATION................................................80
ITEM 9. THE OFFER AND LISTING................................................81
ITEM 10. ADDITIONAL INFORMATION..............................................83
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.........97
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES..............98
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES.....................98
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS.....................................................................98
ITEM 15. CONTROLS AND PROCEDURES.............................................98
ITEM 16. [RESERVED]..........................................................99
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT...................................99
ITEM 16B. CODE OF ETHICS.....................................................99
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES.............................99
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES........100
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUERAND AFFILIATED
PURCHASERS..................................................................100
ITEM 17. FINANCIAL STATEMENTS...............................................101
ITEM 18. FINANCIAL STATEMENTS...............................................101
ITEM 19. EXHIBITS...........................................................101
Exhibit Index...............................................................104
2
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 our consolidated statement of operations
and balance sheet data for the periods and as of the dates indicated. We derive
the consolidated statement of operations data for the years ended December 31,
2002, 2003 and 2004, and the balance sheet data as at December 31, 2003 and 2004
from our consolidated financial statements included elsewhere in this annual
report. Our consolidated financial statements have been audited by Ziv Haft
certified public accountants (Isr.) BDO member firm. The consolidated income
statement data for the years ended December 31, 2000 and 2001 and the
consolidated balance sheet data for the years ended December 31, 2000, 2001 and
2002 is derived from our audited financial statements not included in this
annual report. You should read the selected consolidated financial data together
with our consolidated financial statements included elsewhere in this annual
report. See "Item 5. Operating and Financial Review and Prospects."
3
Year Ended December 31,
---------------------------------------------
---------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
$
-
(In thousands, except per share data)
Consolidated Statement of
Operations Data:
Revenues $456,610 $366,830 $283,310 $387,682 $402,469
Cost of revenues 284,961 230,500 186,908 261,346 239,506
------- ------- ------- -------
Gross profit 171,649 136,330 96,402 126,336 162,963
Research and development 25,036 17,368 15,967 21,287 20,465
costs, net
Selling, general and 128,537 107,103 85,292 151,345 142,006
administrative expenses
Restructuring and
non-recurring costs -- -- 1,829 10,998 2,444
---- ---- ----- ------ -----
Operating income (loss) 18,076 11,859 (6,686) (57,294) (1,952)
Financial income (expenses), (8,904) (3,676) 3,605 2,680 8,467
net
Gain on realization of 8,893 2,756 4,668 773 66,651
shareholdings, net
Other expenses, net 332 90 2,100 36,719 315
--- -- ----- ------ ---
Income (loss) before taxes 17,733 10,849 (513) (90,560) 72,851
on income
Taxes on income 4,631 2,540 2,014 6,239 13,131
Equity in losses of (2,523) (1,071) (2,327) (9,926) (5,633)
affiliated companies, net
Minority interest in losses (2,480) (4,118) 2,448 46,864 (16,108)
------- ------- ----- ------ ------
(profit), net
Net income (loss) 8,099 3,120 (2,406) (59,861) 37,979
Earnings (loss) per share:
Basic earnings (loss) 0.73 0.29 (0.24) (6.42) 4.07
Diluted earnings (loss) 0.65 0.24 (0.24) (6.42) 4.06
Weighted average number of
shares outstanding:
Basic 10,800 10,037 10,171 9,325 9,322
Diluted 10,800 10,285 10,171 9,325 9,363
As of December 31,
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
$
(In thousands)
--------------
Consolidated Balance Sheet
Data:
Total assets 641,020 544,008 467,245 454,544 551,901
Total liabilities 357,663 299,773 241,766 192,532 158,259
Shareholders' equity 186,778 176,004 153,349 166,421 229,672
B. Capitalization and Indebtedness
Not applicable.
C. Reasons for the Offer and Use of Proceeds
4
Not applicable.
D. Risk Factors
Our business, operating results and financial condition could be seriously
harmed due to any of the following risks. The trading price of our ordinary
shares could decline due to any of these risks.
We may experience significant fluctuations in our annual and quarterly results,
which makes it difficult for investors to make reliable period-to-period
comparisons and may contribute to volatility in the market price for our
ordinary shares and American Depositary Shares.
Our quarterly and annual revenues, gross profits and results of operations
have fluctuated significantly in the past and we expect them to continue to
fluctuate significantly in the future. The following events may cause
fluctuations:
o acquisitions and dispositions of companies and consolidation of our
subsidiaries;
o the size, time and recognition of revenue from significant contracts;
o timing of product releases;
o timing of contracts;
o timing of completion of specified milestones and delays in
implementation;
o changes in the proportion of service and license revenues;
o price and product competition;
o increases in selling and marketing expenses, as well as other
operating expenses;
o adverse economic conditions and currency fluctuations;
o the global business slow-down and the decline in capital spending in
the information technology sector; and
o consolidation of our customers.
A substantial portion of our expenses, including most product development
and selling and marketing expenses, must be incurred in advance of when revenue
is generated. If our projected
5
revenue does not meet our expectations, we are likely to experience an even
larger shortfall in our operating profit relative to our expectations. The gross
margins of our subsidiaries also will vary both among themselves and over time.
As a result, changes in the revenue mix from these subsidiaries may affect
quarterly operating results. In addition, we may derive a significant portion of
our net income from transactions which involve equity issuances by our
subsidiaries, the sale of equity securities of our subsidiaries or the sale of
proprietary software technology. These events do not occur on a regular basis
and their timing is difficult to predict. As a result, 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. If this happens, the price of our ordinary shares will likely
decrease.
Capital spending on information technology, or IT, solutions has declined
significantly. This global trend affected our operating results. If IT spending
continues to slow down, our business might be seriously harmed.
We have been affected by global economic changes, in particular the sharp
decline in capital spending in the information technology sector and the IT
business slow-down in North America and Europe, as well as in Israel.
Uncertainties in the North American, European and Israeli markets have
influenced the purchasing patterns of leading software developers who delayed
their planned orders and caused developers to reduce the amount of their planned
license commitments. These changes in purchasing patterns in the IT industry
directly affect our operating results. Our revenues decreased from $402.5
million in 2000 to $387.7 million in 2001 and to $283.3 million in 2002. In 2003
and 2004, as a result of a slight recovery of the market, and the impact of the
consolidation of the results of operations of Sapiens International Corporation
N.V. (beginning with 2003) and Formula Vision Technologies (F.V.T.) Ltd., or
Formula Vision (beginning with 2004), this trend was changed, and our revenues
increased to $366.8 million and $456.6 million, respectively. However, we cannot
assure you that we will be able to continue increasing our revenues or keep our
revenues at the same level as in 2004. We cannot know whether the global market
will recover in the future, and how the economic conditions will continue to
affect our business.
Our success depends upon the development and maintenance of strategic alliances.
We established relationships with strategic partners to provide
international marketing presence and name recognition, as well as the resources
necessary to implement many of our IT services. We are dependent upon our
strategic partners for the marketing and selling of certain of our proprietary
software solutions. In the past few years, due to the IT business slow-down, we
have encountered difficulties in entering into new partnerships. If we cannot
maintain our existing relationships with these partners or if we fail to
establish effective, long-term relationships with additional partners, or if our
partners enter into relationships with our competitors, our ability to market
our proprietary software solutions in international markets may be limited. If
this happens, our growth, if any, might be delayed or slowed-down. As a result,
our
6
business, financial condition, and results of operations could be seriously
harmed.
If our products fail to compete successfully with those of our competitors, we
may have to reduce the prices of our products, which in turn, may adversely
affect our business.
We face competition, both in Israel and internationally, from a variety of
companies, including companies with significantly greater resources than us who
are likely to enjoy substantial competitive advantages, including:
o longer operating histories;
o greater financial, technical, marketing and other resources;
o greater name recognition;
o well-established relationships with our current and potential clients;
and
o a broader range of products and services.
As a result, they may be able to respond more quickly to new or emerging
technologies or changes in customer requirements. They may also benefit from
greater purchasing economies, offer more aggressive product and service pricing
or devote greater resources to the promotion of their products and services. In
addition, in the future, we may face further competition from new market
entrants and possible alliances between existing competitors. We also face
additional competition as we continue to penetrate international markets. As a
result, we cannot assure you that the products and solutions we offer will
compete successfully with those of our competitors. Furthermore, several
software development centers worldwide, like in India, offer software
development services at much lower prices than we do. Due to the intense
competition in the markets in which we operate, software products prices may
fluctuate significantly. As a result, we may have to reduce the prices of our
products, which in turn, may adversely affect our business.
If we fail to compete for acquisitions and investments, we may be unable to
grow.
As part of our strategy, we intend to pursue acquisitions of, and
investments in, other companies. If and when acquisition or investment
opportunities occur, we expect to compete for these opportunities with other
established and well-capitalized entities. We cannot assure you that we will be
able to locate potential acquisition or investment opportunities in Israel or
internationally on terms which are favorable to us. If we fail to consummate
further acquisitions or investments in the future our ability to grow may be
harmed.
Any future acquisitions of companies or technologies may distract our management
and disrupt our business.
7
Our strategy includes selective acquisitions of, and investments in,
companies offering products and services suitable for integration into our
business. We may acquire or make investments in complementary businesses,
technologies, services or products if appropriate opportunities arise. We may
engage in discussions and negotiations with companies about our acquiring or
investing in those companies' businesses, products, services or technologies. We
cannot assure you that we will be able to identify future suitable acquisition
or investment candidates, or if we do identify suitable candidates, that we will
be able to make the acquisitions or investments on commercially acceptable terms
or at all. If we acquire or invest in another company, or if any of our
subsidiaries acquires control in another subsidiary or affiliate, the acquirer
could have difficulty assimilating that company's personnel, operations,
technology or products and service offerings into its own. The key personnel of
the acquired company may decide not to work for the acquirer. These difficulties
could disrupt our ongoing business, distract our management and employees,
increase our expenses and adversely affect our results of operations. We may
incur indebtedness or issue equity securities to pay for any future
acquisitions. The issuance of equity securities could be dilutive to our
existing shareholders.
We intend to pursue acquisitions outside of Israel as part of our
expansion strategy. These acquisitions, as well as any future acquisitions of
companies located outside of Israel, would pose additional risks, including
monitoring a management team from a great distance and integrating a potentially
different business culture. Our failure to successfully integrate these new
businesses could harm our business. In addition, the investigation of
acquisition candidates outside of Israel involves higher costs than those
associated with pursuing domestic acquisitions, and we cannot assure you that
these investigations will result in transactions.
If we fail to raise capital for our subsidiaries, we may be required to borrow
money on unfavorable terms.
Our business strategy involves raising capital for our subsidiaries
through public or private offerings. Our ability to raise capital for our
subsidiaries depends upon market and other conditions which are beyond our
control. If we fail to raise capital for our subsidiaries, it may hinder their
growth. We may therefore be required to seek alternative capital raising
methods, including borrowing money on terms which are not favorable to us. In
the past, due to difficulties we encountered in raising capital for our
subsidiaries, we were required to borrow monies from banks. Difficulties in
raising capital on favorable terms, may materially and adversely affect our
business, operating results and financial condition.
The terms of our credit facilities contain a number of restrictive covenants
which, if breached, could result in acceleration of our obligation to repay our
debt.
Our loan agreements contain a number of conditions and limitations on the
way in which we can operate our business, including limitations on our ability
to raise debt and sell or acquire assets. Our loan agreements also contain
various covenants which require us to maintain certain financial ratios related
to shareholders' equity and operating results that are customary for companies
of comparable size. These limitations and covenants may force us to pursue less
than
8
optimal business strategies or forego business arrangements which could
have been financially advantageous to us or to our shareholders.
Some of our assets are pledged to banks. These assets include certain of
our shareholdings in our subsidiaries consisting of our entire shareholdings in
BluePhoenix Solutions Ltd. and a portion of our shareholdings in Matrix IT Ltd.
and Magic Software Enterprises Ltd. If we are unable to repay the debt, the
lenders could foreclose on our assets that are subject to liens and sell these
holdings to satisfy the debt.
Marketing our products and services in international markets may require
increased expenses and greater exposure to risks that we may not be able to
successfully address.
We intend to continue to focus our efforts on selling proprietary software
solutions in international markets. We expect to continue devoting significant
resources to these efforts. If we are unable to continue achieving market
acceptance for our solutions or otherwise continue to successfully penetrate
international markets, our business will be harmed. In 2003 and 2004, we
received approximately 53% of our total revenues from customers located outside
of Israel. The expansion of our existing operations and entry into additional
international markets will require significant management attention and
financial resources. We are subject to a number of risks customary for
international operations, including:
o changing product and service requirements in response to the formation
of economic and marketing unions, including the European Union;
o economic or political changes in international markets;
o greater difficulty in accounts receivable collection and longer
collection periods;
o unexpected changes in regulatory requirements;
o difficulties and costs of staffing and managing foreign operations;
o the uncertainty of protection for intellectual property rights in some
countries;
o multiple and possibly overlapping tax structures; and
o currency and exchange rate fluctuations.
If we fail to address the strain on our resources caused by changes in our
company, we will be unable to effectively manage our business.
Our business has grown in complexity over the past few years. The growth of
our business, as well as the corporate organizational changes, have placed and
will continue to place a strain on our personnel and resources. Our ability to
manage any future changes or growth, depends on our
9
ability to continue to implement and improve our operational, financial and
management information control and reporting systems on a timely basis and to
expand, train, motivate and manage our work force. If we cannot respond
effectively to changing business conditions, our business, financial condition
and results of operations could be materially adversely affected.
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 may need to hire additional
qualified software, administrative, operational, sales and technical support
personnel. The process of attracting, training and successfully integrating
qualified personnel into our operations can be lengthy and expensive. We may not
be able to compete effectively for the personnel we need. Our future success
depends on our ability to absorb and retain senior employees and to attract,
motivate and retain highly qualified professional employees. We expect to
recruit most of our software and systems personnel in Israel. In addition, our
operations are dependent on the efforts of certain key management. Any loss of
members of senior management or key technical personnel, or any failure to
attract or retain highly qualified employees as needed, could materially
adversely affect our business.
If we fail to estimate accurately the costs of fixed-price contracts, we may
incur losses.
We derive a portion of our revenues from engagements on a fixed-price
basis. We price these commitments 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.
If our tools or solutions do not function efficiently, we may incur additional
expenses.
In the course of providing our software solutions, we conduct testing to
detect the existence of failures, errors and bugs. In addition, we have
instituted a quality assurance procedure for correcting errors and bugs in our
tools. The amount of failures, errors and bugs detected to date, and the cost of
correcting them, have not been significant. However, if our solutions fail to
function efficiently or if errors or bugs are detected in our tools, we might
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, our
contracts may be cancelled and we may be the subject of damages claims.
10
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 this
occurs, customers can cancel our contracts. Any cancellation of a contract could
cause us to suffer damages, since 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 claims may lead to material
damages.
If we are unable to accurately predict and respond to market developments or
demands, our business will be adversely affected.
The IT business is characterized by rapidly evolving technology and
methodologies. This makes it difficult to predict demand and market acceptance
for our services and products. In order to succeed, we need to adapt the
products and services we offer to technological developments and changes in
customer needs. We cannot guarantee that we will succeed in enhancing our
products and services or developing or acquiring new products and services that
adequately address changing technologies and customer requirements. We also
cannot assure you that the products and services we offer will be accepted by
customers. If our products and services are not accepted by customers, our
future revenues and profitability will be adversely affected. Changes in
technologies, industry standards, the regulatory environment, customer
requirements and new product introductions by existing or future competitors
could render our existing products and services obsolete and unmarketable, or
require us to enhance our current products or develop new products. 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.
If we are unable to retain control in our subsidiaries, we would cease to
consolidate them and our operating results may fluctuate significantly.
We currently hold a controlling interest in our subsidiaries through our
direct equity holdings. From time to time, if and when required, we enter into
voting agreements with other shareholders of the companies, in order to retain
control of our subsidiaries. As a result of our controlling interests in the
subsidiaries, we consolidate their operating results with ours. If we are unable
to maintain a controlling interest in our subsidiaries, as a result of equity
issuances by subsidiaries, failure to reach voting agreements or otherwise, we
would cease to consolidate the operating results of these subsidiaries. This may
result in significant fluctuations of our consolidated operating results.
We are exposed to significant claims for damage caused to our customers'
information systems.
Some of the products and services we provide involve key aspects of
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
11
other software products generally. We have never been the subject of a material
damages claim related to our products and services. However, if a customer's
system fails during or following the provision of products or services by us, or
if we fail to provide customers with proper support for our software products,
we are exposed to the risk of a claim for substantial damages being filed
against us, regardless of our responsibility for the failure. When possible, we
limit our liability under our product and service contracts. We cannot guarantee
that these limitations of liability, if any, would be sufficient to protect us
against legal claims. We maintain general liability and professional liability
insurance coverage. However, 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, our business,
operating results and financial condition may be materially adversely affected.
In addition, the filing of legal claims against us in connection with contract
liability may cause us negative publicity and damage to our reputation.
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. We expect that software products may be increasingly subject
to third-party infringement claims as the functionality of products in different
industry segments overlaps. Although our products and services have never been
the subject of an infringement proceeding, 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 non-disclosure undertakings by any of our employees or
contractors may lead to a claim of infringement against us. Any claims, with or
without merit, could:
o be expensive and time-consuming to defend;
o divert management's attention and resources; or
o require us to enter into royalty or licensing agreements to obtain the
right to use a necessary product or component.
Royalty or licensing agreements, if required, may not be available 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 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. Substantially all of our intellectual property
consists of proprietary or confidential information that is not subject to
patent or similar protection. In general, we have
12
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. We have placed, and in the future may
place, certain of our software in escrow. The software may, under specified
circumstances, be made available to our customers. We have provided our software
directly to customers. This may increase the likelihood of misappropriation or
other misuse of our software.
Our largest shareholder, FIMGold LP, controls a significant portion of our
ordinary shares and influences the outcome of matters that require shareholder
approval.
Following a private placement consummated by Formula in March 2005, and
the sale by Dan Goldstein of his entire shareholdings in Formula to FIMGold
Limited Partnership, referred to as FIMGold LP, FIMGold LP owns approximately
33.3% of our outstanding ordinary shares. FIMGold LP is owned in equal shares by
Dan Goldstein, our chief executive officer and chairman of the board, and FIMI
Opportunity Fund, L.P. and parties related to it, jointly referred to as FIMI
OpportunityFund. As a result, FIMGold LP is able to influence significantly the
outcome of those matters requiring shareholder approval, including the election
of directors and approval of significant corporate transactions. This share
ownership may have the effect of delaying or preventing a change in control. In
addition, potential conflicts of interest may arise in the event that we enter
into agreements or transactions with Dan Goldstein or his brother Gad Goldstein,
our president and a member of our board. Although Israeli law imposes certain
procedures (including shareholder approval) for approval of certain related
party transactions, we cannot assure you that these procedures will eliminate
the possible detrimental effects of these conflicts of interest. If certain
transactions are not approved in accordance with required procedures under
applicable Israeli law, these transactions may be void or voidable. See "Item
7.B. Related Party Transactions."
The market price of our ordinary shares and American Depositary Shares may be
volatile and you may not be able to resell your shares at or above the price you
paid, or at all.
The stock market in general has experienced during recent years extreme
price and volume fluctuations. The market prices of securities of technology
companies have been extremely volatile, and have experienced fluctuations that
have often been unrelated or disproportionate to the operating performance of
those companies. These broad market fluctuations could adversely affect the
market price of our ordinary shares and American Depositary Shares, or ADSs.
During 2003, for example, the market price of our ADSs fluctuated between $6.71
and $18.05, and in 2004, the market price of our ADSs fluctuated between $13.44
and $21.80. The market price of the ordinary shares and the ADSs may fluctuate
substantially due to a variety of factors, including:
13
o any actual or anticipated fluctuations in our or our
competitors' quarterly revenues and operating results;
o shortfalls in our operating results from levels forecast by
securities analysts;
o public announcements concerning us or our competitors;
o results of integrating investments and acquisitions;
o the introduction or market acceptance of new service
offerings by us or our competitors;
o changes in product pricing policies by us or our competitors;
o changes in security analysts' financial estimates;
o changes in accounting principles;
o sales of our shares by existing shareholders; and
o the loss of any of our key personnel.
In addition, 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.
We may be adversely affected if the market prices of our publicly traded
subsidiaries decrease.
A significant portion of our assets is comprised of equity securities of
publicly and non-publicly traded companies. Our publicly traded subsidiaries are
BluePhoenix Solutions Ltd. (formerly known as Crystal Systems Solutions Ltd.),
Magic Software Enterprises Ltd., Matrix IT Ltd., Sapiens International
Corporation N.V. and Formula Vision. The stock prices of these publicly traded
companies have been extremely volatile, and have experienced fluctuations due to
market conditions and other factors which are beyond our control. Fluctuations
in the market price and valuations of our holdings in these companies may affect
the value of our assets. In addition, the stock prices of many technology
companies fluctuate significantly for reasons that may be unrelated to operating
results. If the value of our assets decreases significantly as a result of the
above, our business, operating results and financial condition, may be
materially and adversely affected.
Future sales of our shares in the public market or issuances of additional
securities could cause the market price for our ordinary shares and ADSs to
fall.
14
As of June 20, 2005, we had 13,200,000 ordinary shares outstanding, of
which 462,338 were represented by ADSs. Of the 13,200,000 shares outstanding,
4,725,000 shares are held by affiliates. In addition, we have reserved 300,000
ordinary shares for issuance under our option plans. We intend to register for
resale these reserved ordinary shares upon issuance. If a large number of our
ordinary shares held by affiliates are sold in a short period, the price of our
ordinary shares would likely decrease.
Our United States investors could suffer adverse tax consequences if we are
characterized as a passive foreign investment company.
Although we do not believe that we were a passive foreign investment
company, or PFIC, for U.S. federal income tax purposes during 2004, we cannot
assure you that we will not be treated as a passive foreign investment company
in 2005 or in future years. We would be a passive foreign investment company if
75% or more of our gross income in a taxable year is passive income. We would
also be a passive foreign investment company if at least 50% of our assets in a
taxable year produce, or are held for the production of, passive income. Passive
income includes interest, dividends, royalties, rents and annuities. If we are
or become a passive foreign investment company, many of you will be subject to
adverse tax consequences, including having gain realized on the sale of our
ordinary shares or ADSs be treated as ordinary income, as opposed to capital
gain income, and having potentially punitive interest charges apply to such sale
proceeds. A decline in the value of our ordinary shares or ADSs may result in
our being a PFIC. United States shareholders should consult with their own tax
advisors with respect to the United States tax consequences of investing in our
ordinary shares.
For a discussion of how we might be characterized as a PFIC and related
tax consequences, see "Item 7. Taxation--United States Federal Income Tax
Considerations."
Our operating profit may decrease if the rate of inflation in Israel exceeds the
rate of devaluation of the New Israeli Shekel against the dollar or against the
euro.
Most of our revenues from sale of our products and services are in dollars
and euros or are linked to the dollar or the euro, while a substantial portion
of our expenses, principally salaries and related personnel expenses, are in New
Israeli Shekels, or NIS. As a result, we are exposed to any of the following
risks:
o that the inflation rate in Israel will exceed the NIS devaluation rate
against the dollar or the euro;
o that the devaluation process will lag behind the NIS inflation timing; or
o that the euro experience devaluation against the dollar.
If any of these occur, the dollar or euro cost of our operations, as well
as our financial expenses, would increase. We cannot predict any future trends
of the rate of inflation in Israel or the rate of devaluation of the NIS or the
euro against the dollar. An increase in our dollar or euro
15
operational cost will adversely affect our dollar-measured results of
operations. In addition, our operations could be adversely affected if we are
unable to hedge against currency fluctuations in the future. To date, we have
not engaged in significant hedging transactions. In the future, we may enter
into currency hedging transactions to decrease the risk of financial exposure
from fluctuations in the exchange rate of the dollar against the NIS or the
euro. However, we cannot assure you that these measures will adequately protect
us from material adverse effects arising from the impact of inflation in Israel.
For additional information relating to the exchange rates between different
relevant currencies, see "Item 5. Operating and Financial Review and
Prospects--Overview--Our Reporting Currency".
Fluctuations in foreign currency values affect the prices of our products, which
in turn may affect our business and results of operations.
Most of our worldwide sales are currently denominated in dollars. A
decrease in the value of the dollar relative to foreign currencies, in
particular the euro and the new Israeli shekel (NIS) would make our products
more expensive and, therefore, could adversely affect our results and harm our
competitive position in the markets.
Risks Relating to Operations in Israel
Political, economic, and military conditions in Israel could negatively impact
our business.
Our headquarters and principal research and development facilities are
located in Israel. Although we generate approximately 53% of our revenues from
international markets, we are, nonetheless, directly influenced by the
political, economic and military conditions affecting Israel. The execution of
Israel's plan of unilateral disengagement from the Gaza Strip and some parts of
the West Bank may affect Israel's foreign relations and the stability of the
region. Major hostilities involving Israel or the interruption or curtailment of
trade between Israel and its present trading partners could have a material
adverse effect on our business, operating results and financial condition.
Furthermore, several countries restrict business with Israeli companies. 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. While we have
operated effectively under these requirements since our incorporation, 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.
The tax benefits available to us from government programs may be discontinued or
reduced at any time, which would likely increase our taxes.
Certain of our subsidiaries received grants in the past and receive tax
benefits under Israeli government programs, particularly as a result of the
"Approved Enterprise" status of certain operations in Israel. "Approved
Enterprise" status is granted by the Israeli Investment Center of the Ministry
of Industry and Trade and entitles the grantee to a variety of tax incentives.
The
16
incentives awarded to certain of our subsidiaries include reduced tax rates and
a tax holiday. Certain of our subsidiaries were granted a two year tax
exemption, followed by a five year tax reduced tax rate of 25% instead of 35% on
income derived from "Approved Enterprise" investment programs. In order to
qualify for these incentives, the "Approved Enterprise" is required to provide
minimum paid-in-capital (30% of the investment), to show an increase in its
export activities, and to meet other general investing criteria. As of June 20,
2005, our subsidiaries have met those criteria and received tax benefits from
their "Approved Enterprise" programs, as presented in Note 16 to our financial
statements. To maintain the eligibility for these programs and benefits, we must
meet the conditions mentioned above. We cannot assure you that these programs
and tax benefits will continue at the same level in the future. If these tax
benefits and programs are terminated or reduced, we could pay increased taxes in
the future, which could decrease our profits.
It may be difficult to serve process and enforce judgments against our directors
and officers in Israel.
We are organized under the laws of the State of Israel. All of our
executive officers and directors are nonresidents 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:
o effect service of process within the United States on us or any of our
executive officers or directors;
o 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, in the United States or Israel; and
o 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.
ITEM 4. INFORMATION ON THE COMPANY
A. History and Development of the Company
We were incorporated in Israel on April 2, 1985. We maintain our principal
executive offices at 3 Abba Eban Boulevard, Herzlia 46725, Israel and our
telephone number is 011-972-9-959-8800. Our agent in the United States is
Corporation Service Company and its address is 2711 Centerville Road, Suite 400,
Wilmington, DE 19808. In 1991, we completed our initial public offering of
ordinary shares on the Tel Aviv Stock Exchange, or the TASE. In October 1997, we
completed the listing of our ADSs on the Nasdaq National Market.
Since our inception, we have acquired controlling interest and have
invested in companies which are engaged in the IT solutions and services
business. We, together with our subsidiaries and affiliates, are known as the
Formula Group.
17
We have adopted a strategy of seeking opportunities to realize gains
through the selective sale of investments and minority interest in our
subsidiaries and affiliates to outside investors. We believe that this strategy
provides us with capital to support the growth of our subsidiaries, as well as
increasing shareholder value. We expect to continue to develop and enhance the
products, services and solutions of our subsidiaries, and to continue to pursue
additional acquisitions of, or investments in, companies that provide IT
services and proprietary software solutions.
Capital Expenditures and Divestitures
Certain of our investment and financing activities are described below.
For additional information relating to our investment and financing activities
during 2003 and 2004, see "Item 5.B. Liquidity and Capital Resources."
In March 2005, we completed a private placement of 2,400,000 Formula shares
for an aggregate consideration of $36 million. The shares were issued to FIMGold
LP, an entity owned in equal shares by Dan Goldstein and FIMI Opportunity Fund.
Concurrently with the closing of the private placement, Dan Goldstein sold to
FIMGold LP all of his holdings in Formula and in our subsidiary, Formula Vision.
Following these transactions, FIMGold LP holds 33.3% controlling interest in
Formula and approximately 24% interest in Formula Vision.
In March 2001, we completed a $10 million investment in convertible
preferred shares of Sapiens International Corporation N.V., or Sapiens, a
publicly held company traded on the Nasdaq National Market, representing
approximately 24% of the outstanding share capital of Sapiens on an as converted
basis. Under the agreement with Sapiens, we were also granted an option to
invest up to an additional $10 million on the same terms as our initial
investment, subject to certain adjustments. In December 2002, we exercised the
option and invested $10 million in Sapiens in exchange for a discount conversion
price of $0.83 per common share. As part of the transaction, we converted all of
our preferred shares into common shares at the discount price. Since 2002, we
purchased approximately additional 1,500,000 shares of Sapiens for aggregate
consideration of approximately $5.1 million and we currently hold 56% of
Sapiens' outstanding share capital.
In November 2002, we sold to BluePhoenix Solutions Ltd., or BluePhoenix,
in a share exchange transaction, our 57.9% interest in Liraz Systems Ltd., or
Liraz, an international software and services company publicly traded on the
TASE. For more information about this share exchange transaction, see
"Restructuring of Our Corporate Structure--Sale of Liraz Shares to BluePhoenix"
below.
Agreements with Shamrock, FIMI and IDB
In September 1999, we entered into an agreement with Shamrock Holdings of
California Inc., or Shamrock, pursuant to which we granted to Shamrock an
option, until March 2000, to invest in companies in which we hold, directly or
indirectly, at least 25% of the outstanding
18
equity. In addition, we granted to Shamrock an option to exchange the securities
it purchased under the above option for Formula's ordinary shares, exercisable
within a 45 day period, beginning upon the elapse of 27 months from the date of
purchase of the securities or from the date of the agreement, such period to
vary based on the securities involved. The exchange ratio was to be based upon
the original price paid for the securities subject to the exchange and the
market price on the TASE of Formula's ordinary shares at the time of the
exchange, subject to certain requisite adjustments. Notwithstanding the above,
we had the discretion to purchase the securities to be exchanged for cash
instead of exchanging them for Formula's ordinary shares.
In October 1999, we entered into agreements with the First Israel
Mezzanine Investors Ltd., or FIMI, and Israel Discount Bank, or IDB, each on the
same terms in all material respects as the agreement with Shamrock.
In September 1999, an extraordinary general meeting of Formula's
shareholders approved the issuance to Shandol Ltd., a subsidiary of Formula at
that date, of options to purchase 1 million ordinary shares, in order to ensure
the availability of ordinary shares, if the above exchange options are
exercised. For information regarding the terms of the options, see "Item 6.E.
Share Ownership."
In August 2000, an extraordinary general meeting of Formula's shareholders
approved the grant of additional options to Shandol to purchase 500,000 ordinary
shares, to ensure the availibility of ordinary shares for different purposes
while conducting various transactions, including the availability of ordinary
shares, if the above exchange options are exercised. In December 2003, Shandol
exercised these options to purchase 500,000 ordinary shares. The shares
purchased upon exercise of the options were sold by Shandol in transactions on
the TASE.
In November 2001 and January 2002, Shamrock exercised the exchange option
with respect to its investment in certain companies of the Formula Group. In
consideration for the securities held by Shamrock, Shandol transferred to
Shamrock 1,000,000 of our ordinary shares and an aggregate of approximately $1.6
million. In January 2002, Shamrock sold these shares to Dan and Gad Goldstein.
See "Item 7. Major Shareholders and Related Party Transactions."
In April 2002, FIMI and IDB exercised the exchange option with respect to
their investment in certain companies of the Formula Group in an aggregate
amount of $4.7 million (including accrued interest). In connection therewith, we
entered into an agreement with FIMI and IDB, pursuant to which we exchanged the
amount of $4.7 million with a convertible debenture issued by Formula. The
convertible debenture may be converted into Formula's ordinary shares during a
4-year period. The conversion price shall be $19 per share, subject to
adjustments, but in no event less than a minimum price agreed to between the
parties. The principal of the convertible debenture shall be payable in
semi-annual installments beginning 30 months from the date of issuance of the
debenture, unless FIMI and IDB request to postpone this date until the end of
the 4-year period. The principal bears interest at an annual rate of 5% to be
paid quarterly.
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In connection with the exercise of the option by Shamrock, we agreed to
extend until October 2006, the term of the put option with respect to the
securities held by Shamrock in ESI - Expert Systems Industries Ltd., or ESI, and
in ESI's subsidiaries. In addition, we agreed to extend the put option to
securities held by Shamrock in additional Formula Vision portfolio companies. It
was agreed that Shamrock's put option, if exercised, shall be exercised for
cash. We also agreed to extend until December 2005, the term of the option
granted to FIMI and IDB to exchange the securities held by them in Transtech
Control Ltd., or Transtech, for Formula's ordinary shares. The options granted
to Shamrock, FIMI and IDB with respect to shares of Sintec Advanced Technologies
Ltd. were replaced in November 2002 by options relating to shares of Matrix IT
Ltd., as described under "Restructuring of Our Corporate Structure - Sale of New
Applicom, Sintec and Sivan to Matrix," below.
As part of the agreement between us and Formula Vision described below, we
transferred to Formula Vision our rights and obligations with respect to the
transferred companies under our agreements with each of Shamrock, FIMI and IDB.
These companies are ESI and Transtech. If Shamrock, FIMI or IDB exercises the
option to exchange these securities in the transferred companies for Formula's
shares and to the extent exercised, Formula Vision assumed all the rights and
undertakings in connection with the exercise of the option.
Restructuring of Our Corporate Structure
During 1999 until 2003, we conducted a restructuring process, to simplify
our corporate structure and business environment by combining some smaller
subsidiaries to create a smaller number of larger subsidiaries with greater
operating efficiencies. The steps of the restructuring that were taken place
since 2001, include the following:
Transactions with Formula Vision. In July 2001, Formula granted to Formula
Vision an option to purchase our interests in certain privately-held companies
that develop products and services aimed primarily for sale in international
markets. In November 2001, Formula Vision exercised the option.
In connection therewith, Formula Vision issued to Formula, in December
2001, a series of debentures of $58.9 million in the aggregate, linked to the
Israeli CPI and bearing interest at an annual rate of 5%. Formula Vision is
required to repay the debentures in five annual installments, subject to
adjustments based on the income of Formula Vision during each of the five years.
The payments on account of the debentures plus linkage differences will be no
less than 30% and no more than 70% of the income arising from the sale of the
transferred companies in any calendar year. "Income" for these purposes is
defined as the amounts received by Formula Vision, if any, in consideration for
a sale of any of the transferred companies in any given calendar year, less
selling expenses, as well as amounts received by Formula Vision from
distributions to be made by any of the transferred companies in any given
calendar year. Payments to be made on account of the debentures, in any given
calendar year, will be no less than 20% of the annual profit as recorded in the
financial statements of Formula Vision. Any amounts which remain outstanding
will be payable at the end of the 5-year period. In connection with this
transaction, we lent to
20
Formula Vision on March 31, 2002 an additional $19.4 million and Formula Vision
issued to us an additional series of debentures for this amount, with similar
terms as the debentures issued in December 2001.
In the event that during the term of the indebtedness, Formula Vision
issues to a third party convertible debentures, Formula is entitled to convert
the indebtedness into the same class of convertible debentures, having the same
terms of the convertible debentures issued to the third party.
As part of the agreement related to the exercise of the option by Formula
Vision to purchase from Formula its interest in privately held companies, we
also transferred to Formula Vision our rights and obligations with respect to
the transferred companies under our agreements with each of Shamrock, FIMI and
IDB. These companies are ESI and Transtech. If either of Shamrock, FIMI or IDB
exercises the option to exchange the securities in these transferred companies
for Formula's shares and to the extent exercised, Formula Vision assumed all the
rights and undertakings in connection with the exercise of the option.
In January 2004, Formula exchanged approximately $35 million of the
aggregate amount of the debentures for 38,000,000 shares of Formula Vision
issued to Formula and constituting 59.4% of the outstanding share capital of
Formula Vision. The price per share was NIS 4.11 ($0.93) which reflects the
average closing price of Formula Vision's shares on the TASE during the 30 days
preceding Formula's resolution approving the transaction. Following the exchange
of a portion of the debentures, the outstanding amount of the debentures was
$43.2 million. Management believes that by holding a controlling interest in
Formula Vision, Formula would benefit from capital gains generated by Formula
Vision from realization of its assets. Based on this determination, it was in
the best interests of Formula to exchange a portion of the debentures for a
59.4% interest in Formula Vision. For more information, see "Item 7.B. Related
Party Transactions-- Transactions between Formula and Formula Vision."
Sale of Liraz to BluePhoenix. In November 2002, we sold to BluePhoenix, in
a share exchange transaction, 3,912,999 ordinary shares of Liraz, representing
our entire 57.9% interest in Liraz. In consideration, BluePhoenix issued to us
2,343,113 BluePhoenix's ordinary shares. The number of shares issued to us by
BluePhoenix was calculated based on an exchange ratio of 1:1.67, such that
BluePhoenix issued to us one BluePhoenix's share for every 1.67 shares of Liraz.
As part of this transaction, BluePhoenix purchased from certain additional
shareholders of Liraz an aggregate of 1,896,303 Liraz ordinary shares in
exchange for BluePhoenix shares, based on the same exchange ratio as in the
transaction between BluePhoenix and us. As a result, BluePhoenix owned
approximately 86.0% of the outstanding share capital of Liraz. Following this
transaction, BluePhoenix purchased from the public all the remaining outstanding
shares of Liraz through two public tender offerings. In March 2003, Liraz's
shares ceased to be traded on the TASE.
Sale of New Applicom, Sintec and Sivan to Matrix. In November 2002, we
completed a sale to Matrix of our entire shareholdings in New Applicom Ltd., or
New Applicom, Sintec
21
Advanced Technologies Ltd., or Sintec, and Sivan Training and Systems Ltd., or
Sivan, then publicly held companies traded on the TASE, for aggregate
consideration of $29.7 million. In this transaction, we sold to Matrix 3,870,498
shares of New Applicom, representing approximately 60.8% of New Applicom's
outstanding share capital, for an aggregate of $16.9 million, 15,330,309 shares
of Sintec, representing Sintec's entire outstanding share capital, for an
aggregate of $12.5 million, and 8,930,100 shares of Sivan, representing
approximately 69.0% of Sivan's outstanding share capital, for an aggregate of
$346,000. The shares we sold to Matrix were comprised of (i) shares previously
held by us; (ii) shares that we purchased from third parties in October 2002;
and (iii) shares that we bought in tender offers we conducted in October 2002.
The price per share paid to us by Matrix for each of New Applicom's, Sintec's
and Sivan's shares previously held by us and those we purchased from third
parties was equal to the equity per share of each of the companies.
The shares that we purchased from third parties in October 2002 and sold to
Matrix were bought in the following transactions:
(i) 552,789 shares of New Applicom that we purchased in exchange for
1,436,096 shares of Matrix. As part of this transaction, we granted to the
selling shareholders a put option to sell to us Matrix's shares during the
fourth quarter of 2003 for cash at an exercise price based on the cost of New
Applicom's sold shares;
(ii) an aggregate of 4,200,000 shares of Sintec that we purchased in
exchange for 2,180,780 shares of Matrix. As part of this transaction, we granted
to the selling shareholders a put option to sell to us Matrix' shares during the
fourth quarter of 2003 and the first quarter of 2004 at a cash price based on
the cost of Sintec's sold shares. This option was previously granted to the
selling shareholders in 1999 with respect to Sintec's sold shares; and
(iii) an aggregate of 1,100,000 shares of Sintec that we purchased in
exchange for 608,080 shares of Matrix. As part of this transaction, we granted
to the selling shareholders a put option to sell to us Matrix's shares during
November 2003 for cash.
During the fourth quarter of 2003, the selling shareholders exercised the
put options described above and sold to us an aggregate of 4,224,956 shares of
Matrix for aggregate consideration of $10 million.
As part of the sale of the shares of New Applicom, Sintec and Sivan to
Matrix, we conducted in October 2002, cash tender offers for the shares of New
Applicom, Sintec and Sivan not owned by us. As a result, Sintec's shares ceased
to be traded on the TASE. Following the closing of the tender offers, we sold to
Matrix the shares that we purchased in the tender offers for the same purchase
price we paid for the tendered shares; $3.7 for each New Applicom share, $0.8
for each Sintec share and $0.15 for each Sivan share. In November 2002, Matrix
conducted tender offers for the shares of New Applicom and Sivan held by the
public. In June 2003, Matrix conducted an additional tender offer to purchase
the shares of New Applicom, in which Matrix purchased the remaining outstanding
share capital of New Applicom held by the public. In
22
January 2004, Matrix conducted an additional tender offer to purchase the shares
of Sivan, in which Matrix purchased the remaining outstanding share capital of
Sivan held by the public. Matrix currently holds the entire share capital of New
Applicom, Sintec and Sivan.
B. Business Overview
General
We are a global information technology, or IT, solutions and services
company based in Israel. We are principally engaged in providing software
consulting services, developing proprietary software products and providing
computer-based business solutions. We currently deliver our solutions in over 50
countries worldwide to customers with complex IT services needs, including a
number of "Fortune 1000" companies. We operate in two principal business areas,
IT services and proprietary software solutions. Following is a description of
our business areas:
IT Services
We design and implement IT solutions which improve the productivity of our
customers' existing IT assets. In delivering our IT services, we at times use
proprietary software developed by members of the Formula Group. We provide our
IT services across the full system development life cycle, including definition
of business requirements, system analysis, technical specifications, coding,
testing, training, implementation and maintenance. We perform our projects
on-site or at our own facilities.
Proprietary Software Solutions
We design, develop and market proprietary software solutions for sale in
selected niche markets worldwide. We regularly seek opportunities to invest in
or acquire companies with attractive proprietary software solutions under
development which we believe to have market potential. The majority of our
investments and acquisitions in this area have been in companies with products
beyond the prototype stage. In addition, we selectively invest in companies with
proven technology where we believe we can leverage our experience to enhance
product positioning and increase market penetration. We provide our management
and technical expertise, marketing experience and financial resources to help
bring these products to market. We also assist the members of our group to form
teaming agreements with strategic partners to develop a presence in
international markets.
The Formula Group
Formula is the parent company of subsidiaries and affiliates, referred to
collectively as the Formula Group. We currently hold a controlling interest in
our subsidiaries through our equity holdings. From time to time, if and when
required, we enter into voting agreements with other shareholders of the
companies, in order to retain control of our subsidiaries. We appoint a
23
majority of the boards of directors of our subsidiaries through our equity
holdings and, if required, through voting agreements with shareholders who are
often members of our management or of our subsidiaries' management. We provide
our subsidiaries with our management, technical expertise and marketing
experience to help them to penetrate their respective markets.
We direct the overall strategy of our subsidiaries. While the subsidiaries
each have independent management, we monitor the growth of our subsidiaries
through the active involvement in the following matters:
o strategic planning;
o marketing policies;
o senior management recruitment;
o investment and budget policy;
o financing policies; and
o overall ongoing monitoring of each subsidiary's performance.
We promote the synergy and cooperation among our subsidiaries by
encouraging the following:
o transfer of technology and expertise;
o leveling of human resources demand;
o combining skills for specific projects;
o formation of critical mass for large projects; and
o marketing and selling the group's products and services to the group's
customer base.
We, through our subsidiaries, offer a wide range of integrated IT
solutions and services, and design, develop and market proprietary software
solutions for sale in selected niche markets, both in Israel and worldwide.
Our Subsidiaries
Matrix
Matrix IT Ltd. is one of Israel's leading integration and information
technology services
24
companies, according to Dun's 100 "Israel Largest Enterprises 2004". Matrix
employs over 2,000 software, hardware, integration and training personnel, which
provide advanced IT services to more than 500 customers in the Israeli market.
Matrix also markets in Israel software and hardware products manufactured by a
broad range of international manufacturers.
The solutions, services and products supplied by Matrix are designed to
improve Matrix's customers' competitive capabilities, by providing a response to
their unique IT needs in all levels of their operation.
Areas of Operation
Matrix is active in four principal areas: software solutions and services,
software products, infrastructure solutions and hardware products, and training
and assimilation.
Software solutions and services. Matrix provides software services,
software development projects, outsourcing, integration of software systems and
services - all in accordance with its customers' specific needs. Matrix also
provides upgrading and expansion of existing software systems. Matrix software
solutions include the following components: (i) development of dedicated
customer software; (ii) customization of software developed by Matrix or by
third parties to provide a response to customer's requirements; (iii) systems
assimilation; and (iv) integration of all or part of these components. The scope
of the work invested in each individual component varies from one customer to
the other, based on each customer's specific requirements.
Software Products. Matrix's operations in this area include the marketing
and assimilation of software products in various categories, mainly customer
relationship management (CRM) software products, systems management and service
management products, software products for content management, software products
for business intelligence (BI), data warehouses and extract/transform/load
(ETL), software products for integration, database systems, open-code operating
systems, software products for knowledge management, and software development
tools.
Infrastructure solutions and hardware products. These include: (i) supply
of infrastructure solutions for computer and communication systems; (ii) sale
and marketing of PCs, laptops, Intel servers, peripheral equipment, operating
systems, servers and workstations operating on Unix and VMS operating systems,
and sales and marketing of storage and backup systems for mainframe computers
such as HP and IBM; and (iii) maintenance for computers and peripheral
equipment, lab services and a help desk.
Training and assimilation. Matrix operates hi-tech training and
qualification centers providing advanced professional courses for hi-tech
personnel, training and assimilation of computer systems, applications courses
and professional training.
Matrix provides solutions, services and products primarily to the following
four market
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sectors (or verticals): communications and security, banking and finance,
industry and trade, and the public sector.
Matrix offers to each market sector a broad range of solutions and
services, customized for the specific needs of that sector. Matrix operates
dedicated departments, each of which specializes in a particular sector. Each
such department supplies customers in that sector with a product basket
providing a response to most of its IT requirements, based on an in-depth
business understanding of the challenges which are typical to that sector.
Matrix established separated headquarters for each particular market sector,
which manages the operations relating to that sector.
Specialization in the various sectors is reflected in the applications,
professional and marketing aspects of each sector. Accordingly, the professional
and marketing infrastructure required to support each market sector is developed
to address such sector's specific needs.
In addition to the four sector-based areas of operations, Matrix operates
two horizontal entities providing specialist services for all of the different
sectors of operations. These entities include:
o A technology center providing development services, which include
mainly cross-sector applications (applications which can be used in more
than one business sector), as well as the development of applications that
require specialist resources and professional know-how; and
o A strategic consulting center that provides customers with diverse
consultation services on topics such as organization, strategy, business
development and technological development.
Customers
Matrix's customers include large enterprises in Israel, such as Israel
Electric Company, Social Security, Israeli Defense Force, Mekorot, Amidar,
governmental ministries and the Knesset (the Israeli parliament); commercial
banks (such as Bank Leumi, Bank Hapoalim, The First International Bank, Discount
Bank, United Mizrahi Bank and Igud Bank), loan and mortgage banks (such as Leumi
Mortgage and Tfahot), telecommunications services providers -(Bezeq, Bezeq
International and Barak, credit card companies (Visa, Isracard and Leumicard),
leasing companies, insurance companies (such as Harel Hamishmar, Phoenix, Clal,
Migdal), security agencies, cellular operators -(Cellcom, Orange and Pelephone),
satellite operators (YES), hi-tech companies- (Comverse, Motorola and Amdocs)
and media and publishing entities- (Yediot Ahronot).
Matrix's customers also include Israel Electric Company, leasing companies
and security agencies.
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Magic
Magic Software Enterprises Ltd. is a leading provider of rapid application
development and deployment, business integration technology and business
solutions to corporations worldwide. Users of Magic's solutions and technology
include tens of thousands of independent software vendors, system integrators
and corporations worldwide, supported by an extensive global services
organization. In addition to technology, Magic also provides its customers with
consulting, professional services, and training.
Magic Core Technology
Magic develops, markets and supports its software development and
deployment technology, eDeveloper. eDeveloper enables enterprises to accelerate
the process of building and deploying business software applications that can be
rapidly customized to meet current and future needs. eDeveloper is based on a
revolutionary programming paradigm that eliminates wasted time and repetition
from the development cycle. eDeveloper is built around the concept of a smart
application engine that provides unique platform and database independence for
both Web and client/server deployment. eDeveloper integrates with standard
computing architectures, including J2EE and .NET and can act as a bridge between
these and other diverse standards like XML and Web services.
eDeveloper significantly reduces maintenance time and costs. Magic's
research and development department continues to develop and integrate new
technologies into eDeveloper to ensure that customers receive a
state-of-the-art, efficient, development environment.
In addition, Magic provides customers with an extensive framework for
business integration, called the iBOLT Integration Suite. The iBOLT Integration
Suite enables companies to utilize their existing business processes and legacy
investments, and rapidly customize solutions to meet specific enterprise needs.
iBOLT provides affordable enterprise application integration to mid-sized
businesses, system integrators and application vendors which require integration
capabilities. As a comprehensive suite for application integration, iBOLT allows
the simple integration and interoperability of diverse solutions, including
legacy applications in a quick and efficient manner. iBOLT has been identified
by leading industry analysts as a challenger in the market for enterprise
application integration solutions.
As a comprehensive suite for application integration, iBOLT includes a
robust set of capabilities for handling integration and exchanging transactions
in a heterogeneous environment. It includes support for business process
management, monitoring and real time reporting.
iBOLT provides integration and connectivity capabilities that include
database interoperability, the ability to work with multiple databases in the
same process, and the capacity to deploy on a range of systems on varied
platforms. iBOLT also includes an assortment of smart
27
connectors and adapters and ready-to-use components.
Magic development and integration products empower customers to
significantly improve their business performance and return on investments by
enabling the affordable and rapid integration of diverse applications, systems
and databases to streamline business processes.
Magic's technologies adhere to open standards and deliver high levels of
portability and scalability, crucial for today's dynamic business environment,
and operate as a uniform application paradigm independent of architecture
(Internet, Client/Server, Mobile, LAN/WAN), operating systems (Windows, Linux,
UNIX, iSeries), database (DB2, Oracle, Informix, MS SQLServer, Pervasive, etc.),
or platform (.NET, J2EE).
Enabling Business
Magic technology and solutions are particularly in demand when
time-to-market is critical, budgets are tight, integration with multiple
platforms, databases or existing systems and business processes is required,
compliance to industry regulations is needed or a high degree of application
maintenance and customization is anticipated.
Magic addresses customers' critical business need to respond quickly to
changing market demands. Magic creates, deploys and maintains robust business
solutions with unrivaled productivity and time to results. Magic's unique
development methodology enables developers to create better solutions in less
time and with fewer resources.
Development communities have become increasingly disjointed, creating an
even greater need for a development environment that provides open interfaces to
leading technologies and standards. Magic's eDeveloper and iBOLT products
provide developers with the ability to rapidly build integrated applications in
a more productive manner, lowering IT maintenance costs and decreasing
time-to-market.
A wide variety of developers use Magic's products, including in-house corporate
development teams and software houses. Large and medium sized system integrators
use Magic's products in large customized system integration projects and for
developing industry-specific vertical applications.
Professional Services
Magic, together with Magic's partners, offers customers application
integration and development services that assist customers to maximize their
development investments. These services include project management, technical
support, installation services, application development, integration, consulting
and training. All projects are subject to a rigorous standard for project
management and quality assurance.
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Strategic Alliances
Magic forms strategic alliances to help deliver complete solutions to
customers. These solutions encompass application integration, development,
vertical domain expertise and hardware implementation. Magic maintains strategic
alliances with leading vendors, like SAP, IBM, Iway, IDS Scheer and Pervasive
Software. Magic's partnership with SAP, entered into in 2004, focuses on
providing a special edition of iBOLT as a collaboration platform for SAP
business one product. In addition, Magic has alliances with system integrators,
software and hardware vendors and consulting organizations. These partnerships
enable Magic to better serve its customers worldwide.
Vertical Solutions
Magic also develops, markets, and supports, through its subsidiaries and
affiliates, vertical applications, including long-term care, criminal justice,
and multi-facility car and truck rental management solutions.
o Healthcare - Advanced Answers on Demand Holding Corp. develops and markets
application software targeted at the long-term care industry. This
comprehensive solution is designed to meet the management information
needs of retirement homes, nursing homes, assisted living facilities,
continuing care retirement communities, and home health and rehabilitation
agencies.
o Cargo Handling - Hermes (formerly Magic eCargo) is designed expressly for
the cargo industry and is a comprehensive solution for cargo handling and
inventory control that is designed to increase productivity, improve
efficiency, and reduce costs. Hermes handles many aspects of a cargo
operation including inventory control, automated build-up of
flights/manifesting, messaging to CARGO-IMP standards, customs clearance,
weight and balance DCS interfacing, scanning and verification of cargo,
secured tracking and a comprehensive financial package for all aspects of
charging, collecting fees and invoicing.
o Rental Car Leasing - CarPro Systems Ltd. develops, markets and sells
CarPro, a solution that includes more than 90% of the functions usually
required by multi-facility car and truck rental companies worldwide.
CarPro can manage such varied functions as purchasing and selling
vehicles, reservations management, leasing and rental arrangements, and
fleet control and management.
o Banking - Nextstep Infotech PVT Ltd. develops and markets Cheq Mate, a
banking application that provides most of the functionality needed to run
a retail branch, including support for various deposit types, advances,
time deposits, bank guarantees, letters of credit and portfolio
management.
o Professional Services - CoreTech is an information technology consulting
firm offering
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flexible and creative solutions in the areas of infrastructure design and
delivery, application development, technology planning and implementation
services, and supplemental staffing.
Markets and Customers
Magic markets and sells its products and services in approximately 50
countries worldwide. Industries that are significantly represented in the Magic
community base include finance, retail, media, telecommunications,
manufacturing, healthcare, and government agencies. Among the tens of thousands
of end-users running their business systems with Magic's technology are the
following:
o Adidas- o Financial o Minolta
Solomon Times
o Allstate o Hitachi o Nestle
Nespresso
o Athlon Group o John Menzies o Nintendo
o Bank of France o Kodak o Philip Morris
o Burger King o Marconi o GAP
Mobile
o Chase o NEC o State of
Manhattan Washington
Bank
o Club Med o Merrill Lynch o Vodafone
o Compass o Matsushita o The United
Group PLC Nations
o Deka Bank o McDonalds o Victorinox
o Fiat o McKesson
HBOC
BluePhoenix
BluePhoenix Solutions Ltd. (formerly known as Crystal Systems Solutions
Ltd.) develops and markets unique enterprise IT modernization, or EIM, solutions
that enable companies to automate the process of modernizing and upgrading their
mainframe and distributed IT infrastructure and to effectively compete in
today's environment. BluePhoenix's solutions, which include technology for
Understanding, Presentment, Migration, Remediation, and Redevelopment, 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 adapt to new business demands.
BluePhoenix's solution portfolio includes invasive and noninvasive
software products, software tools and support services that address the most
pressing challenges organizations and companies face today.
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BluePhoenix's comprehensive enterprise technologies span mainframe,
midrange, and client/server computing platforms. BluePhoenix has enhanced its
expertise through the successful completion of projects for many large
organizations over the past 18 years, establishing its credibility and achieving
international recognition and presence. Based on BluePhoenix's technology and
that of its affiliates, BluePhoenix develops and markets software products,
tools, and related methodologies. BluePhoenix delivers its tools and
methodologies together with training and support in order to provide enterprises
with comprehensive solutions, primarily for the modernization of existing IT
systems.
In 1997, BluePhoenix introduced its C-MILL millennium conversion tool,
which was developed based on its generic modernization technology, and
BluePhoenix was awarded significant contracts from leading international system
integrators. In 1997 and 1998, BluePhoenix derived substantially all of its
revenues from millennium conversion projects. Since 2000, BluePhoenix has
derived all of its revenues from providing legacy modernization and porting
solutions.
Among the various alternatives to modernization, such as renewing legacy
systems, buying packaged software, or rebuilding entire applications, EIM has
proven to be the most efficient and viable way for companies to protect their
existing investments. BluePhoenix provides 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 EIM market is divided into the following categories: enterprise IT
understanding, enterprise IT presentment, enterprise IT migration, enterprise IT
remediation, and enterprise IT redevelopment. BluePhoenix provides solutions for
each market area, as follows:
Enterprise IT Understanding--BluePhoenix understanding solutions provide
automated, detailed mapping of system-wide IT activity and the interconnections
between all software components. This detailed road map serves as the basis for
optimizing the reuse of existing IT systems, tailoring the modernization plan
for the company's unique IT environment and corporate requirements, and reducing
future ongoing maintenance costs. BluePhoenix IT Discovery provides fast and
convenient access to application inventory, dependency, and operational
information. This tool performs the complete audit necessary to enable companies
to define and analyze all application assets in order to make informed decisions
about ongoing modernization activities.
Enterprise IT Presentment--BluePhoenix enterprise IT presentment solutions
enable companies to more effectively use the large amount of information
produced by batch reports generated from legacy systems and to turn mainframe
applications into Web services directly from the existing development
environment. The presentment process extracts and manages report and document
content and then selectively redisplays it in graphical form over the Web. The
results are easy to access, read, and distribute, fully secure, and do not
require large amounts of storage space. BluePhoenix enterprise IT presentment
suite includes the following solutions:
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o BluePhoenix(TM) PowerText provides companies with the ability to
define XML (Extensible Markup Language)-based data views from their
existing reports. Each data view can be associated with an XSL (Extensible
Stylesheet Language) definition used to create a graphical presentation of
the data.
o BluePhoenix(TM) WS4Legacy enables companies to adapt their existing
development environment by providing access to mainframe systems through
Web services protocols, a standard in today's market. WS4Legacy makes
legacy systems appear as modern systems, and enables them to communicate
with other applications in the same language.
Enterprise IT Migration--BluePhoenix comprehensive, integrated set of
enterprise IT migration solutions enable companies to standardize and
consolidate their IT systems by automatically converting and redeploying
applications, databases, platforms, programming languages, and data that are
implemented on outdated computing platforms.
Buying a packaged application or rebuilding one can often be an expensive
and risky proposition. Therefore, companies often look toward migrating their
existing applications. This option is much more cost-effective and
time-efficient as it leverages their existing investments in custom
applications. Additionally, BluePhoenix migration solutions enable companies to
operate their IT systems independently, without relying on previous technology
support providers. Thus, the migration process provides significant cost
savings on development, maintenance, and human resources. BluePhoenix
enterprise IT migration suite includes the following solutions:
o BluePhoenix(TM) DBMSMigrator--An automated migration tool that
converts applications from nonrelational databases, such as IDMS, ADABAS,
and VSAM, to relational databases, such as DB2, Oracle and SQL Server.
o BluePhoenix(TM) PlatformMigrator--An automated migration tool that
converts a range of platforms, including VSE, MVS, and Bull GCOS, and can
be customized to fit the unique IT configuration and business rules of
each customer site.
o BluePhoenix(TM) LanguageMigrator--An automated migration tool for
converting COBOL and 4GLs (fourth generation languages) such as ADSO,
Natural Mantis and COOL:Gen.
o BluePhoenix(TM) DataMigrator--A Windows-based tool for migrating data
between various data system environments. Coupled with a step-by-step
proven methodology, the tool provides a fully structured but still
versatile automated data migration process.
Enterprise IT Remediation-- BluePhoenix integrated set of enterprise IT
remediation solutions enable companies to extend the life of their existing IT
systems when faced with ongoing regulatory changes and new business
requirements. BluePhoenix remediation solutions address a variety of corporate
needs and include:
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o BluePhoenix(TM) FieldEnabler--FieldEnabler is a rule-based tool that
enables a step-by-step, comprehensive process for making these kinds of
modifications across an enterprise in a reliable and time-efficient
manner.
o BluePhoenix(TM) StandardsEnabler--A highly automated solution for
reliably facilitating system consolidation into a single set of naming
standards. Since all resources being converted must be changed in
parallel, the large task of manually standardizing the naming of system
components is not practical. BluePhoenix solution provides automated
solution to this problem.
o BluePhoenix(TM) COBOL/LE-Enabler--A highly automated solution that
facilitates the migration of COBOL code from non-LE compliant environments
to LE compliant environments.
o BluePhoenix(TM) EuroEnabler--A highly automated solution that enables
the transformation of applications to be euro compliant.
o BluePhoenix(TM) LiraEnabler--A highly automated solution that enables
applications to be compliant with the Turkish currency requirements for
entry into the European Community.
o BluePhoenix(TM) GTIN/UPCEnabler - A highly automated solution that
enables companies to quickly and easily comply with the 2005 Sunrise and
GTIN/GLN initiatives.
Enterprise IT Redevelopment--BluePhoenix enterprise IT redevelopment suite
enables companies to efficiently mine, reuse, and rewrite their existing
applications, thus incrementally redeveloping their legacy systems, extending
them into new technologies, and saving on development and programmer costs.
o BluePhoenix(TM) AppBuilder-- BluePhoenix primary redevelopment legacy
environment 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 until they cease using their legacy
infrastructure.
o Visual MainWin(R) for the Unix and Linux platforms (formerly
MainWin)--Visual MainWin(R) for the Unix and Linux platforms is an
advanced application-porting platform that enables IT organizations to
develop applications in Visual C++ and deploy them natively on Unix and
Linux without the investment that is usually associated with such an
undertaking.
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BluePhoenix's subsidiary, Mainsoft Corporation, has entered into a
licensing agreement with Microsoft, pursuant to which Microsoft granted
Mainsoft access to specified Microsoft source code, including new
versions, service packs, and upgrade releases for Windows. Microsoft also
granted Mainsoft distribution rights to the Windows object code licensed
as a component in Mainsoft's products.
o Visual MainWin(R) for the J2EE platform--In February 2004, Mainsoft
launched its new generation product: Visual MainWin(R) for the J2EE
platform (formerly named Grasshopper). The Visual MainWin(R) for J2EE
Platform is a cross-platform development solution that bridges the
.NET/J2EE divide, enabling Visual Basic .NET and C# developers to develop
J2EE Web Applications and Web services using the Visual Studio .NET
development environment.
In 2003, BluePhoenix completed the acquisition of the entire outstanding
share capital of Liraz Systems Ltd. Liraz's business included the operations of
BluePhoenix Solutions B.V. and its international subsidiaries. Through its
subsidiaries, BluePhoenix develops and markets the AppBuilder, formerly
developed and marketed by Liraz, a software product used for the development of
sophisticated and robust applications needed by large enterprises. Following the
acquisition, BluePhoenix has benefited from Liraz's large installed base that
includes leading international banks and financial institutions, whose
information systems operate in various legacy environments.
BluePhoenix believes that following the Liraz acquisition, utilizing its
combined broad technology offering and its worldwide marketing capabilities,
BluePhoenix became a leading global player in the enterprise IT modernization
market. With 12 offices in 10 countries, five full service delivery centers, and
representatives, BluePhoenix provides its products and services worldwide.
Customers
BluePhoenix provides its modernization solutions directly or through its
strategic partners, such as IBM, Capgemini, EDS, Cook Systems, Temenos,
Millennium and TACT. Additionally, from time to time, other IT services
companies license the technologies for use in modernization projects in various
markets. BluePhoenix customers include, among others:
o In the financial services sector - Banca Carige S.p.A., CitiBank , Credit
Suisse, Fidelity International Resource Management, Rabobank Netherland BV,
Rural Servicios Informaticos (Spain), SDC Udvikling (Denmark) and Temenos Group;
o In the insurance sector - AXA Sunlife Services PCL(UK), Barmenia
Krankenversicherung A.G., Friends Provident Management Services Ltd., LBS
(Germany), Legal and General Resources and Mutual of America.
o In other industries - Altera Corporation, Cadence Design Systems, Inc.,
Cognos, Commonwealth of Australia, Computer Associates Islandia, CSC Denmark
A/S, Crystal
34
Decisions, Electronic Data Systems Corp., Fudicia Informationszentra AG, Global
Exchange Services Inc., IBM Japan Ltd., IBM (Rational Software), Intesa Sistemi
E Servizi, Mentor Graphics Corporation, Microsoft Corporation, Israeli Ministry
of Defense, Scottish Equitable Plc. and Synopsys MT VIEW.
Sapiens
Sapiens International Corporation N.V. is a global provider of IT
solutions that modernize business processes to enable insurance and other
leading companies to quickly adapt to change. Sapiens' solutions, sold as
customizable software modules, align IT with business demands for speed,
flexibility and efficiency. Sapiens' solutions are supplemented by its
technology, methodology and consulting services, which address the complex
issues related to the life-cycle of enterprise business applications. Sapiens'
solutions include scalable insurance applications it has developed for leading
organizations such as AXA, Norwich Union, Liverpool Victoria, OneBeacon, Fortis,
Principal Financial Group, the Surplus Line Association of California and
Menorah Insurance in Israel. Sapiens' service offerings include a standard
consulting offering that helps customers make better use of IT in order to
achieve their business objectives.
Sapiens' core technology, Sapiens eMerge(TM), is a rules-based application
development suite which enables rapid solution development for complex
mission-critical enterprises to deliver new functionality, achieve legacy
modernization and enterprise application integration. The primary building block
of Sapiens' solution offerings is Sapiens eMerge(TM), Sapiens' business rules
engine that has evolved and matured over the course of thousands of man-years of
research and development efforts. The use of Sapiens eMerge(TM) reduces the
complexity of programming so that new applications and modifications of existing
ones can be produced in a much shorter time than through conventional
programming.
Another key advantage of Sapiens eMerge(TM) is the ability to extend the
productive life of older computer systems, while at the same time providing the
basis for using new generation Internet and service-oriented technologies. The
use of rapid application development allows enterprise-specific enhancements to
be made in a shorter time and with a greatly reduced maintenance burden when
compared to other technologies.
Development, deployment, integration and administration of applications
are all accomplished through the technology components of Sapiens eMerge(TM),
providing customers with flexible, scalable and feature-rich systems. Sapiens
eMerge(TM), which serves over 100 of Sapiens' customers worldwide, reduces the
cost of business software development and maintenance.
Sapiens markets its solutions globally through its direct sales force and
through marketing alliances with global IT providers, such as IBM Corporation
and Electronic Data Systems Corporation. Sapiens has cooperated with IBM
Corporation for over 10 years at what IBM refers to as a "Premier Partner"
level. Currently, Sapiens is an "Advanced Partner" of IBM and works with IBM on
solutions, joint development, testing, validation and marketing. Through this
and
35
other business alliances, Sapiens has developed extensive knowledge in mainframe
and mid-range systems, including CICS, DB2, MQSeries and the WebSphere
e-business platform. Sapiens is also a member of the IBM's insurance application
architecture (IAA) group and the ISV advantage program for the small and medium
business insurance market segment.
Sapiens' Business Solutions for the Insurance Industry
Sapiens has formulated INSIGHT, a suite of modular business software
solutions that make use of existing assets to quickly and cost-effectively
modernize business processes that are the key to survival in the current,
challenging insurance landscape. Sapiens' insurance solutions, which include the
INSIGHT family, are based on Sapiens core technology, Sapiens eMerge(TM).
Sapiens INSIGHT(TM) is designed for the general (property and casualty)
and life insurance markets. These solutions can be customized to match specific
legacy systems and business requirements, while providing pre-configured
functionality. These solutions can be used independently or together as follows:
o INSIGHT(TM) for Property & Casualty (formerly known as Policy INSIGHT(TM))
is a fully functional, general insurance policy administration solution
that makes it easier for brokers and agents to do business with carriers.
By automating the process, this web-enabled solution reduces the cost of
doing business and optimizes risk selection through the use of rules based
underwriting.
o INSIGHT(TM) for Life & Pensions (formerly Life & Pensions INSIGHT(TM)) is
a powerful and comprehensive framework-based life and pensions solution
that serves companies administering life insurance, pension funds, health
insurance and saving plans. INSIGHT(TM) for Life & Pensions is dynamic,
highly customizable and can be easily accommodated to administer changes
in processes. It is fully web-enabled, prepared to utilize the advantages
of the internet and intranet.
o INSIGHT(TM) for Underwriting (formerly MediRisk INSIGHT(TM)) is an
underwriting solution for life, health and disability insurance. It
reduces customer's costs by automating a larger portion of the process of
evaluating the risks of new business and by streamlining the procedures
for handling new business. By using this solution, an insurance company
can make underwriting assessments on new cases earlier in the business
cycle and achieve greater consistency in its decision-making. Sapiens
markets INSIGHT(TM) for Underwriting on the basis of licensing and
distribution agreements with MediRisk Solutions Ltd. which developed the
solution and holds the intellectual property rights to it.
o INSIGHT(TM) for Reinsurance (formerly Reinsurance INSIGHT(TM)) is a
sophisticated solution for the insurance market, designed to support
carriers and reinsurers in the management of all types of reinsurance for
the general (property
36
and casualty) and life insurance markets, according to the rapidly
changing requirements of the international reinsurance market. This
state-of-the-art, web-enabled solution streamlines and reduces the cost of
handling all reinsurance functions through automation, is based on ACORD
standards and B2B XML technology, and is designed for a multi- language,
multi- currency, multi- company environment.
o INSIGHT(TM) for Claims (formerly Claims INSIGHT(TM)) is a solution that
effectively manages and streamlines the information flow of claim handling
across an insurance provider's entire organization. This solution uses
highly accessible business rules and messaging standards and allows the
use of a company's existing information assets.
o INSIGHT(TM) for Closed Books (formerly Closed Books INSIGHT(TM)), also
known as LifeLite, is a solution for life insurance companies and pension
funds seeking ways to reduce the cost of maintaining long-term closed
books of business, that is, lines of business that are no longer current.
Sapiens provides customizable solutions that enable companies to
efficiently and more effectively administer policies and claims relating
to closed books. In September 2004, Sapiens purchased the technologies
underlying the INSIGHT(TM) for Closed Books solution from Liverpool
Victoria.
Sapiens collaborates with its customers to tailor the INSIGHT solutions to
achieve the unique operational performance goals of each organization. In
addition, Sapiens has executed independent projects for the insurance market,
providing enhanced information access and visibility to empower the sales, agent
and broker community, thus accelerating transaction processing for improved
customer service and business efficiency. Sapiens' insurance solutions are
compatible with a variety of platforms including IBM zSeries , IBM iSeries and
HP UNIX at the host-side and Intel-based Web servers. They are also compatible
with open architecture standards such as .NET, J2EE, XML, Web Services and
application server platforms such as IBM's WebSphere(TM).
Services
Outsourcing of application maintenance. Sapiens' outsourcing services were
developed from its strong, long-term relationships with its customers. Sapiens
is currently servicing multi-year outsourcing contracts with blue-chip customers
involving mission-critical systems. The outsourcing projects are performed
either on or off the customers' premises. Sapiens' asset discovery solution
contributes to the maintenance and management of an enterprise's IT environment.
IT Services. Sapiens provides customers with specialized IT services in
many areas, including project management and technical assistance. Sapiens'
personnel work with the customer for the duration of the entire project,
collectively undertaking design, development and
37
deployment tasks, coupled with hands-on-training, to achieve a rapid software
solution that matches the customer's business and IT goals. Sapiens has also
evolved its service offerings to include a strategy-based discovery and analysis
blueprint that helps improve the IT impact on a company's business objectives.
Customers
Sapiens markets its solutions primarily to corporate customers and
government entities with large information technology budgets and ongoing
maintenance and development needs. Sapiens' corporate customers include, among
others, insurance companies, banks and other companies offering financial
services and companies in the manufacturing and transportation sectors. The
principal markets in which Sapiens competes are located in North America,
Europe, Israel and Japan.
nextSource Inc.
nextSource Inc. designs, develops and implements web-based, high quality,
innovative human capital management solutions. These offerings allow customers
to save money while managing the business processes related to sourcing,
procuring, and accounting of their workforce.
nextSource's human capital management solutions include:
o A web-based vendor management solution for managing customers' internal
and external contingent workforce. nextSource's Talent Acquisition
Management Solution, also known as TAMS makes it easier for customers to
find, engage and deploy talented personnel, faster and more effectively,
while ensuring competitive labor costs. TAMS streamlines the hiring
process, allowing for enhanced communication with candidates, more
efficient distribution of open positions to vendors and a decrease in
time spent on administrative tasks.
o Agency services through nextSource's value-added reseller program. This
solution provides staffing vendors with opportunities to increase revenue,
bringing added value to existing business relationships. nextSource has also
created The Multiple Listing Staffing Association, an industry-wide network of
independent staffing suppliers working collectively to staff openings for
customers with the best candidates in the shortest time intervals.
o The People Ticker provides businesses with real-time views of market rates
for both contingent and full time workers, based upon skill-set, years of
experience and geographic location. This one-of-a-kind tool enables corporate
customers to truly benchmark their contingent labor costs against the most
current information available.
o The nextSource People Auction utilizes an extensive resume database and
comprehensive searching capabilities to provide an online marketplace that
links qualified talent with
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progressive talent seekers. nextSource also offers a unique reverse auction that
allows potential candidates to bid on a posted opening thereby driving down the
cost to the customer.
o Human resources, or HR, services, include services of a professional
employer organization for payroll processing, benefits administration,
recruiting, and other HR related services. nextSource also offers "payrolling
services" to minimize the co-employment risks and eliminate the administrative
burdens associated with the employment of independent contractors, retirees,
summer interns and other temporary workers.
o A wide range of procurement services and vendor management services to
complement the implementation of nextSource's TAMS solutions and People Ticker
solutions. Through its value-added procurement service, nextSource offers a
fully outsourced procurement/vendor management solution to customers looking
for a complete solution.
Formula Vision
Formula Vision Technologies (F.V.T.) Ltd. is a managing and holding
company, guiding a group of privately held IT companies with innovative,
proprietary technologies and solutions targeting international markets. Formula
Vision holds a controlling interest in some of these privately held companies
and a minority interest in the other members of the group.
Formula Vision's affiliated companies provide IT solutions for broadly
diverse sectors, including telecom and broadcast, aviation, travel, insurance,
retail, customer relations management, 3D-modeling, software testing, system
reliability applications which meet the demand for Web-based systems, legacy
mainframe and mobile networks. Formula Vision provides its affiliated companies
with guidance and support at all levels - management, strategy, technology,
marketing, business intelligence and finance.
Formula Vision's companies have built their success on a solid customer
base and strategic partnerships with "Fortune 500" multinationals, systems
integrators, media groups, and service and solution providers worldwide, such as
IBM, Oracle, Sun, Cap Gemini Ernst & Young, Lockheed Martin and Microsoft.
Formula Vision's principal affiliated companies include:
Transtech
Transtech Control Ltd. is a market-leading provider of comprehensive
airfield control and management systems. Transtech's systems comprise a wide
range of solutions, applications, and products for critical airfield operational
elements. Transtech's airfield lighting control system is currently operating at
more than 130 international, domestic and military airports worldwide.
Transtech's innovative ground surveillance system addresses the industry's
urgent needs by enhancing airport safety and accommodating increased capacity.
The system overcomes the
39
limitations and problems inherent in traditional surveillance systems using
technologies based on unique radar and optical sensors. Transtech's systems have
been installed in various airports, including JFK Airport, New Denver Airport,
Beijing Airport, New Bangkok Airport and San Paolo Airport.
F.T.S. - Formula Telecom Solutions Ltd.
F.T.S. - Formula Telecom Solutions Ltd., referred to as FTS, is a global
provider of converged end-to-end CRM and billing solutions for telecom operators
and service providers. Enabling advanced voice, data and video services, FTS'
integrated "triple-triple play" solutions cater to a trio of wireline, wireless
and other operators, while supporting prepaid, postpaid and converged billing.
FTS maintains a global presence with worldwide installations supported by sales
and service offices in three continents. Combining a proven track record of
on-time, on-budget project delivery with solid backing and extensive resources
from the Formula group, FTS is a CRM and billing one-stop-shop. FTS'
cutting-edge solutions enable operators to increase customer acquisition,
customer retention and profitability - all at a low total cost of ownership.
FTS' customers include, among others, MobilTel, Freenet.de, Comverse,
Cross-Israel Road No. 6 - Israel's National Toll Road and MDC Velcom.
Babylon
Babylon Ltd. is a leading provider of single-click information access
solutions. In 1997, Babylon introduced its flagship product - a desktop
application that delivers translations, conversions and information in a single
click. Since 2001, Babylon's products have been sold online and direct to
personal and business users worldwide. Babylon has now leveraged its patented
technology in an integrated server and client system that gives business
customers a unified platform for instant retrieval of critical information from
corporate information systems.
Babylon also offers add-on premium content from world-renowned dictionary
publishers, including Oxford University Press, Larousse, Langenscheidt, Van
Dale, Melhoramentos, Signum and Taishukan. Babylon's customers include industry
leaders such as Avnet, BASF, Daimler Chrysler, Ericsson, Ernst & Young,
Eurocontrol, Fujitsu Siemens, Gillette/Braun, IBM, John Deere, Lufthansa,
Motorola, Nestle France, Oce, Petrobras, Philips, UBS and Xerox.
A major shareholder in Babylon is Reed Elsevier Ventures, the venture arm
of Reed Elsevier (LSE: REL, NYSE: RUK), a leading publisher and information
provider.
FIS Software
FIS Software Ltd. is dedicated to developing and delivering global
package-based solutions that enable life and pensions companies to run their
businesses more efficiently, and respond to territorial legislation and
regulations. FIS' solutions are based on ALIS, FIS' flagship product. ALIS is a
single packaged, comprehensive and modular software platform that incorporates
all activities along the policy lifecycle and enables insurers to manage life
insurance, pensions and investment products, for individual and group customers
in line with the territorial legislation and regulations. Founded in 1984, FIS
established its international business in 1999
40
and currently employs 360 insurance domain experts and IT software professionals
across offices in the UK, France, Spain, Greece, Israel, South Africa and
Australia.
FIS' customers include AXA, Unum Provident, CNP Assurances, Swiss Life,
Scottish Equitable, Bright Grey, AMP, NPI, Ethiniki, Clal and Eliahu. FIS also
has a number of strategic partnerships with leading systems integrators and
consulting firms such as IBM and TCS.
GigaSpaces
GigaSpaces Technologies Ltd. is a fast-growing provider of innovative
grid-based solutions that solve the performance, reliability and scalability
problems of transaction-intensive, business critical applications. GigaSpaces
was founded in 2000 and is headquartered in New York, with a research and
development center in Israel.
GigaSpaces' customers include AIG, Nortel Networks and Hutchison 3G, among
other major organizations in the financial, telecom and manufacturing
industries.
GigaSpaces Enterprise Application Grid (EAG) is a middleware product that
provides a rich set of tightly-integrated application services (such as Java
massaging services (JMS), clustering, caching and Java database connectivity
(JDBC) - on top of a federated shared memory platform. This allows developers to
rapidly build and deploy high-performance and highly-reliable business-critical
applications that run on a distributed set of IT resources. GigaSpaces EAG
enables an organization to dynamically distribute data across low-cost servers
such as Linux Blades and achieve in-memory levels of performance with
significantly less administration and costs than dedicated hardware solutions.
Clockwork Solutions
Clockwork Solutions Ltd.'s predictive modeling software tools provide life
cycle system-engineering solutions for capital-intensive major industrial
companies, military organizations and government agencies throughout the world.
Clockwork focuses on the defense, process and petrochemical and power
industries, offering products and services to customers such as the US Army, US
Air Force, Raytheon, Lockheed Martin, General Dynamics, GE Aircraft Engines, GE
Energy, DOW Chemical, Conoco Philips, Chevron Texaco and the Israeli Defense
Forces. Clockwork's solutions improve the economic performance of systems by
reducing costs, increasing production, and operating with greater effectiveness.
Clockwork's propriety technology and modeling platform, SPAR, tracks the
behaviors of systems over time, exposing effects of equipment aging, maintenance
policies, and operating procedures. These unique capabilities enable the users
of SPAR technology to relate cause and effect, to quantify risks, and to guide
capital investment and major operation and maintenance improvements. Clockwork's
current focus is on the performance based logistic (PBL) defense market and the
service parts planning (SPP) commercial and defense market. Clockwork has been
identified by Gartner, Inc. and AMR Research, both leading technology market
analysts, as a unique player and provider of innovative solutions in these
markets.
IDIT
41
IDIT I.D.I. Technologies Ltd., or IDIT, is an international vendor of
enterprise application software for the administration and full life-cycle
support of insurance products and financial services in a unique business
package combining know-how, software and business procedures. IDIT's flagship
product is a fully implemented, comprehensive online system for the insurance
industry.
IDIT also provides solutions for the insurance industry to enhance
existing systems, add web capabilities and online call center components.
Capitalizing on new, distributed capabilities while saving investment on legacy
technology, IDIT leverages channel opportunities for rapid return on investment.
IDIT has gained a leading position amongst European suppliers of enterprise
solutions for insurance.
IDIT's customers include AON International, Groupama and Rosiya.
Sintec Media
Sintec Media Ltd. is a developer and manufacturer of broadcast management
systems. Sintec Media's product, OnAir, is an all-in-one software system
designed to meet the rapidly changing management needs of broadcasters. OnAir is
intended for small stations as well as entire networks and station groups,
operating multi-channels over multiple regions and time zones. OnAir features a
set of powerful sales and content-inventory tools that increase efficiency and
raise profits.
Sintec Media's customers include the BBC, Canadian Broadcasting Corporation
(CBC) and RTL.
Sales and Marketing
Our subsidiaries conduct sales and marketing efforts primarily through
division or product managers. In certain cases, the companies devote sales
managers who, aided by their staffs, are responsible for ongoing customer
relationships, as well as sales to new customers. In addition, the IT services
companies participate in competitive bidding processes, primarily for turnkey
and government projects, as well as large IT services contracts. Our
subsidiaries attend trade shows and exhibitions in the high technology markets,
while further supplementing their sales efforts with space advertising and
products and services listing in appropriate directories. In addition, our
subsidiaries organize user group meetings for their customers, where new
products and services are highlighted. We typically enter into strategic
alliances and intend to pursue acquisitions in order to penetrate various
international markets and promote sales of our proprietary software solutions in
international markets.
The following table summarizes our revenues by operating segments for the
periods indicated:
42
Proprietary
Software Software
----------- ----------- ----------
Services Products Total
----------- ----------- ----------
$ thousands
----------------------------------
Year ended December 31,
-----------------------
2004 227,262 229,348 456,610
2003 196,782 170,048 366,830
2002 171,342 111,968 283,310
The following table summarizes the revenues from our IT products and
services by geographic regions of our customers, for the periods indicated:
Year ended December 31,
-------------------------------
2004 2003 2002
--------- ---------- ----------
$ thousands
-------------------------------
Israel 213,020 171,108 156,212
International:
United States 106,849 93,695 65,654
Other (includes various countries,
mainly in Europe) 136,741 102,027 61,444
------- ------- ------
243,590 195,722 127,098
------- ------- -------
Total 456,610 366,830 283,310
Competition
The markets for the IT products and services we offer are rapidly evolving
and highly competitive. Our ability to compete successfully in IT services
markets depends on a number of factors, like breadth of service offerings, sales
and marketing efforts, service, pricing, and quality and reliability of
services. The principal competitive factors affecting the market for the
proprietary software solutions include product performance and reliability,
product functionality, availability of experienced personnel, price, ability to
respond in a timely manner to changing customer needs, ease of use, training and
quality of support.
We face competition, both in Israel and internationally, from a variety of
companies, including companies with significantly greater resources than us who
are likely to enjoy substantial competitive advantages, including:
o longer operating histories;
o greater financial, technical, marketing and other resources;
o greater name recognition;
43
o well-established relationships with our current and potential
clients; and
o a broader range of products and services.
As a result, they may be able to respond more quickly to new or emerging
technologies or changes in customer requirements. They may also benefit from
greater purchasing economies, offer more aggressive product and service pricing
or devote greater resources to the promotion of their products and services. In
addition, in the future, we may face further competition from new market
entrants and possible alliances between existing competitors. We also face
additional competition as we continue to penetrate international markets. As a
result, we cannot assure you that the products and solutions we offer will
compete successfully with those of our competitors. Furthermore, several
software development centers worldwide, such as in India, offer software
development services at much lower prices than we do. Due to the intense
competition in the markets in which we operate, software products prices may
fluctuate significantly. As a result, we may have to reduce the prices of our
products.
Matrix's principal competitors in the domestic Israeli market are Israeli
IT services companies and systems integrators, the largest of which are Ness
Technologies Inc. and Team Computers. Matrix's international competitors in the
Israeli marketplace include H.P., EDS, IBM and Microsoft. These international
competitors often use local subcontractors to provide personnel for contracts
performed in Israel.
Magic's principal competitors in the market for the eDeveloper technology
are Visual Basic (Microsoft), Progress, Delphi and Jbuilder (Borland), Java,
Oracle, Compuware, Lansa and packaged applications such as SAP and PeopleSoft.
The principal competitors in the market for Magic's iBOLT Integration Suite are
WebMethods, Tibco, Vitria, Seeburger, IBM's WebSphere, Microsoft's BizTalk and
Sonic Software (Progress).
BluePhoenix's principal competitors consist of system integrators and tool
vendors, including leading software developers, who enable customers to replace
or modernize their legacy systems. Major system integrators in the market
include IBM, Capgemini, and EDS. In addition, BluePhoenix faces competition from
niche companies operating in each of the five principal areas of the enterprise
IT modernization market (enterprise IT understanding, presentment, migration,
remediation and redevelopment). For example, Micro Focus International markets
its solutions to the COBOL market, Software Technologies addresses the
Natural/ADABAS arena, and other competitors focus on collecting sufficient
information about application portfolios to enable improved working processes.
Other solution developers provide legacy and distributed repository solutions
that are important for a variety of modernization processes.
Sapiens' competitors in the market for solutions offered to the insurance
industry fall into several categories. Examples of competitors are: CSC,
SOLCORP, Fineos, SAP, SunGard Sherwood, Navisys, FIS, ePolicy Solutions,
Taliant, OneShield, Ascendant One, Insurity, The Innovation Group, Duck Creek
and AQS in the United States; Marlborough Sterling Group,
44
Unisys, Sherwood and RebusIs in the United Kingdom; Falmeyer (FJA) and COR AG
Insurance Technologies in Germany. Examples of large integrators in the
insurance field are Electronic Data Systems and CSC (companies that also have
customer or alliance relationships with Sapiens in other fields). An example of
a competitor that is a local integrator is Ness Technologies in Israel.
Sapiens' competitors in the business rule engines and management
marketplace include include Fair-Isaac (Blaze), Pegasystems, ILOG, Computer
Associates, Haley, RulesPower, Corticon, Versata, Gensym and ESI.
Transtech's competitors in the market of airfield lighting control systems
are Siemens and Honeywell, and in the ground surveillance systems' market,
Transtech's competitors are Sensis and Raytheon.
FTS' principal competitors are Amdocs Ltd., Convergys Corp., CSG Systems
International Inc., Portal Software Inc., Intec Telecom Systems PLC and LHS
Group Inc. (formerly known as the SchlumbergerSema Group).
FIS' principal competitors are CSC, Sunguard, Unisys, TIA (The Insurance
Application), Aquila, Fineos Corporation, and RebusIS. GigaSpaces' competitors
are distributed caching vendors such as Gemstone and Tangosol, as well as
compute-grid vendors such as DataSynapse and Platform Computing.
Sintec Media's main competitors are Harris, Pilat Media and in-house
solutions.
Software Development
The software industry is characterized by rapid technological
developments. In order to maintain technological leadership, we engage in
ongoing software development activity through our subsidiaries, aimed at both
creating new proprietary software and services, as well as enhancing and
customizing existing products and services. This effort includes introducing new
supported programming languages and database management systems; improving
functionality and flexibility and enhancing ease of use. We work closely with
current and potential end-users, our strategic partners and leaders in certain
industry segments to identify market needs and define appropriate product
enhancements and specifications.
Intellectual Property Rights
We rely on a combination of trade secret, copyright and trademark laws and
non-disclosure agreements, to protect our proprietary know-how. Some members of
our group have patents and patent applications pending. 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. We believe that, because of the rapid
pace of technological change in the industry, patent and copyright protection
are less significant to our
45
competitive position than factors such as the knowledge, ability and experience
of our personnel, new product development and ongoing product maintenance and
support.
C. Organizational Structure
Formula is the parent company of the Formula Group.
The following table presents certain information regarding the control and
ownership of our significant subsidiaries, as of June 20, 2005.
Subsidiary Country of Percentage
Incorporation Of Ownership
------------------------------- --------------------------------------
Matrix IT Ltd. Israel 50.6%
Magic Software Enterprises Ltd. Israel 50.2%
BluePhoenix Solutions Ltd. Israel 58.8%
Sapiens International Netherlands Antilles
Corporation N.V. Islands 56.0%
nextSource Inc. United States 100.0%
Formula Vision Technologies Israel 56.0%
(F.V.T.) Ltd.
The ordinary shares of BluePhoenix, Magic and Sapiens are traded on the
Nasdaq National Market and on the TASE, and the ordinary shares of Matrix and
Formula Vision are traded on the TASE.
D. Property, Plants and Equipment
Our corporate headquarters, as well as the research and development and
sales and marketing headquarters of a majority of our subsidiaries, are located
in Herzlia, Israel. We lease approximately 70,000 square feet of office space in
Herzlia, pursuant to a lease which will expire on October 31, 2005 with an
option to extend for an additional 36 months. In addition, several of our
subsidiaries lease approximately 75,000 square feet of office space in another
building in Herzlia pursuant to leases ending in December 2006, with an option
to extend for an additional 24 or 48 months. We also lease approximately 145,000
square feet of office space in several other locations in Israel.
We own a 34,000 square feet facility in Or-Yehuda, Israel used for office
space of Magic.
In addition, Sapiens leases approximately 45,000 square feet of office
space in Rechovot, Israel and several of our subsidiaries lease approximately
184,000 square feet of office space and sales and support premises in the United
States, Europe and Asia.
46
The aggregate amount we paid pursuant to our lease agreements in 2004 was
approximately $10.1 million.
We believe that our properties are adequate for our present uses. If in the
future we will require 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.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
Overview
Formula is the parent company of subsidiaries and affiliates, referred to
collectively as the Formula Group. We are principally engaged in providing
software consulting services, developing proprietary software products and
providing computer-based business solutions. We currently hold a controlling
interest in five publicly traded subsidiaries: BluePhoenix, Magic, Matrix,
Sapiens and Formula Vision. In addition, we wholly own nextSource. We
consolidate the results of operations of our subsidiaries with ours. Our
operating results are directly influenced by the consolidation and cessation of
consolidation of our subsidiaries. This could cause significant fluctuations of
our consolidated operating results. As a result, we believe that
period-to-period comparisons of our results of operations are not necessarily
meaningful and you should not rely on these comparisons as indications of our
future performance.
In the first quarter of 2003, our interest in Sapiens exceeded 50% of
Sapiens' outstanding share capital. As a result, we began consolidating Sapiens'
results of operations. The consolidation of Sapiens contributed, among others,
to the increase in our revenues in 2003 and in our selling, general and
administrative expenses.
In January 2004, we acquired a controlling interest in Formula Vision and
accordingly began consolidating Formula Vision's results of operations,
beginning with the first quarter of 2004. Formula Vision's revenues in 2004 were
$61.5 million and its net loss was $10.4 million.
In March 2005, we completed a private placement of 2,400,000 Formula shares
for aggregate consideration of $36 million. The shares were issued to FIMGold
LP, an entity owned in equal shares by Dan Goldstein, our chief executive
officer and chairman of the board, and FIMI Opportunity Fund.
In June 2005, we distributed to our shareholders a cash dividend of
approximately $4 per share. The aggregate amount distributed by Formula was
approximately $53 million.
We recognize revenues in two categories: the delivery of software services
and the delivery of proprietary software solutions. All of our subsidiaries,
including IT services companies and proprietary software solutions companies,
recognize revenues from the delivery of software services, and most of them
recognize revenues in both revenue categories. We have separated our
47
subsidiaries into these categories in accordance with the category in which each
subsidiary has earned most of its revenues.
We recognize, in non-operating income, gains and losses arising from the
sale of previously un-issued capital stock by a subsidiary or an affiliate to
outside investors, if the sale changes our ownership percentage in this entity.
We measure the gain or loss by the difference between our share in the proceeds
from this stock offering and the carrying amount, on an equity basis, of the
proportionate reduction in our investment. Transactions of this nature do not
occur on a regular basis and it is difficult for us to predict their timing.
Beginning with the fiscal year ended December 31, 2002, we prepare our
consolidated financial statements in conformity with accounting principles
generally accepted in the United States, referred to as U.S. GAAP. Under U.S.
GAAP, we cannot use adjusted NIS reflecting changes in the Israeli consumer
price index, as we have used in the past. Instead, we use nominal values of the
NIS translated into dollars as described below. As a result, we have restated
certain figures in our financial statements relating to prior periods.
Our functional and reporting currency
Formula and some of our subsidiaries operate primarily in the economic
environment of the New Israeli Shekel (NIS). The functional currency of our
other subsidiaries is the dollar. We use the dollar as our reporting currency.
We translate our financial statements into dollars, as well as the
financial statements of our subsidiaries whose functional currency is the NIS,
under the principles described in Financial Accounting Standards Board Statement
No. 52. Assets and liabilities have been translated at period-end exchange
rates. Results of operations have been translated at the exchange rate at the
dates on which those transactions occurred or at an average rate. We present
material differences resulting from translation under shareholders' equity in
the item accumulating other comprehensive income (loss). If gains and losses
arising from these translations are immaterial, we record them as financial
expenses included in the statements of income. In the consolidation, we present
the financial statements of subsidiaries whose functional currency is the
dollar, at the original amounts.
Critical Accounting Policies
In preparation of our financial statements, 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 which we believe are the most
critical to aid in fully understanding and evaluating our reported financial
results include the following:
Revenue Recognition
48
The revenue recognition policy of each of our significant subsidiaries is
material because our revenue is a key component of our results of operations.
Our revenue recognition determines the timing of certain expenses, such as
commissions and royalties. We follow very 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 our subsidiaries' managements 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 Statement of Position (SOP) 97-2 "Software Revenue
Recognition" (as amended by SOP 98-4 and SOP 98-9), upon delivery of the
software when collection is probable, the license fee is otherwise fixed or
determinable and persuasive evidence of an arrangement exists. When a project
involves significant modification of software, revenue is generally recognized
according to the percentage of completion method. Under this method, estimated
revenue is generally accrued based on costs incurred to date as a percentage of
total updated estimated costs. If our subsidiaries do not accurately estimate
the resources required or the scope of work to be performed, or do not manage
their projects properly within the planned periods of time or satisfy their
obligations under the contracts, then future margins may be significantly and
negatively affected or losses on existing contracts may need to be recognized.
Any such resulting reductions in margins or contract losses could be material to
our results of operations. Our subsidiaries recognize contract losses, if any,
in the period in which they first become evident.
Under some of our subsidiaries' agreements, the customer may have the
right to receive unspecified upgrades on a when-and-if available basis. These
upgrades are considered post-contract customer support, referred to as PCS, and
the fair value allocated to this right is recognized ratably over the term of
the PCS.
There are no rights of return, price protection or similar contingencies
in our subsidiaries' contracts. Accordingly they do not establish a provision
due to the lack of warranties' claims in the past. Some of our subsidiaries'
contracts include client acceptance clauses. In determining whether revenue can
be recognized, when an acceptance clause exists, they consider their history
with similar arrangements, the customer's involvement in the progress, the
existence of other service providers and the payments terms.
Our subsidiaries' revenue recognition policy does not permit any revenue
recognition when the payment term exceeds 12 months or when there is an
uncertainty related to the relationship with the customer.
We recognize revenues from projects billed on a time and material basis,
based on SOP 81-1 "Accounting for Performance of Construction - Type and Certain
Production - Type Contracts", using contract accounting on a percentage of
completion method, based on the
49
relationship of actual costs incurred to total costs estimated to be incurred
over the duration of the contract. Provision for estimated losses on uncompleted
contracts is made in the period in which such losses are first determined, in
the amount of the estimated loss on the entire contract. As of December 31,
2004, no such estimated losses were identified.
We recognize revenues from consulting fees with respect to fixed fee
contracts, based upon the percentage of completion method. We recognize contract
losses, if any, in the period in which they first become evident.
Revenues from contractual maintenance contract and training are recognized
ratably over the contract period.
Revenues from sales of hardware are recognized when the merchandise is
delivered to the customer, provided no significant vendor obligations remain.
Our management believes that our revenue recognition policies are in
accordance with the Securities and Exchange Commission Staff Accounting Bulletin
No. 101 and Staff Accounting Bulletin No. 104, "Revenue Recognition in Financial
Statements".
Impairment of Goodwill
Goodwill represents excess of the costs over the net assts of businesses
acquired. Under SFAS No. 142, goodwill acquired in a business combination on or
after December 31, 2001 is not amortized. Goodwill arising from acquisitions
prior to December 31, 2001 was amortized until December 31, 2001, on a
straight-line basis over 10 years.
SFAS No. 142 requires goodwill to be tested for impairment on adoption and
at least annually thereafter or between annual tests in certain circumstances,
and written down when impaired, rather than amortized as previous accounting
standards required. Goodwill is tested for impairment at the reporting unit
level by comparing the fair value of the reporting until with its carrying
value. Fair value is determined using discounted cash flows. Significant
estimates used in the methodologies include estimates of future cash flows,
future short-term and long-term growth rates, and weighted average cost of
capital for the reportable unit. As of December 31, 2004, no impairment losses
were identified.
A. Operating Results
Years Ended December 31, 2003 and 2004
Revenues. Revenues increased 24% from $366.8 million in 2003 to $456.6
million in 2004. The increase in revenues was mainly attributable to the
consolidation of Formula Vision which had revenues of $61.5 million in 2004 and
to an increase in revenues of our other subsidiaries, in particular Matrix and
nextSource. Such increase was partially offset by a decrease in Sapiens'
revenues. Revenues from the two categories of our operation were as follows:
Revenues from the delivery of software services increased 16% from $196.8
million in 2003 to $227.3 million in 2004. This increase was attributable to the
growth in Matrix's and
50
nextSource's revenues due to an increased demand for their services. Revenues
from the sale of proprietary software solutions increased 35% from $170.0
million in 2003 to $229.3 million in 2004. This increase was primarily due to
consolidation of Formula Vision, beginning with the first quarter of 2004.
Cost of Revenues. Cost of revenues consists primarily of wages and related
expenses and hardware and other materials costs. Cost of revenues increased 24%
from $230.5 million in 2003 to $285.0 million in 2004. As a percentage of
revenues, cost of revenues remained relatively the same in 2003 and 2004. Cost
of revenues for proprietary software solutions increased 37% to $105.4 million
in 2004 from $76.9 million in 2003, primarily due to the consolidation of
Formula Vision which had cost of revenues of $31.5 million in 2004. This
increase was slightly offset by a decrease in Sapiens' cost of revenues. Cost of
revenues for software services increased 17% from $153.6 in 2003 to $179.6
million in 2004, primarily due to the increase in the cost of revenues of our
subsidiaries Matrix and nextSource.
Software Development Costs, net. Software development costs consist
primarily of wages and related expenses and, to a lesser degree, consulting fees
we pay to independent contractors engaged in research and development. Software
development costs, net, consist of software development costs, gross, less
capitalized software costs. Software developments costs, gross, in 2004 and 2003
were $40.4 million and $27.6 million, respectively. In 2004, we capitalized
software costs of $15.4 million compared to $10.2 million in 2003.
Capitalization of software costs in 2004 was attributable to our proprietary
software solutions subsidiaries. Software development costs, net, increased 44%
from $17.4 million in 2003 to $25.0 million in 2004. As a percentage of
revenues, software development costs, net increased from 4.7% in 2003 to 5.5% in
2004. The increase in software development costs was attributed primarily to the
consolidation of Formula Vision which had research and development expenditures
of $9.7 million in 2004. The increase was partially offset by a decrease in the
research and development expenditures of Sapiens and Magic of $1.0 million and
$900,000, respectively. Amortization of capitalized software costs were $10.1
million in 2004 and $8.1 million in 2003, which amounts were included in cost of
revenues.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of salaries, severance and related
expenses, travel expenses, selling expenses, rent, utilities, depreciation,
amortization and professional fees. Selling, general and administrative expenses
increased 20% from $107.1 million in 2003 to $128.5 million in 2004. As a
percentage of revenues, selling, general and administrative expenses remained
relatively the same in 2003 and 2004. The increase in selling, general and
administrative expenses was primarily attributable to the consolidation of
Formula Vision which incurred selling, general and administrative expenses of
approximately $21.9 million in 2004.
Operating Income. Our operating income increased 52% from $11.9 million in
2003 to $18.1 million in 2004. The operating income in 2004 is attributable to
the improvement in the operating results of our subsidiaries, in particular
Matrix which had operating income of $15.5 million and BluePhoenix which had
operating income of $3.5 million. This improvement was
51
partially offset by the operating loss of $1.7 million of Formula Vision. The
operating income in 2003 is attributable to the improvement in the operating
results of our subsidiaries Magic, BluePhoenix and Matrix which were offset by
the operating loss of Sapiens.
Financial Expenses, net. Financial expenses, net increased 140% from $3.7
million in 2003 to $8.9 million in 2004. Financial expenses, net, is influenced
by various factors, including our cash balance, changes in the exchange rate of
the NIS against the dollar, changes in the exchange rate of the dollar against
the euro and changes in the Israeli CPI. The increase in financial expenses, net
was mainly attributable to the consolidation of Formula Vision which incurred
financial expenses of $3.1 million in 2004, as well as to the influence of the
interest expenses paid on the debentures issued by us to the public and interest
expenses incurred by our subsidiaries, Matrix, Sapiens and BluePhoenix.
Other Expenses, net. Other expenses, net in 2004 and 2003 were $332,000
and $90,000.
Gain on Realization of Shareholdings. Gain on realization of shareholdings
in 2004 was $8.9 million compared to $2.8 million in 2003. Gain on realization
of shareholdings in 2004 was attributable to the sale of a portion of the shares
we hold in Magic, Matrix and Formula Vision in the open market which resulted in
a gain to Formula of $1.1 million, $3.6 million and $383,000, respectively. In
addition, gain on realization of shareholdings in 2004 included gain from
realization of unrealized gains in Matrix of $2.8 million and a gain of $651,000
in Formula Vision due a decrease in its shareholdings in its subsidiary Babylon.
Gain on realization of shareholdings in 2003 was primarily attributable to the
sale of a portion of Magic shares in the market which resulted in gain to
Formula of $722,000, gain from a decrease in our shareholdings in Matrix due to
the issuance of Matrix shares to former shareholders of New Applicom and the
issuance of Matrix shares to the shareholders of an acquired company resulting
in gain of $1.1 million, the sale of Matrix warrants in the market which
resulted in gain of $300,000 and the sale of Level 8 shares by BluePhoenix which
resulted in gain of $376,000 to BluePhoenix.
Taxes on Income. Taxes on income in 2004 were $4.6 million compared to $2.5
million in 2003. The increase in taxes on income in 2004 was mainly attributable
to the consolidation of Formula Vision which had taxes on income of $1 million
and to the increase in taxes of Matrix.
Company's Equity in Results of Affiliates, net. Our equity in losses of
affiliates, net were $2.5 million in 2004 compared to $1.1 million in 2003. Our
equity in losses of affiliates, net relates primarily to affiliates of Formula
Vision.
52
Minority Interest, net. Minority interest, net, includes the minority
interest in companies which are not wholly owned by the Formula Group during
each of the periods indicated. Minority interest in profits of subsidiaries in
2004 was $2.5 million compared to $4.1 million in 2003. This decrease in
minority interest, net is attributable to the consolidation of Formula Vision in
2004 which had net loss of $10.4 million and the increase in the net loss of
Sapiens. These losses were offset by the increase in net profit of our
subsidiaries, Matrix, BluePhoenix and Magic.
Years Ended December 31, 2002 and 2003
Revenues. Revenues increased 29% from $283.3 million in 2002 to $366.8
million in 2003. The increase in revenues was mainly attributable to the
consolidation of Sapiens' results of operations beginning with the first quarter
of 2003, the significant increase in nextSource's revenues and an increase in
demand for certain of our products and services. Revenues from the two
categories of our operation were as follows: Revenues from the delivery of
software services increased from $171.3 million in 2002 to $196.8 million in
2003. Revenues from the sale of proprietary software solutions increased from
$112.0 million in 2002 to $170.0 million in 2003.
Cost of Revenues. Cost of revenues increased 23% from $186.9 million in
2002 to $230.5 million in 2003. As a percentage of revenues, cost of revenues
decreased from 66% in 2002 to 63% in 2003. Cost of revenues for proprietary
software solutions increased 47% to $76.9 million in 2004 from $52.3 million in
2003, primarily due to the consolidation of Sapiens results of operations
beginning with the first quarter of 2003. Cost of revenues for software services
increased 14% to $153.6 million in 2004 from $134.6 million in 2003, principally
as a resultof the increase in cost of revenues of nextSource due to the increase
in its volume of activities.
Software Development Costs, net. Software development costs, net, consist
of software development costs, gross, less capitalized software costs. Software
developments costs, gross, in 2003 and 2002 were $27.6 million and $20.4
million. In 2003, we capitalized software costs of $10.2 million compared to
$4.4 million in 2002. Software development costs, net, increased 9% from $16.0
million in 2002 to $17.4 million in 2003. As a percentage of revenues, software
development costs, net decreased from 5.6% in 2002 to 4.7% in 2003. The increase
in software development costs was attributed primarily to the consolidation of
Sapiens' results of operations which was offset by the decrease in software
development costs of BluePhoenix and Magic, due to efficiency measures taken by
them. Amortization of capitalized software costs were $8.1 million in 2003 and
$5.1 million in 2002, which amounts were included in cost of revenues.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased from $85.3 million in 2002 to $107.1 million
in 2003. As a percentage of revenues, selling, general and administrative
expenses remained relatively the same in 2002 and 2003. The increase in selling,
general and administrative expenses was primarily attributable to the
consolidation of Sapiens' results of operations.
53
Restructuring Costs. We had no restructuring costs in 2003 compared to
restructuring costs of $1.8 million in 2002. Restructuring costs in 2002 consist
primarily of wages and relocation expenses, as well as expenses incurred by
Magic related to closing of branches.
Operating Income (Loss). In 2003, we had operating income of $11.9 million
compared to operating loss of $6.7 million in 2002. The operating income in 2003
is attributable to the improvement in the operating results of our subsidiaries
Magic, BluePhoenix and Matrix which were offset by the operating loss of
Sapiens. The operating loss in 2002 is attributable to the operating loss of
certain of our subsidiaries which were harmed by the global and local slow-down.
Financial Income (Expenses), net. Financial expenses, net in 2003 were $3.7
million compared to financial income, net of $3.6 million in 2002. Financial
income (expenses), net, is influenced by various factors, including our cash
balance, changes in the exchange rate of the NIS against the dollar, as well as
changes in the Israeli CPI.
Other Expenses, net. Other expenses, net in 2003 and 2002 were $90,000 and
$2.1 million. Other expenses, net in 2002 was caused primarily by a partial
write off of an investment by BluePhoenix.
Gain on Realization of Shareholdings. Gain on realization of shareholdings
in 2003 was $2.8 million compared to $4.7 million in 2002. Gain on realization
of shareholdings in 2003 was primarily attributable to the sale of a portion of
Magic shares in the market which resulted in gain to Formula of $722,000, gain
from a decrease in our shareholdings in Matrix due to the issuance of Matrix
shares to former shareholders of New Applicom and the issuance of Matrix shares
to the shareholders of an acquired company resulting in gain of $1.1 million,
the sale of Matrix warrants in the market which resulted in gain of $300,000 and
the sale of Level 8 shares by BluePhoenix which resulted in gain of $376,000 to
BluePhoenix. Gain on realization of shareholdings in 2002 was attributable to
the sale of Level 8 shares by BluePhoenix which resulted in gain of $5.5 million
to BluePhoenix.
Taxes on Income. Taxes on income in 2003 were $2.5 million compared to $2.0
million in 2002. Our effective tax rate relates to a portion of our earnings
that we derive from capital gains. These capital gains are partly offset by
other capital gains that are tax exempt, as well as by a portion of earnings
derived from operations that are tax exempt under the Law of Encouragement of
Capital Investments, 1959. Taxes on income are also attributable to certain of
our subsidiaries that had taxable income.
Company's Equity in Results of Affiliates, net. Our equity in losses of
affiliates, net were $1.1 million in 2003 compared to $2.3 million in 2002. Our
equity in losses of affiliates, net relates to affiliates of BluePhoenix.
Minority Interest, net. Minority interest in profits of subsidiaries in
2003 was $4.1 million compared to minority interest in losses of subsidiaries of
$2.4 million in 2002. This increase in
54
minority interest, net is attributable to the profits of our subsidiaries Magic,
BluePhoenix and Matrix which was offset by a loss at Sapiens.
Impact of Inflation and Currency Fluctuations on Results of Operations
Most of our revenues from sale of our products and services are in dollars
and euros or are linked to the dollar or the euro, while a substantial portion
of our expenses, principally salaries and related personnel expenses, are in New
Israeli Shekels, or NIS. As a result, we are exposed to any of the following
risks:
o that the inflation rate in Israel will exceed the NIS devaluation rate
against the dollar or the euro;
o that the devaluation process will lag behind the NIS inflation timing; or
o that the euro experience devaluation against the dollar.
If any of these occur, the dollar or euro cost of our operations, as well
as our financial expenses, would increase. We cannot predict any future trends
of the rate of inflation in Israel or the rate of devaluation of the NIS or the
euro against the dollar. An increase in our dollar or euro operational cost will
adversely affect our dollar-measured results of operations. In addition, our
operations could be adversely affected if we are unable to hedge against
currency fluctuations in the future. To date, we have not engaged in significant
hedging transactions. In the future, we may enter into currency hedging
transactions to decrease the risk of financial exposure from fluctuations in the
exchange rate of the dollar against the NIS or the euro. However, we cannot
assure you that these measures will adequately protect us from material adverse
effects arising from the impact of inflation in Israel.
Following is a summary of the most relevant monetary indicators for the
reported periods:
For the year ended Inflation rate in Devaluation of NIS Devaluation of
December 31, Israel against the US$ euro against the
US$
% % %
2002 6.5 7.3 (15.7)
2003 (1.9) (7.6) (17.0)
2004 1.2 (1.6) (7.4)
Political, Economic and Military Conditions in Israel
Our headquarters and principal research and development facilities are
located in Israel. Although we generate approximately 53% of our revenues from
international markets, we are, nonetheless, directly influenced by the
political, economic and military conditions affecting Israel. The execution of
Israel's plan of unilateral disengagement from the Gaza Strip and some parts of
the West Bank may affect Israel's foreign relations and the stability of the
region. Major
55
hostilities involving Israel or the interruption or curtailment of trade between
Israel and its present trading partners could have a material adverse effect on
our business, operating results and financial condition. Furthermore, several
countries restrict business with Israeli companies. 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. While we have operated effectively under these
requirements since our incorporation, 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.
B. Liquidity and Capital Resources
Since inception, we have financed our growth and business primarily
through cash provided by operations and through public debt and equity
offerings, as well as through private and public debt and equity offerings of
our subsidiaries. In addition, we finance our business through short-term and
long-term loans and borrowings available under our credit facilities.
Cash
At December 31, 2004 we had cash and cash equivalents and short-term
investments of $146.3 million and at December 31, 2003, we had cash and cash
equivalents and short-term investments of $102.2 million. At December 31, 2004,
we had indebtedness to banks of $124.8 million, of which $107.0 million was
current liabilities and $17.8 million was long-term liabilities. At December 31,
2003, we had indebtedness to banks and others of $88.4 million, of which $66.5
million was current liabilities and $21.9 million was long-term liabilities.
Formula has entered into credit facilities with several banks, pursuant to
which Formula may borrow from time to time, on a short-term and long-term basis,
up to an aggregate of approximately $43.0 million. Formula's loan agreements
contain a number of conditions and limitations on the way in which Formula can
operate its business, including limitations on its ability to raise debt and
sell assets; and prohibition on distribution of dividends. The banks did not
object to the distribution of the dividend made in June 2005. The loan
agreements also contain various covenants which require Formula to maintain
certain financial ratios related to shareholders' equity and operating results.
In addition, one of the loan agreements provides that the loan will be
repayable, at the discretion of the bank, in the event that Dan Goldstein or Gad
Goldstein cease to serve in their current positions in Formula.
Some of Formula's assets are pledged to banks. These assets include certain
of our shareholdings in our subsidiaries consisting of our entire shareholdings
in BluePhoenix and a portion of our shareholdings in Matrix and Magic.
56
Our subsidiaries maintain credit facilities with banks in accordance with
their cash requirements. These credit facilities include, inter alia, certain
covenants related to their operations, such as maintaining a minimum level of
shareholders' equity and reaching certain operating results targets. Some of our
subsidiaries' assets are pledged to the lender banks. If any of our subsidiaries
does not meet the covenants specified in its credit agreement, and a waiver with
respect to the fulfillment of such covenant has not been received from the
lender bank, the lender bank may foreclose on the pledged assets to satisfy the
debt.
Cash flow provided by operating activities in 2004 was $17.8 million
compared to cash flow provided by operating activities of $9.6 million in 2003.
Financing activities
Cash flow provided by financing activities in 2004 was $12.1 million
compared to cash flow used in financing activities of $4.6 million in 2003. This
was mainly the result of the following transactions:
In April 2000, F.I.D. Holdings Ltd. and Israel Discount Bank Ltd. invested
$15 million in eZoneXchange.com, Inc., a subsidiary of Sapiens. This private
placement was accompanied by a put/call agreement, under which the participating
investors were granted the right to require Sapiens to repurchase their shares
in eZone, beginning in May 2004, in exchange for cash and Sapiens common shares.
In February 2001, eZone's operations were discontinued and Sapiens agreed to a
partial exercise of the put option, resulting in a payment to the investors of
$4.5 million. In March 2004, Sapiens entered into a new agreement with the
investors which replaced the put/call agreement and extended the period in which
Sapiens may fulfill the terms of the put option. Sapiens agreed to issue to the
investors, in a private placement, 750,000 common shares and warrants to
purchase an additional 350,000 common shares that are exercisable through
December 31, 2007. In addition, Sapiens agreed to pay the investors by May 1,
2005, in two annual installments, an aggregate of $8.6 million plus interest at
an annual rate of 7.5%. In June 2005, Sapiens entered into a new agreement with
the investors which amends the final payment of $4 million which was due on May
1, 2005. Sapiens paid the investors $2 million in May 2005, and agreed to pay $1
million by April 1, 2006 and an additional $1 million by August 1, 2006. The
investors may, at their sole discretion, convert all or any portion of the $1
million payable by August 1, 2006, into common shares of Sapiens, at a
conversion price per each share of $3.20.
In 2004, our subsidiaries issued shares to minority shareholders resulting
in gross proceeds of $4.4 million in the aggregate, of which $1.6 million was
received by Sapiens, $1.2 million by Magic and $1.5 million by Matrix.
In March 2004, BluePhoenix completed a $5 million private placement to
institutional investors. The terms of this transaction were amended on February
18, 2005. Under the terms of this transaction as amended, BluePhoenix issued to
the institutional investors convertible debentures, bearing interest at a rate
of LIBOR calculated on a semi-annual basis. In addition, the institutional
investors were granted warrants to purchase up to 285,714 of BluePhoenix's
ordinary
57
shares at an exercise price of $6.50 per share, subject to (i) adjustment for
stock dividends, stock splits, recapitalization and other similar events; and
(ii) anti-dilution adjustment. The warrants are exercisable during a period of
five years commencing on September 2004. Under certain circumstances, the
institutional investors may increase their investment by an additional $3
million of debentures convertible into BluePhoenix's ordinary shares at a price
of $4.50 per share, and receive warrants on the same terms as the initial
warrants, exercisable into such number of BluePhoenix's ordinary shares equal to
30% of the ordinary shares into which the debentures are convertible.
In June 2003, we repurchased $2.4 million aggregate principal amount of
debentures issued by us to the public in Israel, in May 2002.
During 2003, we sold 300,000 Formula ordinary shares on the TASE for
aggregate consideration of $4.8 million.
In the first quarter of 2003, Magic distributed a dividend to its
shareholders of 40 cents per share. The aggregate amount distributed by Magic
was $11.8 million.
During 2003, Shandol exercised options to purchase 500,000 ordinary shares
of Formula for an aggregate exercise price of $7.9 million.
In December 2003, Sapiens completed an offering in Israel of convertible
debentures and warrants exercisable into common shares of Sapiens, resulting in
gross proceeds to Sapiens of approximately $17.1 million.
Recent financing activities
In March 2005, we completed a private placement of 2,400,000 Formula shares
for an aggregate consideration of $36 million.
In June 2005, we distributed to our shareholders a cash dividend of
approximately $4 per share. The aggregate amount distributed by Formula was
approximately $53 million.
On June 20, 2005, we repaid the outstanding amount of the debentures issued
by us to the public in Israel, in May 2002. The aggregate amount repaid by us to
the debentures' holders was $14.9 million.
Investment activities
Net cash used in investing activities in 2004 were $17.1 million and in
2003, $4.9 million. These investing activities were comprised of the following
transactions:
In 2004, we sold shares of several of our subsidiaries in the open market,
as follows: 379,657 shares of Magic for aggregate consideration of $2.4 million,
2,600,000 shares of Matrix
58
for aggregate consideration of $6.1 million and 2,000,000 shares of Formula
Vision for an aggregate of $2.1 million.
During 2004, we purchased in the open market 579,132 common shares of
Sapiens for aggregate consideration of $1.4 million.
During 2004, our subsidiaries capitalized software development costs in an
aggregate amount of $15.4 million.
In 2004, our subsidiaries purchased marketable securities for aggregate
consideration of $16.4 million (of which $11 million were paid by Sapiens and $5
million by Magic).
In 2004, Formula Vision invested in and granted loans to, its affiliates in
an aggregate of $6.2 million.
During 2004, we sold certain investments resulting in aggregate proceeds of
$4.2 million ($800,000 to Formula, $600,000 to Formula Vision and $2.8 million
to BluePhoenix).
As a result of the consolidation of Formula Vision in 2004, we increased
our positive net cash by $13.7 million.
During 2003, we purchased shares of several of our subsidiaries in the open
market, as follows: 64,600 shares of BluePhoenix for an aggregate purchase price
of $150,539, 776,154 shares of Magic for an aggregate purchase price of
$911,923, 1,401,189 shares of Sapiens for an aggregate purchase price of $1.2
million and 30,396 shares of Matrix for an aggregate purchase price of $46,398.
During the fourth quarter of 2003, we purchased an aggregate of 4,224,956
shares of Matrix for an aggregate purchase price of $10 million, under put
options we granted in October 2002 to selling shareholders of New Applicom and
Sintec.
During 2003, we sold in the open market 346,364 ordinary shares of Magic
for aggregate consideration of $1.4 million, and warrants of Matrix for
aggregate consideration of $350,000.
During 2003, our subsidiaries capitalized software development costs in an
aggregate amount of $10.2 million.
As a result of the consolidation of Sapiens in 2003, we increased our
positive net cash by $20.5 million.
We believe that the net cash proceeds we raised by financing activities,
together with cash flows from operating activities, will be sufficient to meet
our cash needs for the next 12 months at the current level of operations. We
will consider in the future additional equity issuances, debt issuances or
borrowings from banks if necessary to meet cash needs for our growth.
59
Commitments and Contingent Liabilities
We have pledged some of Formula's assets in favor of banks under our credit
facilities with those banks. These assets include bank accounts, as well as
certain of our shareholdings in the subsidiaries consisting of our entire
shareholdings in BluePhoenix and a portion of our shareholdings in Matrix and
Magic.
Some of our subsidiaries have floating charges in favor of banks and other
financial institutions. In addition, some of our subsidiaries have liens on
leased vehicles, leased equipment and other assets in favor of the leasing
companies.
Other Contractual Commitments
In connection with one of our credit facilities, Formula committed, among
other things, not to distribute dividends. The bank did not object to the
distribution of the dividend made by Formula in June 2005. In addition, one of
our loan agreements provides that the loan will be repayable, at the discretion
of the lender bank, in the event that Dan Goldstein or Gad Goldstein cease to
serve in their current positions in Formula.
In connection with the sale of our interest in certain companies to
Formula Vision, Formula Vision assumed all our rights and obligations under
the agreements with each of Shamrock, FIMI and IDB with respect to the
companies transferred to Formula Vision. For more information, see "Item
4.A. - History and Development of the Company-Capital Expenditures and
Divestitures."
Formula and Matrix committed to banks who provided lines of credit to
them not to grant a security interest in all or substantially all of their
respective assets.
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."
Related Party Transactions
Transactions between Us and Formula Vision
In January 2004, Formula acquired 59.4% of the outstanding share capital
of Formula Vision in exchange for approximately $35 million of the debentures
issued by Formula Vision to Formula in 2001. The price per share was NIS 4.11
($0.93) which reflects the average closing price of Formula Vision's shares on
the TASE during the 30 days preceding Formula's resolution approving the
transaction. This transaction is considered a related party transaction since
Dan Goldstein serves as the chairman of the board of directors and the chief
executive officer of Formula and Formula Vision and was at the time of
consummation of the transaction, a
60
controlling shareholder of Formula Vision. In addition, Gad Goldstein serves as
a director of Formula and Formula Vision. For more information, see "Item 7.B.
Related Party Transactions-- Transactions between Formula and Formula Vision."
We believe that the price per Formula Vision's share paid by Formula in this
transaction reflects a fair value of the shares. We do not believe that the
impact of this transaction on our results of operations would have been
different if the transaction would have been made with a third party not
affiliated with us.
For more information about the transaction between Formula and Formula
Vision, see "Item 4.A. History and Development of the Company - Capital
Expenditures and Divestitures -Restructuring of Our Corporate Structure -
Transactions with Formula Vision."
Private Placement to FIMGold LP
In February 2005, the general meeting of shareholders approved a private
placement of 2,400,000 ordinary shares issued to FIMGold LP for an aggregate
consideration of $36 million. FIMGold LP is an entity owned in equal shares by
Dan Goldstein, our chief executive officer and chairman of the board, and FIMI
Opportunity Fund. Prior to the approval by our shareholders, the private
placement was approved by our audit committe and board of directors. The
purchase price per share in the transaction was $15, which was the approximate
closing price per Formula's share on the NASDAQ National Market and the TASE on
December 28, 2004, the date on which an agreement in principal was reached. We
believe that the price per Formula's share paid by FIMGold LP in the private
placement reflects a fair value of the shares. We do not believe that the price
per share would have been different if the transaction would have been made with
a third party not affiliated with us.
For more information about the private placement and related
transactions, see "Item 7.B. Related Party Transactions - Private Placement to
FIMGold LP."
Effective Corporate Tax Rates in Israel
Certain of the companies in the Formula Group have been granted approved
enterprise status under the Investment Law. Accordingly, if these companies
comply with certain requirements, they are eligible for certain tax benefits for
the first seven years in which they generate taxable income. Income derived from
these companies' approved enterprise programs will be tax exempt for a period of
two years after the companies have taxable income. They will also be subject to
a 25% "company tax" rate for the following five years. Under certain
circumstances, if the percentage of the share capital that foreign shareholders
hold in subsidiaries and affiliates of these companies exceeds 25%, future
approved enterprises of the applicable subsidiary or affiliate would qualify for
reduced tax rates for an additional three years, after the seven years mentioned
above. We cannot assure you that these companies will obtain approval for
additional approved enterprises, that the provisions of the Investment Law will
not change, or that the above-mentioned shareholding portion will be reached or
maintained for each subsequent year. In addition, our equity in affiliated
companies' net income is not subject to tax in Israel. Gains from changes in
holdings in subsidiaries and affiliated companies resulting from issuances
61
to third parties are also not taxable in Israel. These exemptions cause our
effective tax rate to fluctuate from period to period.
On January 1, 2003, Israel's tax laws underwent a significant tax reform
(Amendment 132 to the Income Tax Ordinance (New Version) - 1961). The reform
legislation broadened the categories of taxable income, and reduced the tax
rates imposed on employment income. Among the key provisions of this reform
legislation were (i) changes which may result in the imposition of taxes on
dividends received by an Israeli company from its foreign subsidiaries; and (ii)
the introduction of the controlled foreign corporation concept according to
which an Israeli company may become subject to Israeli taxes on certain income
of a non-Israeli subsidiary if the subsidiary's primary source of income is
passive income (such as interest, dividends, royalties, rental income or capital
gains). 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.
C. Research and Development, Patents and Licenses
In 2004, we spent $25.0 million on research and development activities, in
2003 we spent $17.4 million and in 2002 we spent $16 million. The increase in
the amount spent on research and development activities in 2004 compared to
2003, relates primarily to the consolidation of Formula Vision which had
research and development expenditures of $9.7 million in 2004. The increase in
the amount spent on research and development activities in 2003 compared to
2002, relates primarily to the consolidation of Sapiens. This increase was
partially offset by a decrease in the research and development expenditures of
certain of our subsidiaries as part of a cost restructuring measures taken by
these companies. For a description of our research and development activities,
see "Item 4.B. Business Overview-Software Development."
For information concerning our intellectual property rights, see "Item 4.B.
Business Overview-Intellectual Property Rights."
D. Trend Information
We have been affected by global economic changes, in particular the sharp
decline in capital spending in the information technology sector and the IT
business slow-down in North America and Europe, as well as in Israel.
Uncertainties in the North American, European and Israeli markets have
influenced the purchasing patterns of leading software developers who delayed
their planned orders and caused developers to reduce the amount of their planned
license commitment. These changes in purchasing patterns in the IT industry
affected directly the operating results of some of our subsidiaries, which in
turn affected our consolidated operating results. Our revenues decreased from
$402.5 million in 2000 to $387.7 million in 2001 and to $283.3 million in 2002.
In 2003 and 2004, as a result of a slight recovery of the market, and the impact
of the consolidation of the results of operations of Sapiens (beginning with
2003) and Formula Vision (beginning with 2004), this trend changed, and our
revenues increased to $366.8
62
million and $456.6 million, respectively. We cannot know whether the global
market will recover in the future, or how the economic conditions will continue
to affect our business.
As IT spending is more cautious, we have pursued a strategy aimed at
addressing current market needs through the introduction of cost-effective, new
and enhanced products. We strive to use our best efforts to take advantage of
the current slow-down to prepare our infrastructure to maximize the long-term
growth potential of the software market.
E. Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
F. Tabular Disclosure of Contractual Obligations
The following table summarizes our contractual obligations and commitments
as of December 31, 2004.
Payment due by period
---------------------
More
Less 1-3 3-5 than
---- --- --- ----
Total than 1 years years 5 Other
----- ------ ----- ----- -----
year years (1)
---- ----- ---
$ in thousands
--------------
Long term debt obligations 96,598 51,723 42,663 1,865 347 -
Lease obligations 35,702 11,976 15,144 8,272 310 -
Liability in respect of the 2,036 157 314 314 1,251 -
acquisition of activities
Other long-term liabilities
reflected on our balance
sheet under U.S. GAAP 5,807 - - - - 5,807
----- -------- ------- ------ ------ ------
Total 140,143 63,853 58,121 10,451 1,908 5,807
----------------
(1) Other obligations include unrealized gains and sevarance pay, the due date
of which is unknown.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. Directors and Senior Management
The following table describes information about our directors and senior
management as of June 20, 2005.
Name Age Position
---- --- --------
63
Name Age Position
---- --- --------
Dan Goldstein 51 Chairman of the Board, Chief
Executive Officer
Gad Goldstein 46 President, Director
Shlomo Nass 45 Director
Ishay Davidi 43 Director
Yarom Oren 34 Director
Gil Weizer (1) 63 Director
Daphna Sharir (1) 37 Director
Bruria Gross Prushansky 52 Secretary and General Counsel
Naamit Salomon 41 Vice President, Finance
------------
(1) Outside director. See "Item 6.C. Board Practices -- Outside Directors; Audit
Committee, Internal Auditor, Approval of Certain Transactions", below.
Dan Goldstein has served as a chairman of our board of directors and our
chief executive officer since January 1985. Mr. Goldstein is also the chairman
of the board of directors of Matrix and Formula Vision and is a director of
BluePhoenix, Magic, Sapiens and of other privately-held companies within the
Formula Group. Mr. Goldstein is also the chairman and chief executive officer of
Formula Vision. Mr. Goldstein holds a BA degree in mathematics and computer
sciences and an MA degree in business administration, both from Tel Aviv
University. Dan Goldstein is the brother of Gad Goldstein.
Gad Goldstein has served as one of our directors since January 1985. Mr.
Goldstein was our vice president from 1985 through 1995 and was appointed our
president in 1995. Mr. Goldstein is chairman of the board of BluePhoenix and is
also a director of other companies within the Formula Group, including Matrix,
Magic, Sapiens and Formula Vision. Mr. Goldstein holds a BA degree in economics
and an MA degree in business administration, both from Tel Aviv University. Gad
Goldstein is the brother of Dan Goldstein.
Shlomo Nass has served as one of our directors since April 2003. Mr. Nass
is the president and a partner of I.G.B. - Israel Global Business, an
investment group. Mr. Nass serves as a director of several public companies.
Mr. Nass holds a B.Sc. degree in economics and accounting, and an LL.B degree,
both from the Bar-Ilan University. Mr. Nass is a certified public accountant,
a member of the Israeli Bar and holds a Ph.D. in law. Mr. Nass qualifies as an
independent director and an audit committee financial expert, as such terms are
defined in the Nasdaq rules and/or in the Sarbanes-Oxley Act of 2002.
Ishay Davidi joined our board of directors in March 2005. Mr. Davidi is
the chief executive officer and a senior partner at First Israel Mezzanine
Investors Ltd. and FIMI 2001 Ltd.
Mr. Davidi also serves as chairman of Tadir-Gan (Precision Products) 1993
Ltd. And as a director of Lipman Electronic Engineering Ltd., Caesarea Creation
Industries Ltd., Medtechinca Ltd., Tedea Development & Automation Ltd. and TAT
Technologies Ltd. From 1993 until 1996, Mr. Davidi served as the chief executive
officer of the Tikvah VC Fund. Mr. Davidi holds a B.Sc
64
in industrial and management engineering from Tel-Aviv University and an MBA
from Bar-Ilan University.
Yarom Oren joined our board of directors in March 2005. Mr. Oren is a
senior partner at First Israel Mezzanine Investors Ltd. and FIMI 2001 Ltd. Mr.
Oren also serves as a director of Caesarea Creation Ltd., a textile
manufacturer, Tefron Ltd., a textile manufacturer traded on NYSE, Ginegar
Plastic Products Ltd., a plastic cover films manufacturer, and Mez Op Holdings
Ltd., a holding company wholly controlled by FIMI. Mr. Oren holds a B.Sc in
industrial engineering from Tel Aviv University and an MBA from WBS England.
Gil Weizer joined our board of directors as one of our outside directors
in February 2005. Mr. Weizer serves as a director of several public companies
including Fundtech Ltd., Optibase Ltd., Tescom Software Systems Testing Ltd.,
and ClickSoftware Technologies Ltd. Mr. Weizer was the acting vice chairman for
ORAMA, an international investment banking group, and a board member of the
TASE from 2002 until 2004. From 1995 to 2000, Mr. Weizer served as chief
executive officer of Hewlett Packard (HP), Israel and CMS Corp. Mr. Weizer is
the chairman of the executive board of Haifa University, and is a member of the
Israel High-Tech Association executive committee. Mr. Weizer holds a B.S.
degree in electrical engineering from the Technion in Haifa, and an M.S. in
electronics and computers from the University of Minnesota.
Dafna Sharir joined our board of directors as one of our outside directors
in February 2005. Ms. Sharir is an independent consultant in the areas of
mergers and acquisitions and business development. From 2002 until 2004, Ms.
Sharir served as senior vice president - investments of AMPAL-American Israel
Corporation, a public company traded on the Nasdaq National Market. From 1999
until 2002, Ms. Sharir served as director of mergers and acquisitions of AMDOCS
Limited, and prior to that, from 1994 to 1996 as an associate at the tax
department at Cravath, Swaine & Moore, in New York. Ms. Sharir holds BA degrees
in economics and law, both from Tel Aviv University, an LL.M. in Tax Law from
the New York University, and an MBA from the European Institute of Business
Administration (INSEAD), in Fontainebleau, France.
Bruria Gross Prushansky has served as our secretary and general counsel
since January 1997. From 1994 until the end of 1996, Ms. Gross Prushansky was in
the private practice of law. From 1988 until 1994, Ms. Gross Prushansky was the
general counsel of Elite Industries Ltd., a major Israeli food company. Ms.
Gross Prushansky, who is a member of the Israeli Bar, holds an LL.B. degree from
Tel Aviv University and has an MA degree in business administration from the
Recanati executive MBA program of Tel Aviv University.
Naamit Salomon has served as our vice president, finance since August
1997. Ms. Salomon also serves as a director of Magic and Sapiens. From 1990
through August 1997, Ms. Salomon was a controller of two large, privately held
companies in the Formula Group. Ms. Salomon holds a BA degree in economics and
business administration from Ben Gurion University and an LL.M. degree from the
Bar-Ilan University.
65
B. Compensation
In 2004, we paid to our directors and officers (eight persons) aggregate
direct remuneration of approximately $841,450. This amount includes amounts set
aside or accrued to provide post-employment benefits.
This amount does not include the following:
o amounts expended by us for automobiles made available to our
officers;
o expenses, including business travel, professional and business
association dues and expenses, that we reimburse our officers for;
and
o other fringe benefits that companies in Israel commonly reimburse or
pay to their officers.
The amount also includes payment of director's fees to our outside
directors and Mr. Shlomo Nass. We compensate our outside directors in accordance
with the regulations promulgated under the Israeli Companies Law, 1999, referred
to as the Companies Law. We compensate Mr. Shlomo Nass in the same amounts we
compensate our outside directors. In February 2005, our shareholders approved
the payment of compensation to our other non-employee directors, in addition to
our outside directors and Mr. Nass, in the same amounts we compensate our
outside directors.
Our employee directors do not receive fees for their services as directors.
In 2004, we paid an aggregate amount of $52,250 for post-employment benefits for
our executive officers and directors. Under Israeli law, we are not required to
disclose, and have not otherwise disclosed, the compensation of our senior
management and directors on an individual basis.
In November 2000, options to purchase 16,000 ordinary shares were granted
to certain of our officers under the 2000 share option plan. No director has
been granted options under this plan. The exercise price of the options is $30.8
per share, as indexed to the Israeli CPI. All of these options are currently
exercisable. These options expire on the fifth anniversary of the date of grant.
Effective January 1, 1999, all of our executive officers entered into
written employment agreements with us pursuant to which, among other things, we
pay them a monthly salary in an agreed amount. The salary is linked to the
Israeli CPI. Each party may terminate the agreement upon a 90-day notice. If we
terminate any of these employment agreements, we will have to pay the usual
severance pay required under Israeli law for all employees. In addition, two of
our executive officers are entitled to bonuses which aggregate approximately
3.5% of our consolidated net income exceeding $10 million.
66
C. Board Practices
Pursuant to our articles of association, directors are elected at the
annual general meeting of shareholders by a vote of the holders of a majority of
the voting power represented at the meeting. Our board is comprised of 7
persons. The board includes two outside directors mandated under Israeli law and
subject to additional criteria to help ensure their independence. See "-Outside
Directors" below. Each director, except for the outside directors, holds office
until the next annual general meeting of shareholders. Officers are appointed by
our board of directors. For information regarding the employment agreements of
our officers, see "Item 6.B. Compensation."
Outside Directors
Under the Companies Law, companies incorporated under the laws of Israel
whose shares have been offered to the public in or outside of Israel, are
required to appoint at least two outside directors. This law provides that a
person may not be appointed as an outside director if the person or the person's
relative, partner, employer or any entity under the person's control, has, as of
the date of the person's appointment to serve as outside director, or had,
during the two years preceding that date, any affiliation with the company or
any entity controlling, controlled by or under common control with the company.
The term "affiliation" includes:
o an employment relationship;
o a business or professional relationship maintained on a regular basis;
o control; and
o service as an office holder.
No person may serve as an outside director if the person's position or
other business activities create, or may create, a conflict of interest with the
person's responsibilities as an outside director or may otherwise interfere with
the person's ability to serve as an outside director or if the person is an
employee of the Israel Securities Authority or of an Israeli stock exchange. If,
at the time of election of an outside director, all other directors are of the
same gender, the outside director to be elected must be of the other gender.
Outside directors are to be elected by a majority vote at a shareholders'
meeting, provided that either:
o the majority of shares voted at the meeting, including at least one-third
of the shares of non-controlling shareholders voted at the meeting, vote
in favor of election of the director; or
o the total number of shares of non-controlling shareholders voted against
the election of the director does not exceed one percent of the aggregate
voting rights
67
in the company.
Pursuant to a recent amendment to the Companies Law, an outside director
must have financial and accounting expertise or professional qualifications,
provided that at least one outside director will have financial and accounting
expertise. The terms "financial and accounting expertise" and "professional
qualifications" are to be defined in regulations to be promulgated by the
Israeli Minister of Justice after consultation with the Israel Securities
Authority. These regulations have not yet been promulgated and therefore, the
qualification requirements described above are not yet in effect.
The initial term of an outside director is three years and may be extended
by the general meeting of shareholders, for an additional three years. In
February 2005, Ms. Daphna Sharir and Mr. Gil Weizer were appointed as our
outside directors, each to hold office until February 2008.
Each committee of a company's board of directors is required to include at
least one outside director. However, the audit committee shall include all the
outside directors.
An outside director is entitled to compensation as provided in regulations
promulgated under the Companies Law and is otherwise prohibited from receiving
any compensation, directly or indirectly, in connection with services provided
as an outside director.
Qualifications of Other Directors
Under a recent amendment to the Companies Law, the board of directors of a
publicly traded company will be required to make a determination as to the
minimum number of directors who must have financial and accounting expertise
according to criteria which will be defined in regulations to be promulgated by
the Israeli Minister of Justice. According to the Companies Law, the
determination of the board will be based, among other things, on the type of the
company, its size, the volume and complexity of its activities and the number of
directors. Our board will be required to make the determination as to the
minimum number of directors with financial and accounting expertise within 90
days of the effective date of the applicable regulations.
Audit Committee
The Companies Law requires public companies to appoint an audit committee,
comprised of at least three directors, including all of the outside directors.
The chairman of the board of directors, any director employed by or otherwise
providing services to the company, and a controlling shareholder or any relative
of a controlling shareholder, may not be a member of the audit committee.
We have established an audit committee, consisting of the two outside
directors, Gil Weizer and Daphna Sharir, as well as Shlomo Nass. Each audit
committee member qualifies as an independent director under the applicable
Nasdaq rules and those of the Securities and
68
Exchange Commission. The board has agreed that Shlomo Nass is an "audit
committee financial expert" as defined by applicable SEC regulations. See "Item
16A. Audit Committee Financial Expert."
Under the Companies Law, the audit committee is responsible for overseeing
the business management practices of the company in consultation with the
company's internal auditor and the independent auditor, making recommendations
to the board to improve such practices and approving related party transactions
as required by the Companies Law. In accordance with the Sarbanes-Oxley Act and
Nasdaq requirements, our audit committee is directly responsible for the
appointment, compensation, retention and oversight of our independent auditors.
In addition, the audit committee is responsible for assisting the board in
monitoring our financial statements and the effectiveness of our internal
controls. We are in the process of implementing a formal audit committee charter
embodying these responsibilities.
Internal Auditor
Under the Companies Law, the board of directors must appoint an internal
auditor, nominated by the audit committee. The role of the internal auditor is
to examine, among other matters, whether the company's actions comply with the
law and orderly business procedure. Under the Companies Law, the internal
auditor may be an employee of the company but not an office holder, or an
interested party (i.e., a holder of 5% or more of the voting rights in the
company or of the issued share capital, the chief executive officer of the
company or any of its directors, or a person who has the authority to appoint
the company's chief executive officer or any of its directors), or a relative of
an office holder or of an interested party. In addition, the company's
independent accountant or its representative may not serve as the company's
internal auditor.
Exculpation, Insurance and Indemnification of Directors and Officers
Under the Companies Law, an Israeli company may not exempt an office holder
from liability with respect to a breach of his duty of loyalty, but may exempt
in advance an office holder from his liability to the company, in whole or in
part, with respect to a breach of his duty of care, provided, however, that such
a breach is not related to a distribution of a dividend or any other
distribution by the company.
Office Holders' Insurance. Our articles of association provide that,
subject to the provisions of the Companies Law, we may enter into a contract for
the insurance of the liability of any of our office holders imposed on the
office holder in respect of an act performed in his or her capacity as an office
holder, with respect to:
o a breach of his duty of care to us or to another person;
o a breach of his duty of loyalty to us, provided that the office holder
acted in good faith and had reasonable cause to assume that his act would not
prejudice our interests; or
o a financial liability imposed upon him in favor of another person.
69
We have obtained an insurance policy covering the Formula Group's
directors' and officers' liability. Our subsidiaries participate in the premium
payments of the insurance, on a proportional basis. The total premium we paid
during 2004 was approximately $320,000.
Indemnification of Office Holders. Our articles of association provide that
we may indemnify an office holder against:
o a financial liability imposed on him in favor of another person by any
judgment, including a settlement or an arbitrator's award approved by a court;
concerning an act performed in his capacity as an office holder; and
o reasonable litigation expenses, including attorneys' fees, expended by
the office holder or charged to him by a court, in proceedings we institute
against him or instituted on our behalf or by another person, or in a criminal
charge from which he was acquitted, in each case relating to an act performed in
his capacity as an office holder.
Under the Companies Law, as amended recently, an undertaking by a company
to indemnify an office holder in advance for a financial liability imposed on
the office holder, must be limited to (i) such events which, in the opinion of
the board of directors, are foreseeable in light of the actual activities of the
company at the time the undertaking is provided; and (ii) such amount or
criteria determined to be reasonable by the board. In light of the recent
amendment to the Companies Law, we are considering updating our articles of
association, if required, in order to comply with the current provisions of the
Companies Law.
Limitations on Exemption, Insurance and Indemnification. The Companies Law
provides that a company may not indemnify an office holder, enter into an
insurance contract which would provide coverage for any monetary liability, or
exempt an office holder from liability, with respect to any of the following:
o a breach by the office holder of his duty of loyalty unless the office
holder acted in good faith and had a reasonable basis to believe that
the act would not prejudice the company;
o a breach by the office holder of his duty of care if the breach was
done intentionally or recklessly, except for a breach that was made in
negligence;
o any act or omission done with the intent to derive an illegal personal
benefit; or
o any fine levied against the office holder.
In addition, under the Companies Law, indemnification of, and procurement
of insurance coverage for, our office holders must be approved by our audit
committee and our board of directors and, in specified circumstances, by our
shareholders.
In February 2002, we granted to each of our office holders an
indemnification letter,
70
pursuant to which we undertook to indemnify each office holder in respect of
certain obligations and expenses. We are considering updating the
indemnification letters granted to our office holders, if required, in light of
the recent amendment to the Companies Law adopted in March 2005. For information
concerning the indemnification arrangement with our office holders, see "Item
7.B. Related Party Transactions-Indemnification of Office Holders."
Approval of Certain Transactions under the Companies Law
The Companies Law codifies the fiduciary duties that "office holders,"
including directors and executive officers, owe to a company. An office holder's
fiduciary duties consist of a duty of care and a duty of loyalty. The duty of
loyalty includes (i) avoiding any conflict of interest between the office
holder's position in the company and his personal affairs, (ii) avoiding any
competition with the company, (iii) avoiding exploiting any business opportunity
of the company in order to receive personal advantage for himself or others, and
(iv) revealing to the company any information or documents relating to the
company's affairs which the office holder has received due to his position as an
office holder. Each person listed in the table under "Directors and Senior
Management" above is an office holder. Under the Companies Law, arrangements
regarding the compensation of directors require the approval of the audit
committee, the board of directors and shareholder approval.
The Companies Law requires that an office holder of a company promptly
disclose any personal interest that he or she may have and all related material
information known to him or her, in connection with any existing or proposed
transaction by the company. In addition, if the transaction is an "extraordinary
transaction" as defined under the Companies Law, the office holder must also
disclose any personal interest held by the office holder's spouse, siblings,
parents, grandparents, descendants, spouse's descendants and the spouses of any
of the foregoing. In addition, the office holder must also disclose any interest
held by any corporation in which the office holder owns 5% or more of the share
capital, is a director or general manager or in which he or she has the right to
appoint at least one director or the general manager. An "extraordinary
transaction" is defined as a transaction other than in the ordinary course of
business, otherwise than on market terms, or that is likely to have a material
impact on the company's profitability, assets or liabilities.
Under the Companies Law, after the office holder complies with the
disclosure requirements described above, only board approval is required for any
transaction which is not an extraordinary transaction, unless the articles of
association of the company provide otherwise, and provided the transaction is
not adverse to the company's interest. If the transaction is an extraordinary
transaction, the company must receive any approval stipulated by the articles of
association, the approval of the company's audit committee and the approval of
the board of directors, as well as, under certain circumstances, approval by a
meeting of the shareholders of the company. An office holder who has a personal
interest in a matter which is considered at a meeting of the board of directors
or the audit committee may not be present at this meeting or vote on this matter
unless the majority of the board members or members of the audit committee, as
applicable, have a personal interest in such matter and in such case, the matter
should also be
71
approved by the shareholders of the company.
The Companies Law applies the same disclosure requirements to a controlling
shareholder of a public company, which includes a shareholder that holds 25% or
more of the voting rights in the company if no other shareholder owns more than
50% of the voting rights in the company. Extraordinary transactions with a
controlling shareholder or in which a controlling shareholder has a personal
interest, and the terms of compensation of a controlling shareholder or its
relative who is an office holder or an employee of the company, require the
approval of the audit committee, the board of directors and the shareholders of
the company. The shareholder approval must include at least one-third of the
shareholders who have no personal interest in the transaction and are voting on
the subject matter or, alternatively, the total shareholdings of those who have
no personal interest in the transaction who vote against the transaction must
not represent more than one percent of the voting rights in the company. In
certain cases provided in regulations promulgated under the Companies Law,
shareholder approval is not required.
The approvals of the board of directors and shareholders is required for a
private placement of securities (or a series of related private placements
during a 12-month period or that are part of one continuous transaction or
transactions conditioned upon each other) in which:
o the securities issued represent at least 20% of the company's actual voting
power prior to the issuance of such securities, and such issuance increases
the relative holdings of a 5% shareholder or causes any person to become a
5% shareholder, and the consideration in the transaction (or a portion
thereof) is not in cash or in securities listed on a recognized stock
exchange, or is not at a fair market value; or
o a person would become, as a result of such transaction, a controlling
shareholder of the company.
D. Employees
We have approximately 5,300 full-time employees, of whom approximately
4,650 are software professionals. In 2003, we had approximately 3,500 full-time
employees, of whom approximately 3,100 were software professionals. In 2002, we
had the same approximate number of employees as in 2003. The increase in the
number of employees in 2004 compared to 2003 relates primarily to the
consolidation of Formula Vision and its affiliates, which employ in the
aggregate approximately 1,000 employees. The increase also stems from an
increase in the number of employees of other members of the group as a result of
the growth in their activities, in particular Matrix and nextSource. The number
of our employees in 2002 and 2003 remained relatively the same as a result of an
increase in the number of employees of Matrix and nextSource in 2003 that was
offset by a decrease in the number of employees of Magic and Sapiens due to
restructuring measures taken by these subsidiaries including closing of branches
and business lines.
With respect to our employees in Israel, we are subject to various Israeli
labor laws and labor practices, and to administrative orders extending certain
provisions of collective bargaining
72
agreements between the Histadrut (Israel's General Federation of Labor) and the
Coordinating Bureau of Economic Organizations (the Israeli federation of
employers' organizations) to all private sector employees. For example,
mandatory cost of living adjustments, which compensate Israeli employees for a
portion of the increase in the Israeli consumer price index, are determined on a
nationwide basis. Israeli law also requires the payment of severance benefits
upon the termination, retirement or death of an employee. We meet this
requirement by contributing on an ongoing basis towards "managers' insurance"
funds that combine pension, insurance and, if applicable, severance pay
benefits. In addition, Israeli employers and employees are required to pay
specified percentages of wages to the National Insurance Institute, which is
similar to the United States Social Security Administration. Other provisions of
Israeli law or regulation govern matters such as the length of the workday,
minimum wages, other terms of employment and restrictions on discrimination. We
are also subject to the labor laws and regulations of other jurisdictions in the
world where we have employees.
E. Share Ownership
The following table presents information regarding the ownership of our
ordinary shares by the persons listed in the table under "Directors and Senior
Management", as of June 20, 2005.
Name Shares beneficially owned Options to purchase
---- ------------------------- -------------------
ordinary shares
------------------
Percentage of
outstanding
ordinary
Number shares (1)
------ ---------------
Dan Goldstein (2) 4,400,000 33.3%
Gad Goldstein 325,000 2.5%
All directors and officers
as a group (8 persons) (3) 4,725,000 35.8% 16,000(4)
-----------------
(1) Percentages in the above table are based on 13,200,000 ordinary shares
outstanding as of June 20, 2005.
(2) Dan Goldstein holds a 50% interest in FIMGold Limited Partnership, which
owns approximately 33.3% of Formula's outstanding ordinary shares. Dan
Goldstein may be deemed to beneficially own all such shares by virtue of
shared voting and dispositive power pursuant to a shareholders agreement
entered between Dan Goldstein, through his wholly owned company, Ildani
Holdings Ltd., and FIMI Opportunity Fund, with respect to FIMGold Ltd., the
general partner of FIMGold LP. However, Mr. Goldstein disclaims beneficial
ownership from one half of such shares. For more information about the
shareholders agreement, see "Item 7.A. Major Shareholders."
(3) Each of the directors and executive officers not separately identified in
the above table beneficially owns less than one percent of our outstanding
ordinary shares (including options held by each of these persons) and have
therefore not been separately disclosed.
(4) All of these options are currently exercisable at an exercise price of
$30.8 per share, as indexed to the Israeli CPI. These options expire in
November 2005.
Arrangements Involving the Issue or Grant of Options to Purchase Shares
73
The 2000 Share Option Plan
In November 2000, we adopted a share option plan under which we may grant
options to purchase up to an aggregate of 300,000 ordinary shares to employees
and members of our management. Of these options, we granted in November 2000,
options to purchase 64,500 ordinary shares to certain of our employees,
including options to purchase 16,000 shares granted to certain of our officers
and directors. The exercise price of these options is $30.8 per share, as
indexed to the Israeli CPI. The options vested over a three-year period from the
date of grant. The options expire on the fifth anniversary of the date of grant.
As of June 20, 2005, none of these options has been exercised.
Option Plans of Our Subsidiaries
Our operating subsidiaries generally have share option plans pursuant to
which qualified directors, employees and consultants may be granted options for
the purchase of securities in these subsidiaries. In addition, these
subsidiaries may from time to time grant options to third parties as part of a
business transaction.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. Major Shareholders
The following table presents information regarding the ownership of our
ordinary shares at June 20, 2005 by each person known to us to be the beneficial
owner of more than 5% of our ordinary shares based on information provided to us
by the holders or disclosed in public filings with the Securities and Exchange
Commission. None of the holders of the ordinary shares listed in this table have
voting rights different from other holders of our ordinary shares.
Except where we indicated otherwise, we believe, based on information furnished
by these owners, that the beneficial owners of our shares listed below have sole
investment and voting power with respect to the shares.
Shares Beneficially Percent of
Name and Address Owned Class (1)
----------------------------------- -------------------- --------------------
FIMGold Limited Partnership (2) 4,400,000 33.3%
Bank Leumi Le'Israel B.M. (3) 964,127 7.3%
--------------------
(1) Ordinary shares deemed beneficially owned by virtue of the right of any
person or group to acquire these ordinary shares within 60 days of June 20,
2005, are treated as outstanding only for the purposes of determining the
percent owned by this person or group. Percentages in the above table are
based on
74
13,200,000 ordinary shares outstanding as of June 20, 2005.
(2) In March 2005, FIMGold LP purchased from Formula in a private placement
2,400,000 ordinary shares. FIMGold LP is owned in equal shares by Dan
Goldstein, our chief executive officer and chairman of the board, and FIMI
Opportunity Fund. Concurrently with the closing of the private placement,
Dan Goldstein sold to FIMGold LP his entire shareholdings in Formula,
constituting 2,000,000 ordinary shares. Following these transactions,
FIMGold LP owns 4,400,000 of our ordinary shares, representing
approximately 33.3% of our outstanding share capital. In connection with
the acquisition by FIMGold LP of Formula's shares, Dan Goldstein, through
his wholly owned company, Ildani Holdings Ltd., and FIMI Opportunity Fund,
entered into a shareholders agreement with respect to FIMGold Ltd., the
general partner of FIMGold LP, pursuant to which each party has the right
to designate one-half of the members of the board of directors of FIMGold
Ltd. and each resolution of the board of directors requires the approval of
at least one member designated by each party, including resolutions
relating to selling, acquiring and voting Formula's shares held by FIMGold
LP. Notwithstanding the foregoing, the shareholders agreement provides that
each party has the right to cause the sale of up to an aggregate of 20% of
the amount of Formula's shares held by FIMGold LP without the consent of
the other party. Pursuant to the shareholders agreement, Formula's shares
held by FIMGold LP will be voted for the election of two nominees of each
party to our board of directors. In addition, we granted registration
rights to FIMGold LP in respect of Formula's shares held by it, on
customary terms and conditions.
(3) Bank Leumi Le'Israel B.M. is publicly traded on the TASE. The major
shareholder of Bank Leumi is the Government of Israel (28.3%). Shlomo
Eliahu Holdings Ltd. holds a 10% interest in Bank Leumi, Otzar Hityashvut
Hayehudim holds a 4.9% interest and Bank Hapoalim holds 5.2%.
As of June 20, 2005, 13,200,000 ordinary shares were issued and
outstanding, excluding 24,780 ordinary shares that we purchased during 2002. At
that date, we had approximately 15 shareholders of record. All of our ordinary
shares have equal voting rights. However, under applicable Israeli law, the
shares we hold have no voting rights and, therefore, are excluded from the
number of our outstanding shares.
As of June 20, 2005, 462,338 ADSs were issued and outstanding pursuant to a
depositary agreement with The Bank of New York, representing 462,338 of our
ordinary shares. As of that date, there were 18 registered holders of ADSs in
the United States.
B. Related Party Transactions
Private Placement to FIMGold LP
In February 2005, the general meeting of shareholders approved a private
placement of 2,400,000 ordinary shares issued to FIMGold LP for an aggregate
consideration of $36 million. FIMGold LP is an entity owned in equal shares by
Dan Goldstein, our chief executive officer and chairman of the board, and FIMI
Opportunity Fund. Prior to the approval by our shareholders, the private
placement was approved by our audit committe and board of directors. The
purchase price per share in the transaction was $15, which was the approximate
closing price per Formula's share on the NASDAQ National Market and the TASE on
December 28, 2004, the date on which an agreement in principal was reached.
Concurrently with the closing of the private placement, Dan Goldstein sold to
FIMGold LP his entire shareholdings in Formula, constituting 2,000,000 ordinary
shares, for an aggregate purchase price of $30 million. Following these
transactions, FIMGold LP owns 4,400,000 of our ordinary shares, representing
approximately 33.3% of our outstanding share capital. In addition, Dan Goldstein
concurrently
75
sold to FIMGold LP all of his 15,500,000 ordinary shares in Formula Vision for
an aggregate purchase price of $17 million.
In connection with the acquisition by FIMGold LP of Formula's shares, Dan
Goldstein, through his wholly owned company, Ildani Holdings Ltd., and FIMI
Opportunity Fund, entered into a shareholders agreement with respect to FIMGold
Ltd., the general partner of FIMGold LP, pursuant to which each party has the
right to designate one-half of the members of the board of directors of FIMGold
Ltd. and each resolution of the board of directors requires the approval of at
least one member designated by each party, including resolutions relating to
selling, acquiring and voting Formula's shares held by FIMGold LP.
Notwithstanding the foregoing, the shareholders agreement provides that each
party has the right to cause the sale of up to an aggregate of 20% of Formula's
shares held by FIMGold LP without the consent of the other party. Pursuant to
the shareholders agreement, Formula's shares held by FIMGold LP will be voted
for the election of two nominees of each party to our board of directors. In
addition, we granted registration rights to FIMGold LP in respect of Formula's
shares held by it, on customary terms and conditions.
Registration Rights Agreements
In March 2005, in connection with the private placement of 2,400,000
Formula's shares issued to FIMGold LP, and the purchase by FIMGold LP of
2,000,000 Formula's shares from Dan Goldstein, Formula granted to FIMGold LP
registration rights with respect to the 4,400,000 shares owned by it. Under the
registration rights agreement entered into between Formula and FIMGold LP,
Formula has agreed that at the request of FIMGold LP, and on no more than two
occasions, Formula will file a registration statement under the Securities Act
of 1933, as amended, referred to as the Securities Act, for an offering of the
shares with respect to which registration is requested. In addition, if Formula
otherwise proposes to register its ordinary shares under the Securities Act,
FIMGold LP may request that Formula register its shares as well, subject to
certain limitations. Formula shall bear all fees and expenses in connection with
the registration, except that FIMGold LP will pay all fees and expenses of its
own counsel and all underwriting discounts and commissions relating to its
shares.
In 1997, Formula, Dan Goldstein, Gad Goldstein, Aaron Crystal and an
additional shareholder, referred to collectively as the holders, entered into a
registration rights agreement with BluePhoenix. Under this registration rights
agreement, the holders have certain registration rights with respect to their
BluePhoenix shares. BluePhoenix has agreed that, beginning January 31, 1998, at
the request of the holders of a majority of the shares held by the holders, and
on no more than two occasions, BluePhoenix will file a registration statement
under the Securities Act of 1933, as amended, referred to as the Securities Act,
for an offering of the shares with respect to which registration is requested.
In addition, if BluePhoenix otherwise proposes to register its ordinary shares
under the Securities Act, these holders may request that BluePhoenix register
their shares as well, subject to certain limitations. BluePhoenix shall bear all
fees and expenses in connection with the registration, except that the holders
will pay all fees and expenses of their own counsel and all underwriting
discounts and commissions relating to their shares. In accordance with this
agreement, in May 2004, BluePhoenix included 100,000 BluePhoenix
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shares held by each of Dan Goldstein, Gad Goldstein and Aaron Crystal, in a
registration statement on Form F-3 filed by BluePhoenix under the Securities
Act. Such registration statement was declared effective in March 2005.
In October 2002, Formula and other shareholders of Liraz entered into a
registration rights agreement with BluePhoenix as part of a share exchange
agreement with those shareholders. Under this agreement, BluePhoenix agreed
that, until October 12, 2005, at the request of the holders of at least 20% of
the shares issued to Liraz shareholders under the share exchange agreement, and
no more than once, BluePhoenix will, subject to certain limitations, file a
registration statement under the Securities Act for an offering of their shares
with respect to which registration is requested. In addition, if BluePhoenix
otherwise proposes to register its ordinary shares under the Securities Act,
these holders may request that BluePhoenix registers their shares as well,
subject to certain limitations. BluePhoenix 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 accordance with this agreement, in May 2004, BluePhoenix included 100,000
BluePhoenix shares held by Arie Kilman, in a registration statement on Form F-3
filed by BluePhoenix under the Securities Act. Such registration statement was
declared effective in March 2005.
Voting Agreement
Messrs. Dan Goldstein and Gad Goldstein have entered into voting
agreements that require them to vote the ordinary shares of BluePhoenix held by
them as instructed by Formula. The voting agreements may be terminated by either
party upon a prior notice.
Transactions between Formula and Formula Vision
In connection with the exercise by Formula Vision in Novemebr 2001 of an
option to purchase from Formula its entire interest in Formula's privately held
companies, Formula Vision issued to Formula, in December 2001, a series of
5-year debentures of $58.9 million in the aggregate, linked to the Israeli CPI
and bearing interest at an annual rate of 5%. On March 31, 2002, we lent to
Formula Vision an additional $19.4 million in consideration for a series of
debentures with similar terms of the debentures issued in December 2001.
As part of the agreement related to the exercise of the option by Formula
Vision to purchase from Formula its interest in privately held companies, we
also transferred to Formula Vision our rights and obligations with respect to
the transferred companies under our agreements with each of Shamrock, FIMI and
IDB. This series of transactions is considered a related party transaction since
Dan Goldstein serves as the chairman of the board of directors and the chief
executive officer of Formula and Formula Vision and was at that time, a
controlling shareholder of Formula Vision. In addition, Gad Goldstein serves as
a director of Formula and Formula Vision.
In January 2004, Formula Vision issued to Formula 38,000,000 shares
representing 59.4% of Formula Vision's outstanding share capital in exchange for
$35 million of the amount of the
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debentures. The transaction was approved by Formula's audit committee and by its
board of directors. The price per share reflected the average closing market
price of Formula Vision's share on the TASE during the 30 days preceding the
date of approval of the transaction by Formula's board of directors. In
connection with this transaction, following the receipt by Formula Vision of the
opinion of the Israeli Securities Authority, referred to as the ISA, regarding
this transaction, Formula Vision informed its shareholders that it was the ISA's
opinion that the said transaction requires the approval of Formula's
shareholders with the special majority required under the Israeli law for
approval of related party transactions. In the absence of such approval, if
required, Formula may revoke the transaction, and may also claim damages from
Formula Vision, without revoking the transaction, provided Formula Vision knew
of Messrs. Goldstein's personal interest in the said transaction and knew, or
should have known, about the absence of such approval. The ISA's opinion was
based on the assumption that Messrs. Goldstein's ability to direct Formula's
activity derives mainly from their substantial holdings in Formula, and as such,
their positions as office holders could not be viewed as unrelated to their
shareholdings.
The Company is of the view, based on its legal counsels' opinion, that at
the time of consummation of the transaction, Messrs. Goldstein did not hold a
controlling interest in Formula under the law.
For more information about the transaction between Formula and Formula
Vision, see "Item 4.A. History and Development of the Company - Capital
Expenditures and Divestitures -Restructuring of Our Corporate Structure."
Indemnification of Office Holders
In February 2002, we granted to each of our office holders an
indemnification letter, pursuant to which we undertook to indemnify each office
holder in respect of an obligation or expense imposed on the office holder in
respect of an act performed in his or her capacity as an office holder,
provided, however, that the undertaking is limited to categories of events
specified in the indemnification letter and subject to the provisions of any
law, as follows:
(i) a financial obligation imposed on him or her in favor of another person
by a court judgment, including a compromise judgment or an arbitrator's
award approved by court; and
(ii) reasonable litigation expenses including attorneys' fees, expended by
an office holder or charged to the office holder by a court, in a
proceeding instituted against the office holder by the company or on its
behalf or by another person, or in a criminal charge from which the office
holder was acquitted, or in a criminal proceeding in which the office
holder was convicted of an offense that does not require proof of criminal
intent.
The indemnification described above shall also apply to an obligation or
expense imposed on the office holder in respect of an act performed in his or
her capacity as an office holder or an
78
employee of one of our subsidiaries. Our undertaking for indemnification is
limited to up to 25% of our shareholders' equity as it appears in our latest
financial statements known at the date of indemnification.
Our undertaking for indemnification shall not apply to a liability incurred
as a result of any of the following:
(i) a breach by the office holder of his or her duty of loyalty,
unless the office holder acted in good faith and had a reasonable
basis to believe that the act would not prejudice the company;
(ii) a breach by the office holder of his or her duty of care if the
breach was done intentionally or recklessly;
(iii) any act or omission done with the intent to derive an illegal
personal benefit; or
(iv) any fine levied against the office holder.
We shall not be required to indemnify an office holder, if the office
holder, or anyone on its behalf, already received payment in respect of a
liability subject to indemnification, under an effective insurance coverage or
an effective indemnification arrangement with a third party, provided, however,
that if such payment made to the office holder does not cover the entire
liability subject to the indemnification, we shall indemnify the office holder
in respect of the difference between the amount paid to the office holder and
the liability subject to the indemnification.
In light of the recent amendment to the Companies Law adopted in March
2005, we are considering updating the indemnification letters described above,
if required pursuant to the law.
Office Holders' Insurance
We have obtained an insurance policy covering the Formula Group's
directors' and officers' liability. Our subsidiaries participate in the premium
payments of the insurance, on a proportional basis. The total premium Formula
paid during 2003 was approximately $120,000.
Other Transactions
From time to time, in our ordinary course of business, we engage in
transactions with our subsidiaries and affiliates. We believe that these
agreements are made on an arms' length basis upon terms and conditions no less
favorable to us, our subsidiaries and affiliates, as we could obtain from
unaffiliated third parties. If we engage with our subsidiaries and affiliates in
transactions which are not in the ordinary course of business, we receive the
approvals required
79
under the Companies Law. These approvals include audit committee approval, board
approval and, in certain circumstances, shareholder approval. See "Item 6.C.
Board Practices."
C. Interests of Experts and Counsel
Not applicable.
ITEM 8. FINANCIAL INFORMATION
A. Consolidated Statements and Other Financial Information
Financial Statements
The financial statements required by this item are found at the end of
this annual report, beginning on page F-1.
Legal Proceedings
We are not involved in any proceedings in which any of our directors,
members of our senior management or any of our affiliates is either a party
adverse to us or to our subsidiaries or has a material interest adverse to us or
to our subsidiaries. We are also not involved in any material legal proceedings,
except as described below.
In July 2003, a former Liraz shareholder filed an application with the Tel
Aviv Jaffa District Court to approve a claim filed by him against BluePhoenix,
as a class action. The claim relates to the acquisition of Liraz shares, which
BluePhoenix completed in March 2003. The shareholder alleges that the share
price BluePhoenix 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 $5.8 million in the aggregate. In
the lawsuit, the plaintiff has applied for the court's approval to represent all
of the shareholders of Liraz who sold their shareholdings pursuant to the tender
offer and the mandatory acquisition. No hearing has been scheduled for this
lawsuit. Based on BluePhoenix's 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 BluePhoenix in this proceeding are without merit and
intend to vigorously defend the claim and contest the allegations made therein.
Dividend policy
In August 2001, Formula distributed to its shareholders a dividend in kind
of Formula Vision's (formerly known as Mashov) shares held by Formula.
In May 2005, Formula declared a cash dividend in the amount of
approximately $4 per
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ordinary share, or approximately $53 million in the aggregate, which was
distributed to its shareholders on June 1, 2005.
Under Formula's new dividend policy adopted recently by its board of
directors, sums that are not planned to be used for investments in the near
future, will be distributed to the shareholders as a cash dividend, to the
extent that our performance allows such distribution.
B. Significant Changes
In March 2005, we completed a private placement of 2,400,000 Formula shares
for aggregate consideration of $36 million. The shares were issued to FIMGold
LP, an entity owned in equal shares by Dan Goldstein and FIMI Opportunity Fund.
In June 2005, we distributed to our shareholders a cash dividend of
approximately $4 per share. The aggregate amount distributed by Formula was
approximately $53 million.
Except as described above and disclosed elsewhere in this annual report,
there has been no material change in our financial position since December 31,
2004.
ITEM 9. THE OFFER AND LISTING
A. Offer and Listing Details
Price Range of Ordinary Shares
The following table shows the high and low closing price for our ordinary
shares on the TASE, for the periods indicated. The exchange rate reported by the
Bank of Israel on June 20, 2005 was NIS 4.54 = $1.00.
Calendar Period Closing Price Per Share
--------------- -----------------------
in NIS
High Low
---- ---
2000 355.00 116.60
2001 151.30 48.11
2002 75.80 40.12
2003 79.40 34.03
First Quarter 41.33 34.03
Second Quarter 63.90 38.05
Third Quarter 61.40 50.70
Fourth Quarter 79.40 56.70
2004
First Quarter 98.40 77.30
Second Quarter 94.70 80.80
Third Quarter 91.07 61.83
81
Calendar Period Closing Price Per Share
--------------- -----------------------
in NIS
High Low
---- ---
Fourth Quarter 74.77 62.21
2005
First Quarter 89.65 74.75
January 84.73 77.20
February 83.04 74.75
March 89.65 79.21
April 82.36 76.82
May 72.04 63.75
June (through June 20) 64.79 50.55
Price Range of American Depositary Shares
The following table shows, for the periods indicated, the high and low
closing sale prices for the ADSs, as reported by the Nasdaq National Market.
Calendar Period Closing Price Per Share
--------------- -----------------------
in $
High Low
---- ---
2000 92.19 27.00
2001 38.00 11.25
2002 16.92 8.16
2003 18.05 6.71
First Quarter 8.75 6.71
Second Quarter 14.35 8.01
Third Quarter 14.32 10.75
Fourth Quarter 18.05 12.51
2004
First Quarter 22.08 16.61
Second Quarter 20.61 17.33
Third Quarter 20.00 13.44
Fourth Quarter 17.57 14.40
2005
First Quarter 20.44 16.92
January 19.20 17.51
February 19.00 16.92
March 20.44 18.03
April 18.87 17.52
May 22.99 14.32
June (through June 20) 14.62 11.29
B. Plan of Distribution
Not applicable.
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C. Markets
Since our initial public offering in 1991, our ordinary shares have been
traded in Israel on the TASE. No U.S. trading market exists for the ordinary
shares. Since October 1997, our ADSs are traded on the NASDAQ National Market,
under the symbol "FORTY".
D. Selling Shareholders
Not applicable.
E. Dilution
Not applicable.
F. Expenses of the Issue
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
A. Share Capital
Not applicable.
B. Memorandum and Articles of Association
We are registered with the Israeli Companies Register under the number
52-003669-0. Our objects are specified in our memorandum of association. These
objects include:
o operating within the field of informational and computer systems;
o providing management, consulting and sale services for computers,
computer equipment, software for computers and for information
systems;
o the business of systems analysis, systems programming and computer
programming; and
o establishing facilities for instruction and training for computers and
digital systems.
Description of Our Share Capital
83
Our company share capital consists of ordinary shares. Our articles of
association do not restrict in any way the ownership of our ordinary shares by
non-residents, except that these restrictions may exist with respect to citizens
of countries which are in a state of war with Israel.
Dividend and Liquidation Rights
We may declare a dividend to be paid to the holders of ordinary shares
according to their rights and interests in our profits. We may invest or use for
our own benefit all unclaimed dividends. If dividends remain unclaimed for seven
years from the date we declared the dividend they lapse and revert back to us.
Our board of directors can cause us to pay the dividend to a holder who would
have been entitled if the dividend had not reverted back to us. In case of
liquidation, after satisfying liabilities to creditors, our assets will be
distributed to the holders of ordinary shares in proportion to their holdings.
This right may be affected by the grant of a preferential dividend or
distribution rights to the holders of a class of shares with preferential rights
that may be authorized in the future. Under the Companies Law, the declaration
of a dividend does not require the approval of the shareholders of the company,
unless the company's articles of association require otherwise. Our articles of
association provide that our board of directors may declare and pay dividends
without any further action of our shareholders.
Redemption provisions
In accordance with our articles of association, we may issue redeemable
shares and accordingly redeem those shares.
Voting, Shareholder Meetings and Resolutions
Holders of our ordinary shares have one vote for each ordinary share held
on all matters submitted to the vote of shareholders. These voting rights may be
affected by the grant of any special voting rights to the holders of a class of
shares with preferential rights that may be authorized in the future.
We must hold an annual general meeting once a year with a maximum period
of fifteen months between the meetings. All other meetings of shareholders other
than annual general meetings are considered special general meetings. Our board
of directors may call a special general meeting whenever it decides it is
appropriate. In addition, shareholders representing 5% of the outstanding share
capital may require the board of directors to call a special general meeting.
The quorum required for a general meeting of shareholders consists of two or
more holders present in person or by proxy who hold or represent at least 25% of
the voting power. A meeting adjourned for a lack of a quorum generally is
adjourned to the same day in the following week at the same time and place or
any time and place as the chairman of the meeting may decide with the consent of
the holders of a majority of the voting power represented at the meeting in
person or by proxy and voting on the question of adjournment. At the reconvened
84
meeting, if a quorum is not present within half an hour from the time appointed
for holding the meeting, the required quorum will consist of two shareholders
present in person or by proxy.
Under the Companies Law, unless otherwise provided in the articles of
association or applicable law, all resolutions of the shareholders require a
simple majority, except in certain circumstances provided for under the Israeli
law, which require a majority of at least 75% of the shares present at the
meeting.
Under the Companies Law, a shareholder has a duty to act in good faith
towards the company in which he holds shares and towards other shareholders and
to refrain from abusing his power in the company including voting in the general
meeting of shareholders on:
o any amendment to the articles of association
o an increase of the company's authorized share capital
o a merger; or
o approval of some of the acts and transactions which require
shareholder approval.
A shareholder has the general duty to refrain from depriving rights of
other shareholders. Any controlling shareholder, any shareholder who knows that
it possesses the power to determine the outcome of a shareholder vote and any
shareholder that, under the provisions of the articles of association, has the
power to appoint an office holder in the company, is under a duty to act in
fairness towards the company. The Companies Law does not describe the substance
of this duty.
Transfer of Shares
Fully paid ordinary shares are issued in registered form and may be freely
transferred under our articles of association unless the transfer is restricted
or prohibited by another instrument.
Modification of Class Rights
Under our articles of association, the rights attached to any class unless
otherwise provided by the terms of the class including voting, rights to
dividends and the like, may be varied by adoption of the necessary amendment to
the articles of association, provided that the affected shareholders approve the
change by a class meeting in which a simple majority of the voting power of the
class represented at the meeting and voting on the matter approves the change.
85
Election of Directors
Our ordinary shares do not have cumulative voting rights in the election
of directors. As a result, the holders of ordinary shares that represent more
than 50% of the voting power represented at a shareholders meeting have the
power to elect all of our directors, other than the outside directors which are
appointed by a special majority of shareholders. For a summary of those
provisions in our articles of association with respect to the directors, see
"Item 6. Directors, Senior Management and Employees."
Anti-Takeover Provisions; Mergers and Acquisitions under Israeli Law
Mergers
The Companies Law permits merger transactions if approved by each party's
board of directors and shareholders. In determining whether the required
majority has approved the merger in the event of "cross ownership" between the
merging companies, namely, if the merging company's shares are held by the other
party to the merger, or by any person holding at least 25% of the means of
control of the other party to the merger, then a vote against the merger by
holders of the majority of the shares present and voting, excluding shares held
by the other party to the merger or by such person, or anyone acting on behalf
of either of them, including any of their affiliates, is sufficient to reject
the merger transaction. In the event that the merger transaction has not been
approved by the special majority described above, the holders of at least 25% of
the voting rights of such company may apply to the court for approval of the
merger. The court may approve the merger if it is found that the merger is fair
and reasonable, taking into account the value of the parties to the merger and
the consideration offered to the shareholders. Upon the request of a creditor of
either party to the proposed merger, the court may delay or prevent the merger.
A merger may not be consummated unless at least 50 days have passed from the
time that a proposal for approval of the merger has been filed with the Israeli
Registrar of Companies and 30 days have passed from the date of the approval of
the shareholders of the merging companies.
The Companies Law further provides that the foregoing approval requirements
will not apply to shareholders of a wholly-owned subsidiary in a rollup merger
transaction, or to the shareholders of the acquirer if:
o the transaction does not involve an amendment to the acquirer's memorandum
or articles of association;
o the transaction does not contemplate the issuance of more than 25% of the
voting rights of the acquirer which would result in any shareholder
becoming a controlling shareholder; and
o there is no "cross ownership" of shares of the merging companies, as
described above.
86
Tender Offers
The Companies Law provides that an acquisition of shares of a public
company must be made by means of a tender offer if as a result of the
acquisition, the purchaser would become a holder of 25% or more of the voting
rights in the company. This rule does not apply if there is already another
holder of 25% or more of the voting rights in the company. Similarly, the
Companies Law provides that an acquisition of shares in a public company must be
made by means of a tender offer if as a result of the acquisition the purchaser
would become a holder of more than 45% of the voting rights of the company, if
there is no other holder of more than 45% of the voting rights of the company.
The foregoing provisions do not apply to:
o a private placement in which the company's shareholders approved such
holder owning 25% or more of the voting rights in the company (if there is
no other shareholder that holds 25% or more of the voting rights in the
company); or more than 45% of the voting rights in the company (if there is
no other shareholder that holds 45% or more of the voting rights in the
company); or
o a purchase from an existing holder of 25% or more of the voting rights in
the company that results in another person becoming a holder of 25% or more
of the voting rights in the company or a purchase from an existing holder
of more than 45% of the voting rights in the company that results in
another person becoming a holder of more than 45% of the voting rights in
the company.
Regulations adopted under the Companies Law provide that these tender
offer requirements do not apply to companies whose shares are listed for trading
outside of Israel if, according to the law in the country in which the shares
are traded, including the rules and regulations of the stock exchange on which
the shares are traded, there is either a limitation on acquisition of any level
of control of the company, or the acquisition of any level of control requires
the purchaser to do so by means of a tender offer to the public.
The Companies Law also provides that if following any acquisition of
shares, the acquirer holds 90% or more of the company's shares or of a class of
shares, the acquisition must be made by means of a tender offer for all the
target company's shares or all the shares of the class, as applicable. An
acquirer who wishes to eliminate all minority shareholders must do so by way of
a tender offer and acquire 95% of all shares not held by or for the benefit of
the acquirer before the acquisition. If, however, the tender offer to acquire
95% is not successful, the acquirer may not acquire shares tendered if by doing
so the acquirer would own more than 90% of the shares of the target company.
C. Material Contracts
We consider the private placement completed in March 2005, and the
transactions with
87
Formula Vision as material contracts. For a summary of the terms of these
contracts, see "Item 4.A. Information on the Company - Capital Expenditures and
Divestitures."
D. Exchange Controls
Under current Israeli regulations, we may pay dividends or other
distributions in respect of our ordinary shares either in non-Israeli or Israeli
currencies. If we make these payments in Israeli currency, they will be freely
transferred in non-Israeli currencies at the rate of exchange prevailing at the
time of conversion. We expect therefore, that dividends, if any, that we pay to
holders of ADSs, will be paid in dollars, net of conversion expenses of the
depositary, the Bank of New York and Israeli income taxes. Because exchange
rates between the NIS and the dollar fluctuate continuously, a U.S. shareholder
will be subject to the risk of currency fluctuations between the date when we
declare NIS-denominated dividends and the date when we pay them in NIS. See
"Item 3.D. Risk Factors."
Non-residents of Israel may freely hold and trade our ADSs or ordinary
shares pursuant to the general permit issued under the Israeli Currency Control
Law, 1978. Neither our articles of association nor the laws of the State of
Israel restrict in any way the ownership of our ordinary shares by
non-residents, except that these restrictions may exist with respect to citizens
of countries which are in a state of war with Israel.
E. Taxation
Israeli Taxation
The following is information regarding Israeli tax laws to which U.S. and
other non-Israeli shareholders may be subject. The information below does not
apply to specified persons or cover specified situations. Therefore, you are
advised to consult your own tax advisor as to particular tax consequences unique
to you related to an investment in our ordinary shares or ADSs, including the
effects of applicable Israeli or foreign or other tax laws and possible changes
in the tax laws.
To the extent that the discussion is based on legislation yet to be
judicially or administratively interpreted, we cannot assure you that the views
we express herein will accord with any such interpretation in the future.
Under current Israeli law, individual or corporate shareholders (which are
not subject to the provisions of the Inflationary Adjustments Law), selling our
ordinary shares are subject to a 15% tax rate on any capital gain accrued after
January 1, 2003 when certain conditions are met. However, foreign residents are
exempt from capital gains tax on the sale of traded securities of Israeli
companies. The foregoing does not apply to companies or individuals which are
subject to Chapter II of the Income Tax (Inflationary Adjustments) Law, 1985. In
general, Chapter II of the Inflationary Adjustments Law applies to all Israeli
companies and individuals, except for those companies which comply with all of
the following: (i) they do not generate any business
88
income; (ii) they do not apply for a deduction of financing expenses; and (iii)
they are held only by individuals. Notwithstanding the foregoing, dealers in
securities in Israel are taxed at regular tax rates applicable to business
income. We obtained a ruling from the Israeli income tax authorities confirming
that capital gains received upon sale of ADSs will be subject to the same
treatment as capital gains received upon sale of our ordinary shares.
Pursuant to the convention between the Government of the United States of
America and the Government of Israel with respect to taxes on income (the
U.S.-Israel tax treaty), the sale, exchange or disposition of our ADSs or
ordinary shares by a person who qualifies as a resident of the United States
under the treaty and who is entitled to claim the benefits afforded to him by
the treaty, will generally not be subject to Israeli capital gains tax. This
exemption shall not apply to a person who held, directly or indirectly, shares
representing 10% or more of the voting power in our company during any part of
the 12-month period preceding the sale, exchange or disposition, subject to
certain conditions. A sale, exchange or disposition of our shares by a U.S.
resident qualified under the treaty, who held, directly or indirectly, shares
representing 10% or more of the voting power in our company at any time during
the preceding 12-month period would be subject to Israeli tax, to the extent
applicable. However, under the treaty, this U.S. resident would be permitted to
claim a credit for these taxes, if apply, against the U.S. income tax with
respect to the sale, exchange or disposition, subject to the limitations in U.S.
laws applicable to foreign tax credits in accordance with tax treaties.
Non-residents of Israel are subject to income tax on passive income
accrued or derived from sources in Israel like dividends, royalties and
interest, as well as non-passive income from services rendered in Israel. On
distributions of dividends other than bonus shares (stock dividends) we should
generally withhold at source income tax at a rate of 25%, unless a different
rate applies under a treaty between Israel and the shareholder's country of
residence. Under the U.S.-Israel tax treaty, the maximum tax on dividends paid
to a holder of our ADSs or ordinary shares who is a resident of the United
States will be 25% or 12.5% if certain conditions are met including, interalia,
that the holder is a corporation which holds, directly or indirectly, shares
representing 10% or more of the voting power in our company during the relevant
period preceding the date of payment of the dividend. However, under the Law for
the Encouragement of Capital Investments, 1959 (the Investments Law), dividends
generated by an approved enterprise are taxed at the rate of 15%.
United States Federal Income Tax Considerations
Subject to the limitations described herein, this discussion summarizes
the material United States federal income tax consequences of the purchase,
ownership and disposition of our ordinary shares or ADSs to a United States
holder. A United States holder is a holder of our ordinary shares or ADSs who
is:
o an individual citizen or resident of the United States;
o a corporation (or another entity taxable as a corporation for United
89
States federal income tax purposes) created or organized under the
laws of the United States or any political subdivision thereof;
o an estate, the income of which is subject to United States federal
income tax regardless of its source; or
o a trust (i) if, in general, a United States court is able to
exercise primary supervision over its administration and one or more
United States persons have the authority to control all of its
substantial decisions or (ii) that has in effect a valid election
under applicable United States Treasury regulations to be treated as
a United States person.
Unless otherwise specifically indicated, this discussion does not consider
the United States tax consequences to a person that is not a United States
holder and considers only United States holders that will own the ordinary
shares or ADSs as capital assets.
This discussion is based on current provisions of the Internal Revenue
Code of 1986, as amended, referred to as the Code, current and proposed Treasury
regulations promulgated under the Code and administrative and judicial
interpretations of the Code, all as currently in effect and all of which are
subject to change, possibly with a retroactive effect. This discussion does not
address all aspects of United States federal income taxation that may be
relevant to any particular United States holder based on the United States
holder's individual circumstances. In particular, this discussion does not
address the United States federal income tax consequences to United States
holders who are broker-dealers or who own, directly, indirectly or
constructively, 10% or more of our outstanding voting shares, United States
holders holding the ordinary shares or ADSs as part of a hedging, straddle or
conversion transaction, United States holders whose functional currency is not
the United States dollar, insurance companies, tax-exempt organizations,
financial institutions, persons who acquired their shares upon the exercise of
employees stock options or otherwise as compensation, and persons subject to the
alternative minimum tax, who may be subject to special rules not discussed
below. Additionally, the tax treatment of persons who are, or hold the ordinary
shares or ADSs through, a partnership or other pass-through entity is not
considered, nor is the possible application of United States federal estate or
gift taxes or any aspect of state, local or non- United States tax laws.
You are advised to consult your tax advisor with respect to the specific
United States federal, state, local and foreign income tax consequences to you
of purchasing, holding or disposing of our ordinary shares or ADSs.
Taxation on Distributions on the Ordinary Shares or ADSs
In August 2001, Formula distributed to its shareholders a dividend in kind
of Formula Vision's shares held by Formula, which was distributed in the form of
cash to holders of our ADRs. In June 2005, Formula distributed a cash dividend
to its shareholders. If Formula makes
90
distributions in the future, the amount of the distribution with respect to the
ordinary shares or ADSs will equal the amount of cash and the fair market value
of any property distributed and will also include the amount of any Israeli
taxes withheld, as described above under "Israeli Taxation." Subject to the
discussion below under "Tax Consequences if We are a Passive Foreign Investment
Company," a distribution paid by us with respect to the ordinary shares or ADSs
to a United States holder will be treated as dividend income to the extent that
the distribution does not exceed our current and accumulated earnings and
profits, as determined for United States federal income tax purposes. Dividends
that are received by United States holders that are individuals, estates or
trusts will be taxed at the rate applicable to long-term capital gains (a
maximum rate of 15%), provided that such dividends meet the requirements of
"qualified dividend income." Dividends that fail to meet such requirements, and
dividends received by corporate United States holders, are taxed at ordinary
income rates. No dividend received by a United States holder will be a qualified
dividend (1) if the United States holder held the ordinary share or ADS with
respect to which the dividend was paid for less than 61 days during the 121-day
period beginning on the date that is 60 days before the ex-dividend date with
respect to such dividend, excluding for this purpose, under the rules of Code
section 246(c), any period during which the United States holder has an option
to sell, is under a contractual obligation to sell, has made and not closed a
short sale of, is the grantor of a deep-in-the-money or otherwise nonqualified
option to buy, or has otherwise diminished its risk of loss by holding other
positions with respect to, such ordinary share or ADS (or substantially
identical securities); or (2) to the extent that the United States holder is
under an obligation (pursuant to a short sale or otherwise) to make related
payments with respect to positions in property substantially similar or related
to the ordinary share or ADS with respect to which the dividend is paid. If we
were to be a "passive foreign investment company," a "foreign personal holding
company" or a "foreign investment company" (as such terms are defined in the
Code) for any year, dividends paid on our ordinary shares or ADSs in such year
or in the following year would not be qualified dividends. In addition, a
non-corporate United States holder will be able to take a qualified dividend
into account in determining its deductible investment interest (which is
generally limited to its net investment income) only if it elects to do; in such
case the dividend will be taxed at ordinary income rates.
The amount of any distribution which exceeds the amount treated as a
dividend will be treated first as a non-taxable return of capital, reducing the
United States holder's tax basis in its ordinary shares or ADSs to the extent
thereof, and then as capital gain from the deemed disposition of the ordinary
shares or ADSs. Corporate holders will not be allowed a deduction for dividends
received in respect of the ordinary shares or ADSs.
Dividends paid by us in NIS will be included in the income of United
States holders at the dollar amount of the dividend (including any Israeli taxes
withheld therefrom), based upon the spot rate of exchange in effect on the date
of the distribution. United States holders will have a tax basis in NIS for
United States federal income tax purposes equal to that dollar value. Any
subsequent gain or loss in respect of NIS arising from exchange rate
fluctuations will generally be taxable as United States source ordinary income
or loss.
91
Subject to the limitations set forth in the Code and the Treasury
regulations thereunder, United States holders may elect to claim as a foreign
tax credit against their United States federal income tax liability the Israeli
income tax withheld from dividends received in respect of the ordinary shares or
ADSs. The limitations on claiming a foreign tax credit include, among others,
computation rules under which foreign tax credits allowable with respect to
specific classes of income cannot exceed the United States federal income taxes
otherwise payable with respect to each such class of income. In this regard,
dividends paid by us will be foreign source "passive income" for U.S. foreign
tax credit purposes or, in the case of a financial services entity, "financial
services income." United States holders that do not elect to claim a foreign tax
credit may instead claim a deduction for the Israeli income tax withheld if they
itemize deductions. The rules relating to foreign tax credits are complex, and
you should consult your tax advisor to determine whether and to what extent you
would be entitled to this credit. A United States holder will be denied a
foreign tax credit for Israeli income tax withheld from a dividend received on
the ordinary shares or ADSs (i) if the United States holder has not held the
ordinary shares or ADSs for at least 16 days of the 30-day period beginning on
the date which is 15 days before the ex-dividend date with respect to such
dividend or (ii) to the extent the United States holder is under an obligation
to make related payments with respect to positions in substantially similar or
related property. Any days during which a United States holder has substantially
diminished its risk of loss on the ordinary shares or ADSs are not counted
toward meeting the required 16-day holding period.
Taxation on Disposition of the Ordinary Shares or ADSs
Subject to the discussion below under "Tax Consequences if We are a
Passive Foreign Investment Company," upon the sale, exchange or other
disposition of our ordinary shares or ADSs, a United States holder will
recognize capital gain or loss in an amount equal to the difference between the
amount realized on the disposition and the United States holder's tax basis in
the ordinary shares or ADSs. The gain or loss recognized on the disposition will
be long-term capital gain or loss if the United States holder held the ordinary
shares or ADSs for more than one year at the time of the disposition. Gain or
loss recognized by a United States holder on a sale, exchange or other
disposition of ordinary shares or ADSs will be treated as U.S. source income or
loss for United States foreign tax credit purposes.
A United States holder that uses the cash method of accounting calculates
the dollar value of the proceeds received on the sale as of the date that the
sale settles. However, a United States holder that uses the accrual method of
accounting is required to calculate the value of the proceeds of the sale as of
the trade date and may therefore realize foreign currency gain or loss. A United
States holder may avoid realizing foreign currency gain or loss by electing to
use the settlement date to determine the proceeds of sale for purposes of
calculating the foreign currency gain or loss. In addition, a United States
holder that receives foreign currency upon disposition of ordinary shares or
ADSs and converts the foreign currency into dollars after the settlement date or
trade date (whichever date the United States holder is required to use to
calculate the value of the proceeds of sale) will have foreign exchange gain or
loss based on any appreciation
92
or depreciation in the value of the foreign currency against the dollar, which
will generally be United States source ordinary income or loss.
Tax Consequences if We are a Passive Foreign Investment Company
We will be a passive foreign investment company, or PFIC, for a taxable
year if either (1) 75% or more of our gross income in the taxable year is
passive income; or (2) 50% or more of the value, determined on the basis of a
quarterly average, of our assets in the taxable year produce, or are held for
the production of, passive income. If we own (directly or indirectly) at least
25% by value of the stock of another corporation, we will be treated for
purposes of the foregoing tests as owning our proportionate share of the other
corporation's assets and as directly earning our proportionate share of the
other corporation's income. If we are a PFIC, a United States holder must
determine under which of three alternative taxing regimes it wishes to be taxed:
o The "QEF" regime applies if the United States holder elects to treat us as
a "qualified electing fund" ("QEF") for the first taxable year in which
the United States holder owns our ordinary shares or ADSs or in which we
are a PFIC, whichever is later, and if we comply with certain reporting
requirements. If the QEF regime applies, then each year that we are a PFIC
such United States holder will include in its gross income a proportionate
share of the our ordinary earnings (which is taxed as ordinary income) and
net capital gain (which is taxed as long-term capital gain), subject to a
separate election to defer payment of taxes, which deferral is subject to
an interest charge. These amounts would be included in income by an
electing United States holder for its taxable year in which our taxable
year ends, whether or not such amounts are actually distributed to the
United States holder. A United States holder's basis in our ordinary
shares or ADSs for which a QEF election has been made would be increased
to reflect the amount of any taxed but undistributed income. Generally, a
QEF election allows an electing United States holder to treat any gain
realized on the disposition of his ordinary shares or ADSs as capital
gain.
Once made, the QEF election applies to all subsequent taxable years of the
United States holder in which it holds our ordinary shares or ADSs and for
which we are a PFIC, and can be revoked only with the consent of the
Internal Revenue Service. The QEF election is made by attaching a
completed Internal Revenue Service Form 8621, including the PFIC annual
information statement, to a timely filed United States federal income tax
return. Even if a QEF election is not made, a U.S. person who is a
shareholder in a PFIC must file a completed Internal Revenue Service Form
8621 every year.
If a QEF election is made after the first taxable year in which a United
States holder holds our ordinary shares or ADSs and we are a PFIC, then
special rules would apply.
93
o A second regime, the "mark-to-market" regime, may be elected so long as
our ordinary shares or ADSs are publicly traded. Pursuant to this regime,
an electing United States holder's ordinary shares or ADSs are
marked-to-market each year and the United States holder recognizes as
ordinary income or loss an amount equal to the difference as of the close
of the taxable year between the fair market value of our ordinary shares
or ADSs and the United States holder's adjusted tax basis therein. Losses
are allowed only to the extent of net mark-to-market gain previously
included by the United States holder under the election for prior taxable
years. An electing United States holder's adjusted basis in our ordinary
shares or ADSs is increased by income recognized under the mark-to-market
election and decreased by the deductions allowed under the election.
Under the mark-to-market election, gain on the sale of our ordinary shares
or ADSs is treated as ordinary income, and loss on the sale of our
ordinary shares or ADSs, to the extent the amount of loss does not exceed
the net mark-to-market gain previously included, is treated as ordinary
loss. The mark-to-market election applies to the tax year for which the
election is made and all later tax years, unless the ordinary shares or
ADSs cease to be marketable or the Internal Revenue Service consents to
the revocation of the election.
If the mark-to-market election is made after the first taxable year in
which a United States holder holds our ordinary shares or ADSs and we are
a PFIC, then special rules would apply.
o A United States holder making neither the QEF election nor the
mark-to-market election is subject to the "excess distribution" regime.
Under this regime, "excess distributions" are subject to special tax
rules. An excess distribution is either (1) a distribution with respect to
ordinary shares or ADSs that is greater than 125% of the average
distributions received by the United States holder from us over the
shorter of either the preceding three years or such United States holder's
holding period for our ordinary shares or ADSs, or (2) 100% of the gain
from the disposition of our ordinary shares or ADSs (including gain deemed
recognized if the ordinary shares or ADSs are used as security for a
loan).
Excess distributions must be allocated ratably to each day that a United
States holder has held our ordinary shares or ADSs. A United States holder
must include amounts allocated to the current taxable year and to any
period prior to the first day of the first taxable year for which we are a
PFIC in its gross income as ordinary income for the current taxable year.
All amounts allocated to other years of the United States holder would be
taxed at the highest tax rate for each such prior year applicable to
ordinary income. The United States holder also would be liable for
interest on the deferred tax liability for each such other year calculated
as if such liability had been due with respect to each such other year. A
United States holder that is an individual is not allowed a deduction for
interest on the deferred tax liability. The portions of distributions that
are not characterized as
94
"excess distributions" are subject to tax in the current year under the
normal tax rules of the Code.
A United States person who inherits shares or ADSs in a foreign
corporation that was a PFIC in the hands of the decedent (who was not a
non resident alien and did not make either of the elections described
above), is denied the otherwise available step-up in the tax basis of such
shares or ADSs to fair market value at the date of death. The U.S. person
steps into the shoes of the decedent and will be subject to the rules
described above.
We believe that in 2004 we were not a PFIC and currently we expect that we
will not be a PFIC in 2005. However, PFIC status is determined as of the end of
the taxable year and is dependent on a number of factors, including the value of
our assets and the amount and type of our gross income. Therefore, there can be
no assurance that we will not become a PFIC for the current fiscal year ending
December 31, 2005 or in a future year. We will notify United States holders in
the event we conclude that we will be treated as a PFIC for any taxable year to
enable United States holders to consider whether or not to elect to treat us as
a QEF for United States federal income tax purposes or to "mark to market" the
ordinary shares or ADSs or to become subject to the "excess distribution"
regime.
United States holders are urged to consult their tax advisors regarding
the application of the PFIC rules, including eligibility for and the manner and
advisability of making, the QEF election or the mark-to-market election.
Information Reporting and Backup Withholding
A United States holder generally is subject to information reporting and
may be subject to backup withholding at rate of up to 28% with respect to
dividend payments and receipt of the proceeds from the disposition of the
ordinary shares or ADSs. Backup withholding will not apply with respect to
payments made to exempt recipients, including corporations and tax-exempt
organizations, or if a United States holder provides a correct taxpayer
identification number (or certifies that he has applied for a taxpayer
identification number), certifies that such holder is not subject to backup
withholding or otherwise establishes an exemption. Backup withholding is not an
additional tax and may be claimed as a credit against the United States federal
income tax liability of a United States holder, or alternatively, the United
States holder may be eligible for a refund of any excess amounts withheld under
the backup withholding rules, in either case, provided that the required
information is furnished to the Internal Revenue Service.
Non-United States holders of Ordinary Shares or ADSs
Except as provided below, a non-United States holder of ordinary shares or
ADSs (except certain former United States citizens and long-term residents of
the United States) will not be subject to United States federal income or
withholding tax on the receipt of dividends on, and the proceeds from the
disposition of, an ordinary share or ADS, unless that item is effectively
95
connected with the conduct by the non-United States holder of a trade or
business in the United States and, in the case of a resident of a country which
has an income tax treaty with the United States, that item is attributable to a
permanent establishment in the United States or, in the case of an individual, a
fixed place of business in the United States. In addition, gain recognized by an
individual non-United States holder will be subject to tax in the United States
if the non-United States holder is present in the United States for 183 days or
more in the taxable year of the sale and other conditions are met.
Non-United States holders will not be subject to information reporting or
backup withholding with respect to the payment of dividends on ordinary shares
or ADSs unless the payment is made through a paying agent, or an office of a
paying agent, in the United States. Non-United States holders will be subject to
information reporting and backup withholding at a rate of up to 28% with respect
to the payment within the United States of dividends on the ordinary shares or
ADSs unless the holder provides its taxpayer identification number, certifies to
its foreign status, or otherwise establishes an exemption.
Non-United States holders will be subject to information reporting and
backup withholding at a rate of up to 28% on the receipt of the proceeds from
the disposition of the ordinary shares or ADSs to, or through, the United States
office of a broker, whether domestic or foreign, unless the holder provides a
taxpayer identification number, certifies to its foreign status or otherwise
establishes an exemption. Non-United States holders will not be subject to
information reporting or backup withholding with respect to the receipt of
proceeds from the disposition of the ordinary shares or ADSs by a foreign office
of a broker; provided, however, that if the broker is a U.S. person or a "U.S.
related person," information reporting (but not backup withholding) will apply
unless the broker has documentary evidence in its records of the non-United
States holder's foreign status or the non-United States holder certifies to its
foreign status under penalties of perjury or otherwise establishes an exemption.
For this purpose, a "U.S. related person" is a broker or other intermediary that
maintains one or more enumerated U.S. relationships. Backup withholding is not
an additional tax and may be claimed as a credit against the United States
federal income tax liability of a non-United States holder, or alternatively,
the non-United States holder may be eligible for a refund of any excess amounts
withheld under the backup withholding rules, in either case, provided that the
required information is furnished to the Internal Revenue Service.
F. Dividend and Paying Agents
Not applicable.
G. Statement by Experts
Not applicable.
H. Documents On Display
96
Formula files annual and submits special reports and other information
with the SEC. You may inspect and copy such material at the public reference
facilities maintained by the SEC, 450 Fifth Street, N.W., Washington, D.C.
20549. You may also obtain copies of such material from the SEC at prescribed
rates by writing to the Public Reference Section of the SEC, 450 Fifth Street,
N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further
information on the public reference room.
The SEC maintains an Internet website at http://www.sec.gov that contains
reports and other material that are filed through the SEC's Electronic Data
Gathering, Analysis and Retrieval ("EDGAR") system. Formula began filing through
the EDGAR system beginning in October 2002.
Formula's ADSs are quoted on the NASDAQ National Market. You may inspect
reports and other information concerning Formula at the offices of the National
Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C.
20006.
Information about Formula is also available on its website at
http://www.formulasystems.com. Such information on our website is not part of
this annual report.
As a foreign private issuer, Formula is exempt from the rules under the
Exchange Act prescribing the furnishing and content of proxy statements, and
Formula's officers, directors and principal shareholders are exempt from the
reporting and "short-swing" profit recovery provisions contained in Section 16
of the Exchange Act. In addition, Formula is not required under the Exchange Act
to file periodic reports and financial statements with the Securities and
Exchange Commission as frequently or as promptly as United States companies
whose securities are registered under the Exchange Act.
I. Subsidiary Information
Not applicable.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Currency Exchange Rate Fluctuations and Impact of Inflation
In light of the nature of Formula's activities, Formula invests its cash
and cash equivalents in short term deposits. As of December 31, 2004, Formula
invested substantially all of the cash it held in dollar accounts bearing
interest based on LIBOR and in NIS accounts bearing interest based on the
Israeli prime rate. In addition, Formula has outstanding short-term and
long-term loans in NIS. In May 2002, Formula issued debentures to the public. We
repaid these debentures in accordance with their terms, on June 20, 2005.
Principal and interest on those debentures were linked to the Israeli CPI.
97
An increase in value of the NIS against the dollar (after taking into
account the rate of inflation or deflation in Israel) may have a negative impact
on our operating results and financial condition. In particular, our finance
expenses may increase. Depending upon the circumstances, we will consider
entering into currency hedging transactions to decrease the risk of financial
exposure from fluctuations in the exchange rate of the dollar against the NIS.
There can be no assurance that these activities, or others that we may use from
time to time, will eliminate the negative financial impact of currency
fluctuations and inflation.
We do not engage in currency speculation. Generally, we do not hold nor
have we issued, to any material extent, any derivatives or other financial
instruments for trading purposes.
Fluctuations in Market Price of Securities We Hold
We hold securities of several publicly traded companies on the Nasdaq
National Market and the TASE. These companies include Magic, BluePhoenix,
Matrix, Sapiens and Formula Vision. We consider these holdings as long-term
holdings. We are exposed to the risk of fluctuation of the price of these
companies' securities. All of these publicly traded companies have experienced
significant historical volatility in their stock prices. Fluctuations in the
market price of our holdings in these companies may result in the fluctuation of
the value of our assets. We typically do not attempt to reduce or eliminate our
market exposure on these securities.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.
Not applicable.
P A R T II
===========
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES.
Not applicable.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
Not applicable.
ITEM 15. CONTROLS AND PROCEDURES
98
(a) Disclosure Controls and Procedures. We have carried out an evaluation,
as of the end of our fiscal year, under the supervision and with the
participation of our management, including our chief executive officer and chief
financial officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based upon that evaluation, the chief
executive officer and chief financial officer concluded that our disclosure
controls and procedures are effective as of our fiscal year end to ensure that
information required to be disclosed by us in reports that we file or submit
under the Securities Exchange Act of 1934 was recorded, processed, summarized
and reported within the time periods specified in the Securities Exchange
Commission rules and forms.
(b) Not applicable.
(c) Not applicable.
(d) Changes in Internal Control Over Financial Reporting. There have been
no significant changes in our internal controls over financial reporting that
occured during the the year ended December 31, 2004, that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
ITEM 16. [RESERVED]
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
Our board of directors has agreed that Mr. Shlomo Nass, a member of our
audit committee and an independent member of our board of directors pursuant to
the Nasdaq requirements, is an audit committee financial expert, as defined by
applicable SEC regulations.
ITEM 16B. CODE OF ETHICS
Formula has adopted a code of business conduct and ethics applicable to
its executive officers, directors and all other employees. A copy of the code
is available to all Formula's employees, investors and others upon request to
the following address: Formula Systems (1985) Ltd., 3 Abba Eban Boulevard,
Herzliya 46725, Israel, Attn: General Counsel. Any waiver of this code for
executive officers or directors will be disclosed through the filing of a Form
6-K.
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Policy on Pre-Approval of Audit and Non-Audit Services of Independent Auditors
Our audit committee is responsible for the oversight of our independent
auditor's work. The audit committee's policy is to pre-approve all audit and
non-audit services provided by Ziv Haft certified public accountants (Isr.) BDO
member firm. These services may include audit services, audit-related services,
tax services and other services, as further described below. The audit committee
sets forth the basis for its pre-approval in detail, listing the particular
services or
99
categories of services which are pre-approved, and setting forth a specific
budget for such services. Additional services may be pre-approved by the audit
committee on an individual basis. Once services have been pre-approved, Ziv Haft
certified public accountants (Isr.) BDO member firm and our management then
report to the audit committee on a periodic basis regarding the extent of
services actually provided in accordance with the applicable pre-approval, and
regarding the fees for the services performed.
Principal Accountant Fees and Services
The Company paid the following fees for professional services rendered by
Ziv Haft certified public accountants (Isr.) BDO member firm, for the years
ended December 31:
2004 2003
---- ----
($ in thousands)
Audit Fees 723 825
Audit-Related Fees 120 88
Tax Fees 92 79
All Other Fees -- --
-- --
Total 935 972
The audit fees for the years ended December 31, 2004 and 2003 were for
professional services rendered for the audits of our annual consolidated
financial statements, review of our consolidated quarterly financial statements,
statutory audits of Formula and certain subsidiaries, issuance of comfort
letters, consents and assistance with review of documents filed with the SEC.
The audit-related fees for the years ended December 31, 2004 and 2003 were
incurred by one of our subsidiaries for assurance and related services related
to accounting consultations and audits in connection with acquisitions, issuance
of convertible debentures and related warrants and review of a registration
statement by the SEC.
Tax fees for the years ended December 31, 2004 and 2003 were for services
related to tax compliance, including the preparation of tax returns and claims
for refund, and tax advice.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not applicable.
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
Not applicable.
100
P A R T III
===========
ITEM 17. FINANCIAL STATEMENTS
We have responded to Item 18 in lieu of this item.
ITEM 18. FINANCIAL STATEMENTS
The financial statements required by this item are found at the end of
this annual report, beginning on page F-1.
ITEM 19. EXHIBITS
Exhibit No.
-----------
1.1 Memorandum of Association(1)
1.2 Articles of Association as amended on January 7, 2001(2)
2 The description of terms of debentures issued by the Registrant
in May 2002, contained in Section 2.3 of the prospectus of the
Registrant dated May 23, 2002 (3)
4.1 Agreement dated October 1, 1999 between the Registrant and
Shamrock Holdings of California Inc.(4)
4.2 Agreement dated January 24, 2001 among the Registrant, Sapiens
International Corporation N.V. and Yarnfield International
Limited(2)
4.3 Amendment to the agreement among the Registrant, Sapiens
International Corporation N.V. and Yarnfield International
Limited, dated October 20, 2002(5)
4.4 Agreement dated December 30, 2001 between the Registrant and
Formula Vision Technologies (F.V.T.) Ltd. (English summary
accompanied by Hebrew original)(5)
4.5 Agreement dated December 15, 2003 between the Registrant and
Formula Vision Technologies (F.V.T.) Ltd. (5)
4.6 Share Purchase Agreement dated February 16, 2005 between the
Registrant and FIMGold LP(7)
4.7 Registration Rights Agreement dated March 3, 2005 between the
Registrant and FIMGold LP(7)
101
Exhibit No.
-----------
4.8 Form of the 1997 Share Option Plan (English translation from
Hebrew original)(1)
4.9 Form of the 2000 Share Option Plan (English translation from
Hebrew original)(2)
4.10 Letter of Indemnification, dated February 14, 2002(6)
8 List of Subsidiaries(7)
12.1 Certification of the Chief Executive Officer pursuant to ss.302
of the Sarbanes-Oxley Act
12.2 Certification of the Principal Financial Officer pursuant to
ss.302 of the Sarbanes-Oxley Act
13.1 Certification of the Chief Executive Officer pursuant to 18
U.S.C. sec. 1350, as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act
13.2 Certification of the Principal Financial Officer pursuant to 18
U.S.C. sec. 1350, as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act
--------------
(1) Incorporated by reference to the Registration Statement on Form F-1 (File
No. 333-8858).
(2) Incorporated by reference to the Annual Report on Form 20-F filed with
the Securities and Exchange Commission on June 29, 2001.
(3) Incorporated by reference to the Form 6-K filed with the Securities and
Exchange Commission on June 14, 2002.
(4) Incorporated by reference to the Annual Report on Form 20-F filed with
the Securities and Exchange Commission on June 21, 2000.
(5) Incorporated by reference to the Annual Report on Form 20-F filed with
the Securities and Exchange Commission on June 30, 2004.
(6) Incorporated by reference to the Annual Report on Form 20-F filed with
the Securities and Exchange Commission on June 28, 2002.
(7) Incorporated by reference to the Annual Report on Form 20-F filed with
the Securities and Exchange Commission on June 30, 2005.
102
SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing
on Form 20-F and that it has duly caused and authorized the undersigned to sign
this Amendment No. 2 to the annual report on its behalf.
FORMULA SYSTEMS (1985) LTD.
By: /s/ Dan Goldstein December 19, 2005
------------------------- -----------------
Dan Goldstein Date
Chairman of the Board and
Chief Executive Officer
103
Exhibit Index
-------------
Exhibit No.
-----------
1.1 Memorandum of Association(1)
1.2 Articles of Association as amended on January 7, 2001(2)
2 The description of terms of debentures issued by the Registrant
in May 2002, contained in Section 2.3 of the prospectus of the
Registrant dated May 23, 2002 (3)
4.1 Agreement dated October 1, 1999 between the Registrant and
Shamrock Holdings of California Inc.(4)
4.2 Agreement dated January 24, 2001 among the Registrant, Sapiens
International Corporation N.V. and Yarnfield International
Limited(2)
4.3 Amendment to the agreement among the Registrant, Sapiens
International Corporation N.V. and Yarnfield International
Limited, dated October 20, 2002(5)
4.4 Agreement dated December 30, 2001 between the Registrant and
Formula Vision Technologies (F.V.T.) Ltd. (English summary
accompanied by Hebrew original)(5)
4.5 Agreement dated December 15, 2003 between the Registrant and
Formula Vision Technologies (F.V.T.) Ltd. (5)
4.6 Share Purchase Agreement dated February 16, 2005 between the
Registrant and FIMGold LP(7)
4.7 Registration Rights Agreement dated March 3, 2005 between the
Registrant and FIMGold LP(7)
4.8 Form of the 1997 Share Option Plan (English translation from
Hebrew original)(1)
4.9 Form of the 2000 Share Option Plan (English translation from
Hebrew original)(2)
4.10 Letter of Indemnification, dated February 14, 2002(6)
8 List of Subsidiaries(7)
12.1 Certification of the Chief Executive Officer pursuant to ss.302
of the Sarbanes-Oxley Act
12.2 Certification of the Principal Financial Officer pursuant to
ss.302 of the Sarbanes-Oxley Act
13.1 Certification of the Chief Executive Officer pursuant to 18
U.S.C. sec. 1350, as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act
104
13.2 Certification of the Principal Financial Officer pursuant to 18
U.S.C. sec. 1350, as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act
--------------
(1) Incorporated by reference to the Registration Statement on Form F-1 (File
No. 333-8858).
(2) Incorporated by reference to the Annual Report on Form 20-F filed with
the Securities and Exchange Commission on June 29, 2001.
(3) Incorporated by reference to the Form 6-K filed with the Securities and
Exchange Commission on June 14, 2002.
(4) Incorporated by reference to the Annual Report on Form 20-F filed with
the Securities and Exchange Commission on June 21, 2000.
(5) Incorporated by reference to the Annual Report on Form 20-F filed with
the Securities and Exchange Commission on June 30, 2004.
(6) Incorporated by reference to the Annual Report on Form 20-F filed with
the Securities and Exchange Commission on June 28, 2002.
(7) Incorporated by reference to the Annual Report on Form 20-F filed with
the Securities and Exchange Commission on June 30, 2005.
105
FORMULA SYSTEMS (1985) LTD.
(An Israeli corporation)
2004 Annual Report
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
2004 CONSOLIDATED FINANCIAL STATEMENTS
TABLE OF CONTENTS
-----------------
Page
----
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM: F-1
CONSOLIDATED FINANCIAL STATEMENTS:
Balance Sheets F-2
Statements of Operations F-4
Statements of Changes in Shareholders' Equity F-5
Statements of Cash Flows F-6
Notes to Financial Statements F-10
The amounts are stated in U.S. dollars ($).
----------------------
-------------
------
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of
FORMULA SYSTEMS (1985) LTD.
We have audited the consolidated balance sheets of Formula Systems (1985) Ltd.
and its subsidiaries (the "Company") as of December 31, 2004 and 2003 and the
consolidated statements of operations, changes in shareholders' equity and cash
flows for each of the three years in the period ended December 31, 2004. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We did not audit the financial statements of certain subsidiaries, whose
consolidated assets constitute approximately 26.86% and 28.44% of total
consolidated assets as of December 31, 2004 and 2003, respectively, and whose
consolidated revenues constitute approximately 28.58%, 31.82% and 21.82% of
total consolidated revenues for the years ended December 31, 2004, 2003 and
2002, respectively. We did not audit the financial statements of certain
affiliated companies, the Company's investment in which, as reflected in the
balance sheets of December 31, 2004 is $18.4 million, and the Company's share in
losses of which is $1.4million. The financial statements of those subsidiaries
were audited by other auditors, whose reports have been furnished to us, and our
opinion, insofar as it relates to the amounts included in respect of those
subsidiaries is based solely on the reports of the other auditors.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting.
Our audits included consideration of internal control over financial reporting
as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Company's internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, based on our audits and the reports of other auditors, the
consolidated financial statements present fairly, in all material respects, the
consolidated financial position of the Company as of December 31, 2004 and 2003,
and the related consolidated results of operations and cash flows for each of
the three years in the period ended December 31, 2004, in conformity with
generally accepted accounting principles as applied in the United States of
America.
Tel-Aviv, Israel
June 28, 2005
Ziv Haft
Certified Public Accountants (Isr.)
BDO member firm
F-1
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED BALANCE SHEETS
December 31,
----------------------
2004 2003
------- ------
(U.S. $ in thousands)
----------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents 107,174 93,456
Short-term investments (Note 3) 39,073 8,773
Trade receivables (net of allowances for doubtful
debts of $5,988 and $5,365 as of December 31, 2004
and 2003, respectively) 114,533 93,298
Other current assets (Note 17A) 26,105 18,846
Inventories 4,668 2,635
------- -------
291,553 217,008
------- -------
LONG-TERM INVESTMENTS, LOANS AND RECEIVABLES:
Loans and other investments (Note 4) 5,247 *3,092
Investments in affiliates (Note 5) 24,389 3,373
------- -------
29,636 6,465
------- -------
DEBENTURES (Note 2B) -- 80,246
------- -------
SEVERANCE PAY FUND 31,943 *26,226
------- -------
PROPERTY AND EQUIPMENT, NET (Note 6) 26,529 25,756
------- -------
GOODWILL (Note 1J and Note 7) 196,921 *142,214
------- -------
OTHER ASSETS, NET (Note 8) 64,438 *46,113
------- -------
641,020 544,028
======= =======
F-2
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
December 31,
---------------------------
2004 2003
---------- ----------
(U.S. $ in thousands)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Liabilities to banks and others (Notes 10 and 17B) 104,975 *66,543
Trade payables 41,605 31,327
Other accounts payable (Note 17C) 81,105 71,092
Debentures (Note 9) 32,374 *15,340
Customer advances, net of work in progress 6,900 --
----------- -----------
266,959 184,302
----------- -----------
LONG-TERM LIABILITIES:
Debentures (Note 11) 27,086 50,983
Provision for losses in formerly owned investee 1,971 1,971
Deferred taxes 958 942
Customer advances 1,114 2,312
Liabilities to banks and others (Note 10) 19,789 21,900
Liability in respect of the acquisition of activities 2,036 2,149
Accrued severance pay 37,750 *30,755
Unrealized gains (Note 13) -- 4,459
----------- -----------
90,704 115,471
----------- -----------
MINORITY INTEREST 96,579 68,251
----------- -----------
COMMITMENTS AND CONTINGENCIES (Note 14)
SHAREHOLDERS' EQUITY (Note 15):
Share capital - ordinary shares of NIS 1 par value
(authorized - December 31, 2004 and 2003 - 25,000,000
shares; issued: December 31, 2004 and 2003 -
10,824,780 shares) 3,215 3,215
Additional paid-in capital 99,535 99,275
Retained earnings 99,166 91,067
Accumulated other comprehensive loss (14,879) (17,294)
----------- -----------
187,037 176,263
----------- -----------
Cost of 24,780 treasury shares (259) (259)
----------- -----------
Total shareholders' equity 186,778 176,004
----------- -----------
----------- -----------
641,020 544,028
=========== ===========
* Reclassified
The accompanying notes form an integral part of the financial statements.
F-3
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
-------------------------------------------
2004 2003 2002
------- -------- --------
(U.S. $ in thousands, except per share amounts)
Revenues (Note 17I(2))
Proprietary software products 229,348 170,048 111,968
-------- -------- --------
Software services 227,262 196,782 171,342
-------- -------- --------
Total revenues 456,610 366,830 283,310
-------- -------- --------
Cost of revenues
-------- -------- --------
Proprietary software products 105,394 76,862 52,293
Software services 179,567 153,638 134,615
Total cost of revenues 284,961 230,500 186,908
Gross profit 171,649 136,330 96,402
Research and development costs, net 25,036 17,368 15,967
Selling, general and administrative expenses 128,537 107,103 85,292
Restructuring and non-recurring costs (Note 17D) -- -- 1,829
-------- -------- --------
Operating income (loss) 18,076 11,859 (6,686)
Financial (expenses) income, net (Note 17E) (8,904) (3,676) 3,605
Gain on realization of shareholdings, net (Note 17G) 8,893 2,756 4,668
Other expenses, net (Note 17F) (332) (90) (2,100)
-------- -------- --------
Income (loss) before taxes on income 17,733 10,849 (513)
Taxes on income (Note 16) 4,631 2,540 2,014
-------- -------- --------
13,102 8,309 (2,527)
Equity in losses of affiliated companies, net (2,523) (1,071) (2,327)
Minority interest in losses (earnings) of subsidiaries, net (2,480) (4,118) 2,448
-------- -------- --------
Net income (loss) 8,099 3,120 (2,406)
======== ======== ========
Earnings (loss) per share (Note 17J):
Basic 0.73 0.29 (0.24)
======== ======== ========
Diluted 0.65 0.24 (0.24)
======== ======== ========
Weighted average number of shares outstanding
(Note 17J):
Basic 10,800 10,037 10,171
======== ======== ========
Diluted 10,800 10,285 10,171
======== ======== ========
The accompanying notes form an integral part of the financial statements.
F-4
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Share Capital
----------------------
Accumulated
Additional other Cost of
Number of paid-in Retained comprehensive Treasury
Shares Amount Capial Earnings loss Shares Total
--------- ------ ---------- -------- ------------- -------- -------
(U.S. $ in t h o u s a n d s )
----------------------------------------------------------------------------------------
Balance as of January 1, 2002 10,324,780 3,101 89,930 90,353 (16,963) -- 166,421
Changes during 2002:
Net loss -- -- -- (2,406) -- -- (2,406)
Currency translation adjustments -- -- -- -- (6,734) -- (6,734)
---------
Total comprehensive loss -- -- -- -- -- -- (9,140)
Issuance of options in connection
with debenture -- -- 1,056 -- -- -- 1,056
Deferred compensation -- -- 214 -- -- -- 214
Purchase of treasury stock (324,780) -- -- -- -- (3,398) (3,398)
Elimination of tax benefit
resulting from issuance expenses -- -- (1,804) -- -- -- (1,804)
----------- --------- ---------- ---------- ---------- ---------- ---------
Balance as of December 31, 2002 10,000,000 3,101 89,396 87,947 (23,697) (3,398) 153,349
Changes during 2003:
Net Income -- -- -- 3,120 -- -- 3,120
Currency translation adjustments -- -- -- -- 6,403 -- 6,403
---------
Total comprehensive income -- -- -- -- -- -- 9,523
Deferred compensation -- -- 406 -- -- -- 406
Proceeds from sale of treasury
stock 300,000 -- 1,657 -- -- 3,139 4,796
Exercise of share options 500,000 114 7,816 -- -- -- 7,930
----------- --------- ---------- ---------- ---------- ---------- ---------
Balance as of December 31, 2003 10,800,000 3,215 99,275 91,067 (17,294) (259) 176,004
Changes during 2004:
Net Income -- -- -- 8,099 -- -- 8,099
Unrealized gains from available-
for-sale securities, net -- -- -- -- (50) -- (50)
Currency translation adjustments -- -- -- -- 2,465 -- 2,465
---------
Total comprehensive income -- -- -- -- -- -- 10,514
Beneficial conversion features -- -- 106 -- -- -- 106
Deferred compensation -- -- 101 -- -- -- 101
Capital fund arising from
elimination of gain on
realization of development
stage entity -- -- 53 -- -- -- 53
----------- --------- ---------- ---------- ---------- ---------- ---------
Balance as of December 31, 2004 10,800,000 3,215 99,535 99,166 (14,879) (259) 186,778
=========== ========= ========== ========== ========== ========== =========
Accumulated unrealized gain from
available - for-sale securities (50)
Accumulated currency translation
adjustments (14,829)
----------
Accumulated other comprehensive loss (14,879)
==========
The accompanying notes form an integral part of the financial statements.
F-5
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
------------------------------------
2004 2003 2002
------- ------ --------
(U.S. $ in thousands)
------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) 8,099 3,120 (2,406)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Impairment and write down of investments in investees and loans 471 915 1,656
Minority interest in earnings (losses) of consolidated subsidiaries 2,480 4,118 (2,448)
Equity in losses of affiliated companies, net 2,523 1,071 2,472
Depreciation and amortization 20,597 18,547 12,906
Impairment of software development costs 901 -- --
Increase (decrease) in accrued severance pay, net 287 (620) 219
Loss (gain) from sale of property and equipment (60) (26) 176
Gain on realization of shareholdings (8,893) (2,756) (4,668)
Amortization of deferred option compensation 194 456 430
Erosion, change in accrued interest and capital loss on debentures 3,471 3,583 (2,945)
Erosion (appreciation) in value of long term loans and deposits, net 715 (1,659) 108
Deferred taxes (1,101) 827 (410)
Accrued interest on redeemable shares in a subsidiary 64 320 --
Gain (loss) on payment of convertible subordinated notes 50 (61) --
Sale of trading marketable securities, net (3,533) *(2,665) *(1,857)
Increase (decrease) in trade marketable securities (26) (991) 435
Capital gain on sale of available for sale marketable securities (64) -- --
Changes in operating assets and liabilities:
Decrease (increase) in inventories (1,850) (265) 1,159
Decrease (increase) in trade receivables (8,044) (12,649) 14,153
Decrease (increase) in other accounts receivable (2,146) 7,913 1,827
Increase (decrease) in trade payables 3,033 2,927 (9,483)
Increase (decrease) in other accounts payable and restructuring accrual (4,641) (12,475) (8,212)
Increase (decrease) in customer advances, net of work in progress 5,279 -- --
------- ------- -------
Net cash provided by operating activities 17,806 9,630 3,112
------- ------- -------
* Reclassified.
The accompanying notes form an integral part of the financial statements.
F-6
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
-------------------------------------
2004 2003 2002
------- ------ ------
(U.S. $ in thousands)
-------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of newly-consolidated subsidiaries (Appendix C) 13,724 20,481 (1,774)
Proceeds from realization of investment in previously-consolidated
subsidiaries (Appendix D) (353) 12 (9)
Investment in debentures -- -- (19,422)
Proceeds from repayment of debentures -- 301 2,919
Loans to employees (235) -- --
Restricted short term deposit, net (600) -- --
Restricted long term deposit, net 2,554 -- --
Purchase of property and equipment (5,718) (4,887) (3,382)
Purchase of available for sale marketable securities, net (16,413) -- --
Proceeds from sale of property and equipment 1,827 1,246 1,160
Investment in and loans to affiliated and other companies (6,162) (1,685) (17,488)
Proceeds from sale of investments in and loans to affiliated companies 4,160 1,581 2,128
Purchase of an activity by a consolidated company -- (429) (1,330)
Purchase of intangible assets by consolidated companies (449) -- (353)
Investment in long term bank deposits, net (639) 18 (180)
Capitalization of software development and other costs (15,367) (10,172) (4,424)
Purchase of minority interest in subsidiaries (5,710) (23,599) (16,231)
Proceeds from realization of investment in subsidiaries 11,025 2,846 --
Proceeds from investments in short term bank deposits, net 1,245 9,400 --
Dividends received from affiliated companies -- -- 31
-------- -------- --------
Net cash used in investing activities (17,111) (4,887) (58,355)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of subsidiary call warrants -- 1,386 2,174
Issuance of convertible debt 4,357 20,977 29,453
Purchase of treasury stock -- -- (3,398)
Issuance of treasury stock -- 4,796 --
Exercise of share options -- 7,930 --
Dividend to minority shareholders in subsidiaries (88) (4,831) (128)
Short-term bank credit, net 20,410 (41,344) 37,061
Repayment of long-term loans (29,521) (5,061) (5,045)
Receipt of long-term loans 12,681 19,581 4,841
Issuance in a subsidiary to minority shareholders, net 4,405 479 356
Convertible debt issuance expenses in a subsidiary (32) (1,496) --
Payment of convertible subordinated notes in a subsidiary -- (4,144) --
Payment of issuance expenses in a subsidiary (20) (361) --
Debenture redemption -- (2,484) --
Purchase of treasury stock in a subsidiary by a subsidiary thereof (102) -- (482)
-------- -------- --------
Net cash used in financing activities 12,090 (4,572) 64,832
-------- -------- --------
Effect of exchange rate changes on cash and cash equivalents 933 2,724 (2,575)
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 13,718 2,895 7,014
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 93,456 90,561 83,547
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR 107,174 93,456 90,561
======== ======== ========
The accompanying notes form an integral part of the financial statements.
F-7
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Appendix A - Supplemental cash flow information:
Year ended December 31,
-----------------------------------
2004 2003 2002
----- ----- -----
(U.S. $ in thousands)
-----------------------------------
Cash paid during the year in respect of:
Interest 7,066 6,547 5,616
===== ===== =====
Income tax 6,357 4,652 5,940
===== ===== =====
Appendix B - Non-cash activities:
Year ended December 31,
-----------------------------------
2004 2003 2002
----- ----- -----
(U.S. $ in thousands)
-----------------------------------
Purchase of fixed assets against trade payables 39 80 --
----- ----- -----
Investment in a consolidated company against issuance of share
capital to minority shareholders of consolidated company -- 5,101 9,358
----- ----- -----
Purchase of activity against long term liability -- -- 2,503
----- ----- -----
Investment in affiliates and other companies, recorded against
accounts payable -- 807 --
----- ----- -----
Purchase of shares from minority shareholders of subsidiary, against
accounts payable -- -- 262
----- ----- -----
Realization of convertible debenture in a subsidiary -- 229 242
----- ----- -----
Purchase of shares from minority shareholders of subsidiary
against debentures -- -- 1,310
----- ----- -----
Realization of investment in an exchange shares transaction -- -- 6,422
----- ----- -----
Purchase of technology from affiliated company against loan 1,695 1,917 --
----- ----- -----
Purchase of intellectual property rights against settlement of loan -- 642 --
----- ----- -----
Warrants issued as consideration for purchase of activity -- 121 --
----- ----- -----
The accompanying notes form an integral part of the financial statements.
F-8
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Appendix C - Acquisition of newly-consolidated subsidiaries:
Year ended December 31,
----------------------------------
2004 2003 2002
------- ------- -----
(U.S. $ in thousands)
----------------------------------
Assets and liabilities of subsidiaries consolidated as of
acquisition date:
Working capital (other than cash and cash equivalents) 11,670 12,726 (1,019)
Liabilities arising from purchase of an activity -- -- 743
Investment in affiliates and others including loans (27,436) 19,014 6,232
Property and equipment (4,671) (4,074) (480)
Other assets and deferred expenses (13,085) (23,748) (413)
Goodwill arising upon acquisition (60,524) (14,379) (6,654)
Long-term liabilities 18,507 8,887 77
Debentures 45,336 12,099 --
Unrealized gain (1,508) -- --
Minority interest at acquisition date 9,182 9,956 (260)
Exchange of debentures against shares 36,253 -- --
------- ------- -------
Total 13,724 20,481 (1,774)
======= ======= =======
Appendix D - Proceeds from realization of investments in previously-consolidated
subsidiaries:
Assets and liabilities of consolidated subsidiaries as of date of
realization
Working capital (other than cash and cash equivalents) (14,204) 330 (289)
Investment in affiliate (including loans) 1,139 (2,613) 221
Property and equipment 2,081 360 --
Other assets and deferred expenses -- 67 (31)
Goodwill 7,756 2,133 76
Long-term liabilities (392) (201) 14
Loss (gain) from realization of investments in subsidiaries -- 27 --
Minority interest 3,267 (91) --
------- ------- -------
Total (353) 12 (9)
======= ======= =======
The accompanying notes form an integral part of the financial statements.
F-9
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies:
A. General:
Formula Systems (1985) Ltd. ("Formula") was incorporated in Israel in
1985. Since 1991, the Company's shares have been traded on the Tel Aviv
Stock Exchange (the "TASE") and since 1997, through American Depositary
Shares ("ADS") under the symbol FORTY on the NASDAQ National Market in the
United States. Each ADS represents one ordinary share of the Company.
Formula, through its subsidiaries (collectively, the "Company" or the
"Group") is engaged in the development, production and marketing of
information technology ("IT") solutions and services. The Group operates
in two principal business segments, IT Services and Proprietary Software
Solutions. For a description of the segments - see Note 17H. The following
table presents certain information regarding the control and ownership of
Formula's significant subsidiaries and material investments, as of the
dates indicated:
Name of subsidiary: Percentage of ownership and control
-----------------------------------------
December 31, 2004 December 31, 2003
-----------------------------------------
%
-----------------------------------------
Matrix IT Ltd. ("Matrix") 58.63 72.15
BluePhoenix Solutions Ltd. ("BluePhoenix")
(formerly - "Crystal Systems Solutions Ltd.") 58.66 58.8
Magic Software Enterprises Ltd. ("Magic") 50.1 52.9
NextSource Inc. 100 100
Sapiens International Corporation N.V.
("Sapiens") 52.37 50.69
Formula Vision Technologies (F.V.T.) Ltd.
("Formula Vision") 56.2 -
The above list consists only of active companies that are held directly by Formula.
F-10
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
A. General (cont.):
Accounting Principles
The consolidated financial statements have been prepared in accordance
with generally accepted accounting principles ("GAAP") as applied in the
United States.
Functional and Reporting Currency
The currency of the primary economic environment in which the operations
of Formula and most of its subsidiaries are conducted is the New Israeli
Shekel (NIS). The functional currency of the remaining subsidiaries is the
United States dollar ("dollar"). Formula has elected to use the dollar as
its reporting currency.
The financial statements of Formula and most of its subsidiaries whose
functional currency is the NIS have been translated into dollars under the
principles described in Financial Accounting Standards Board Statement No.
52, "Foreign Currency Translation". Assets and liabilities have been
translated at period-end exchange rates. The results of operations have
been translated at the exchange rates on the dates on which the
transactions occurred or at average exchange rates. Differences resulting
from translation are presented under shareholders' equity, in the item
"accumulated other comprehensive loss". Accordingly, the financial
statements of subsidiaries whose functional currency is the dollar are
presented in the consolidated financial statements in their original
amounts.
Use of Estimates and Assumptions in the Preparation of the Financial
Statements.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
the disclosure of contingent assets and liabilities as of the dates of the
financial statements and the reported amounts of revenues and expenses
during the reporting periods. The actual results may differ from these
estimates.
B. Principles of Consolidation:
The consolidated financial statements include Formula's financial
statements as well as those of its subsidiaries in which it has a
controlling interest, and a certain variable interest entity that the
Company is required to consolidate pursuant to Financial Accounting
Standards Board Interpretation No. 46, "Consolidation of Variable Interest
Entities" as revised in December 2003 ("FIN 46"). Acquisition of
subsidiaries is accounted for under the purchase method. All inter-company
balances and transactions have been eliminated upon consolidation.
C. Cash and Cash Equivalents:
F-11
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash equivalents are considered by the Company to be highly-liquid
investments, including, inter-alia, short-term deposits with banks, the
maturity of which did not exceed three months at the time of acquisition
and which are unrestricted.
Note 1 - Summary of Significant Accounting Policies (cont.):
D. Investments:
Investments in non-marketable securities of companies in which the Company
does not have the ability to exercise significant influence over operating
and financial policy are recorded at cost. The Company accounts for
investments in marketable equity securities and debt securities in
accordance with SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities ("SFAS No. 115"). Management determines the
appropriate classification of its investments in marketable equity
securities and debt securities at the time of purchase and reevaluates
such determinations at each balance sheet date. Marketable equity
securities and debt securities that are classified as "trading or as
available-for-sale" are reported at fair value.
Unrealized gains and losses from marketable securities classified as
"available for sale" are excluded from earnings and are reported as a
component of accumulated other comprehensive income (loss) in
shareholder's equity.
Unrealized gains and losses from marketable securities classified as
"trading" are reported in the statement of income.
Investments are periodically reviewed to determine whether an impairment
in value has occurred that is of a non-temporary nature, in which case the
investment is written down to its fair value.
E. Provision for Doubtful Accounts:
The provision for doubtful accounts was calculated on the basis of
specific receivables, where, in the opinion of Group management, doubt
exists as to their collectability.
F. Inventory:
Inventory is comprised of hardware and software.
Inventory is valued at the lower of cost or market value. Cost is
determined on the "first in - first out" basis.
G. Debentures:
Debentures from sale of investments relates to the transaction carried out
on December 31, 2001. The debentures were issued by Formula Vision, in
connection with the sale of non-public companies held by Formula to
Formula Vision.
Formula evaluated periodically (until December 31, 2003), the financial
strength of Formula Vision and its ability to meet the repayment schedule
of the loan (see Note 2B).
F-12
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
H. Investments in Affiliates:
Affiliates are companies over which significant influence is exercised,
but which are not consolidated subsidiaries, and are accounted for by the
equity method, net of write-down for decrease in value, which is not of a
temporary nature.
I. Property and Equipment, net:
Property and equipment are stated at cost, net of accumulated
depreciation. Depreciation is calculated by the straight-line method over
their estimated useful lives. The following are the annual depreciation
rates:
%
---
Computers and equipment 6 - 33 (mainly 33)
Motor vehicles 15-33 (mainly 15)
Buildings 4
Leasehold improvements 10 - 20 (mainly 20)
J. Goodwill:
Goodwill reflects the excess of the purchase price of subsidiaries
acquired over the fair value of net assets acquired. Until December 31,
2001, goodwill was amortized in equal annual installments, over a period
of 10 years. In the event it was determined that goodwill was not
recoverable, its book value was written off and charged to the statement
of operations as goodwill impairment.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). SFAS 142 requires goodwill to be tested
for impairment on an annual basis and more frequently in certain
circumstances, and written down when impaired rather than being amortized
as required by previous accounting standards. Furthermore, SFAS 142
requires purchased intangible assets other than goodwill to be amortized
over their useful lives unless those lives are determined to be
indefinite.
SFAS 142 was effective for fiscal years beginning after December 15, 2001.
In accordance with SFAS 142, the Company ceased amortizing goodwill
totaling $105 million as of the beginning of 2002.
During 2002 the Company completed its transitional impairment review of
goodwill. Based on the impairment tests performed, there was no impairment
of goodwill as of January 1, 2002. The Company has selected December 31st
as the date on which it will perform its annual goodwill impairment test.
As of December 31, 2004, 2003 and 2002, no impairment was required. There
can be no assurance that future goodwill impairment tests will not result
in a charge to net income.
F-13
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
K. Software Development Costs:
Development costs of software, which is intended for sale that are
incurred after the establishment of technological feasibility of the
relevant product, and are capitalized. Technological feasibility is
determined when detailed program design is completed and verified in
accordance with the provisions of SFAS No. 86, "Accounting for the Costs
of Computer Software to Be Sold, Leased, or Otherwise Marketed" of the
FASB.
Software development costs incurred before technological feasibility has
been established are charged to the statement of income as incurred, net
of participation of the Office of the Chief Scientist of the Israeli
Ministry of Industry and Trade (the "OCS").
Amortization of capitalized software development costs begins when the
product is available for general release to customers. Annual amortization
is calculated according to the higher of the straight-line method over the
remaining useful life of the product or based on the ratio of current
gross revenues to current and anticipated future gross revenues. At
present, amortization is computed under the straight-line method, mainly
over a period of 3 years. During the year ended December 31, 2004,
consolidated subsidiaries capitalized software development costs
aggregating $15.4 million (2003 - $10.2 million, 2002 - $4.4 million) and
amortized capitalized software development costs aggregating $10.1 million
(2003 - $8.1 million, 2002 - $5.1 million).
As of December 31, 2004, the unamortized capitalization of a subsidiary's
software development costs exceeded the net realizable value of this
intangible asset in the amount of $901,000 and therefore a subsidiary
included an impairment of capitalized software development costs in the
amount of $901,000 which is presented in cost of revenues.
Management estimates that the total capitalized costs do not exceed the
net realizable value of the software product. In the event that
unamortized software development costs exceed the net realizable value of
the product, they are written down to net realizable value.
L. Other Intangible Assets:
Other intangible assets are comprised of related intangible assets of
customers and acquired technology and are amortized over their useful
lives using a method of amortization that reflects the pattern in which
the economic benefits of the intangible assets are consumed or otherwise
used up. Related intangible assets of customerand acquired technology are
amortized over a period of 8 and 5-10 years, respectively.
The Company reviews the useful life of its intangible assets annually.
F-14
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
M. Impairment in Value of Long-Lived Assets:
The Company's long-lived assets are reviewed for impairment in accordance
with Statement of Financial Accounting Standard No. 144, "Accounting for
the Impairment or Disposal of Long-lived Assets" ("SFAS No. 144"),
whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. The recoverability of assets
held and used is measured by a comparison of the carrying amount of the
assets to the future undiscounted cash flows expected to be generated by
the assets. If such assets are considered to be impaired, the impairment
to be recognized is measured by the amount by which the carrying amount of
the assets exceeds the fair value of the assets. For the years ended
December 31, 2004, 2003 and 2002, no impairment losses have been
identified.
N. Severance Pay:
The Company's liability for severance pay to its employees pursuant to
Israeli law and employment agreements is covered in part by managers'
insurance policies, for which the Company makes monthly payments. The
value of these polices is recorded as an asset in the Company's balance
sheet. The Company may only make withdrawals from the managers' insurance
policies for the purpose of paying severance pay. The severance pay
liability is calculated on the basis of one month's salary for each year
of service, based on the most recent salary of each employee.
Pursuant to Section 14 of the Severance Compensation Act, 1963 ("Section
14"), certain employees of the Company who elected to be included under
this section, are entitled only to monthly deposits, at a rate of 8.33% of
their monthly salary, made in their name with insurance companies.
Payments in accordance with Section 14 release the Company from any future
severance payments in respect of those employees. Deposits under Section
14 are not recorded as an asset in the Company's balance sheet.
The expenses in respect of severance pay for the years ended December 31,
2004, 2003 and 2002 were $5,121,000, $5,216,000 and $2,917,000,
respectively.
O. Revenue Recognition:
Revenues derived from direct software license agreements are recognized in
accordance with Statement of Position (SOP) 97-2 "Software Revenue
Recognition" (as amended by SOP 98-4 and SOP 98-9), upon delivery of the
software when collection is probable, where the license fee is otherwise
fixed or determinable, and when there is persuasive evidence that an
arrangement exists.
When a project involves significant modification of software, revenue is
generally recognized according to the percentage of completion method.
Under this method, estimated revenue is generally accrued based on costs
incurred to date as a percentage of the total updated estimated costs.
F-15
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
O. Revenue Recognition (cont.):
The arrangements, which include multiple elements, are usually
arrangements where the Company sells software products and Post Contract
Support (PCS).
In addition there are certain arrangements where the Company sells
software and consulting services. Consulting service fees are based on
time invested. For these multiple elements, SOP 97-2 requires that the
fair value of each component in a multiple element arrangement will be
determined based on the vendor's specific objective evidence (VSOE) for
that element, and revenue is allocated to each component based on its fair
value. SOP 98-9 requires that revenue be recognized under the "residual
method" when VSOE does not exist for all the delivered elements, VSOE of
fair value exists for all undelivered elements, and all other SOP 97-2
critera are met. Under the residual method, any discount in the
arrangement is allocated to the delivered elements. The specific objective
evidence for the PCS is established by the price charged on separate PCS
renewal contracts. The VSOE for the consulting services is established by
the price charged on other time based consulting service contracts where
no sale of other elements is involved, considering, among other things,
the territory where the service is performed, the size of the customer,
the quantity of the purchased services and the professional expertise of
the consultants. The revenue associated with the delivered elements is
recognized using the residual method discussed above.
The Company recognizes revenues from consulting fees with respect to
projects billed on a time and material basis, based on the number of hours
performed. In some of the agreements with the Company's customers, the
customers have the right to receive unspecified upgrades on an if-and-when
available basis (the Company does not provide specific upgrades). These
upgrades are considered PCS.
Revenue allocated to the PCS is recognized ratably over the term of the
PCS.
The Company recognizes revenues from projects as follows:
(i) Revenue from projects billed on a time and material basis is
recognized in accordance with SOP 81-1 "Accounting for Performance
of Construction - Type and Certain Production - Type Contracts",
using contract accounting on a percentage of completion method, on
the basis of the relationship between actual costs incurred and the
total costs that are expected to be incurred over the duration of
the contract. Provision is made for estimated losses and uncompleted
contracts, in the amount of the estimated losses on the entire
contract in the period in which such losses first become evident. As
of December 31, 2004, no such estimated losses were identified.
(ii) Revenue from fixed fee contracts is also recognized in accordance
with the percentage of completion method. The Company recognizes
contract losses, if any, in the period in which they first become
evident.
F-16
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
O. Revenue Recognition (cont.):
Revenues from consulting services, consisting of billable hours for
services provided, are recognized as the services are rendered. Revenues
from maintenance and training contracts are recognized relatively over the
contract period. Revenues from sale of hardware are recognized when the
merchandise is delivered to the customer, provided no significant vendor
obligations remain.
Some of the Company's contracts include client acceptance clauses. In
these contracts, the Company follows the guidance of TPA 5100.67 and SAB
104. In determining whether revenue can be recognized, when an acceptance
clause exists, the Company considers, among other things, its history with
similar arrangements, the customer's involvement in the progress, and the
existence of other service providers and the payment terms.
There are no rights of return, price protection or similar contingencies
in the Company's contracts. Revenues from sales of hardware are recognized
when the merchandise is delivered to the customer, provided no significant
vendor obligations remains.
Management believes that the Company's revenue recognition policies are in
accordance with the Securities and Exchange Commission Staff Accounting
Bulletin No. 101 and SAB 104, "Revenue Recognition in Financial
Statements".
P. Government Grants:
Royalty-bearing grants from the Government of Israel for the funding of
research and development projects are recognized at the time that the
Company is entitled to such grants on the basis of the related costs
incurred, and are recorded as a deduction from research and development
costs.
The Company also received non-royalty-bearing grants from the Fund for the
Encouragement of Marketing Activity. These grants are recognized at the
time the Company is entitled to such grants, on the basis of the costs
incurred, and included as a deduction from selling, marketing, general and
administrative expenses.
Q. Provision for Warranty:
In light of the past experience, Formula and the majority of its
subsidiaries do not record any provision for warranties in respect of
their products and services.
R. Advertising Costs:
The Company records advertising expenses as incurred.
F-17
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
S. Gain on Realization of Shareholdings:
Gain on realization of shareholdings includes the results of realization
of the Company's shareholdings in investees arising either on the sale of
such shareholdings or from the issuance of stock by the investees to third
parties, which is recognized in accordance with the provisions of Staff
Accounting Bulletin (SAB) No. 51 issued by the Securities and Exchange
Commission. The Company charges to the statement of operations such
results, provided that the conditions stipulated by SAB 51 for such
recognition have been met.
T. Deferred Income Taxes:
Formula and its subsidiaries account for income taxes in accordance with
Statement of Financial Accounting Standard No. 109, "Accounting for Income
Taxes" ("SFAS No. 109"). This Statement prescribes the use of the
liability method whereby deferred tax assets and liability account
balances are determined based on the differences between the financial
reporting and tax bases 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. Formula and its subsidiaries provide a valuation
allowance, where necessary, in order to reduce deferred tax assets to an
amount that is more likely than not to be realized.
U. Earnings (Loss) Per Share:
Earnings (loss) per share ("EPS") are calculated in accordance with the
provisions of SFAS No. 128 of the FASB ("SFAS 128"). SFAS 128, "Earnings
per Share" requires the presentation of both basic and diluted EPS.
Basic net earnings (loss) per share are calculated on the basis of the
weighted average number of common shares outstanding during each year. The
diluted earnings (loss) per share are calculated on the basis of the
weighted average number of common shares outstanding during each year,
plus the dilutive potential common shares considered outstanding during
the year.
V. Treasury Shares Held by the Company:
Shares of the Company that are held by the Company (treasury shares) are
presented as a reduction of shareholders' equity, at their cost to the
Company. Gains and losses upon the sale of these shares, net of related
income taxes, are carried to additional paid-in capital and to retained
earnings, respectively.
F-18
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
W. Concentration of Credit Risks - Allowance for Doubtful Accounts:
Most of the Group's cash and cash equivalents and short-term investments
as of December 31, 2004 and 2003 were deposited with Israeli, U.S. and
European banks. The Company is of the opinion that the credit risk in
respect of these balances is remote.
Most of the Group's sales are made in Israel, North America and Europe, to
a large number of customers.
The Group's trade receivables are derived from sales to large, solid
organizations located mainly in Europe, North America and Israel. The
Group performs ongoing credit evaluations of its customers and has
established an allowance for doubtful accounts based upon factors relating
to the credit risk of specific customers and other information. In certain
circumstances, the Company may require letters of credit, other collateral
or additional guarantees. From time to time, the Company sells certain of
its accounts receivable to financial institutions, within the normal
course of business. Where receivables are sold without recourse to the
Company, the relevant receivable is de-recognized and cash recorded. Where
receivables are sold with full or partial recourse to the Company, the
receivable is not de-recognized and a liability reflecting the obligation
to the financial institution is recorded within financial debts until the
Company's liability is discharged through the financial institution
receiving payment from the customer.
Formula and its subsidiaries had no off-balance-sheet concentration of
credit risk such as foreign exchange contracts, options contracts or other
foreign hedging arrangements as of December 31, 2004.
The provision for doubtful accounts charged to general and administrative
expenses amounted to $1.2 million, $14,000 and $2.8 million in the years
2004, 2003 and 2002, respectively, and was determined for specific debts
where doubt existed as to their collectability.
X. Options Granted to Employees:
The Company accounts for its Employee Stock Option Plans using the
treatment prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and FASB issued
Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation" ("FIN 44"). Under APB 25, the cost of compensation for
employee stock option plans is measured using the intrinsic value based
method of accounting.
F-19
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
X. Options Granted to Employees (cont.):
In October 1995, the FASB issued Statement No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"). This Statement, effective as of
the 1997 financial statements, established a fair value based method of
accounting for employee stock options or similar equity instruments, and
encourages the adoption of that method for stock compensation plans. SFAS
148 "Accounting for Stock Based Compensation" amended SFAS 123 to provide
alternative methods of transition for a voluntary change to the fair value
based method of accounting for such plans.
However, it also allows companies to account for those plans, with respect
to options granted to employees, using the accounting treatment prescribed
by APB 25.
The Company has elected to account for share option plans according to APB
25 and FIN 44 and has accordingly complied with the disclosure
requirements set forth in SFAS 123 for companies electing to apply APB 25.
Compensation costs in respect of such plans in the net amounts of $65,000,
$193,000 and $239,000, respectively, were charged to income in 2004, 2003
and 2002. Had the compensation costs in respect of the Company's plans
been determined based on the fair value at the grant date, consistent with
the method of SFAS 123 as amended by SFAS 148, the Company's net income
and earnings per share would have been decreased to the pro-forma amounts
indicated below:
Year Ended December 31
---------------------------------------------
2004 2003 2002
------- -------- --------
(U.S. $ in thousands except per share amounts)
--------------------------------------------
Net income (loss), as reported 8,099 3,120 (2,406)
Add: Stock-based employee compensation expenses
included in reported net income, net of related tax
effects 65 193 239
Less: Total stock-based employee compensation
expenses determined under the fair value based
method for all awards, net of related tax effects (1,615) (1,832) (1,421)
------ ------ --------
Pro-forma net income (loss) 6,549 1,481 (3,588)
====== ====== ========
Earnings (loss) per share:
Basic - as reported 0.73 0.29 (0.24)
====== ====== ========
Basic - pro forma 0.58 0.12 (0.35)
====== ====== ========
Diluted - as reported 0.65 0.24 (0.24)
====== ====== ========
Diluted - pro forma 0.51 0.09 (0.35)
====== ====== ========
F-20
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
Y. Derivatives and Hedging:
The Company accounts for derivatives and hedging based on Financial
Accounting Standards Board Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities" as amended ("SFAS No. 133"). SFAS 133
requires companies to recognize all of its derivative instruments on the
balance sheet at fair value. The accounting for changes in the fair value
of a derivative instrument depends on whether it has been designated and
qualifies as part of a hedging relationship and further, on the type of
hedging relationship.
Some subsidiaries enter into forward exchange contracts to hedge certain
transactions denominated in foreign currencies. The purpose of Company's
foreign currency hedging activities is to protect the subsidiaries from
risk that the eventual dollar cash flow from international activities will
be adversely affected by changes in the exchange rates. The subsidiaries'
forward contracts did not qualify as hedging instruments under SFAS No.
133. Changes in the fair value of forward contracts are reflected in the
consolidated statements of operations as financial income or expense.
Z. Fair Value of Financial Instruments:
The estimated fair value of financial instruments has been determined by
the Company using available market information and valuation
methodologies. Considerable judgment is required in estimating fair
values. Accordingly, the estimates may not be indicative of the amounts
the Company could realize in a current market exchange. The carrying
amounts of cash and cash equivalents, trade receivables, short-term bank
credit and trade payables approximate their fair values due to the
short-term maturity of such instruments. The fair value for marketable
securities is based on quoted market prices and do not significantly
differ from a carrying amount.
F-21
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
Z. Fair Value of Financial Instruments (cont.):
The carrying amounts of the Company's long-term borrowing arrangements
approximate their fair value. Fair values were estimated using discounted
cash flow analyses, based on prevailing market borrowing rates.
The fair value of the debentures with a carrying value in the amount of
$50,107,000 as of December 31, 2004 according to the quoted price in
the TASE is $53,370,000. The fair value of the traded warrants does
not significantly differ from their carrying amount.
AA. Reclassification:
Certain comparative figures for previous years have been reclassified to
conform to the presentation of the current year.
AB. Recently Issued Accounting Pronouncement:
In December 2004, the Financial Accounting Standards Board ("FASB") issued
FASB Statement No. 123 (revised 2004), "Share-Based Payment", ("SFAS
123(R)") which is a revision of FASB Statement No. 123, "Accounting for
Stock-Based Compensation" (SFAS 123"). SFAS 123(R) supersedes APB Opinion
No. 25, "Accounting for Stock issued to Employees", and amends FASB
Statement No. 95, "Statement of Cash Flows". Generally, the approach in
SFAS 123(R) is similar to the approach described in SFAS 123. However,
SFAS 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the income statement
of operations based on their fair values. Pro forma disclosure is no
longer an alternative.
SFAS 123(R) permits public companies to adopt its requirements using one
of two methods:
1. A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the
requirements of SFAS 123(R) for all share-based payments granted
after the effective date and (b) based on the requirements of SFAS
123 for all awards granted to employees prior to the effective date
of SFAS 123(R) that remain unvested on the effective date.
2. A "modified retrospective" method which includes the requirements of
the modified prospective method described above, but also permits
entities to restate based on the amounts previously recognized under
SFAS 123 for purposes of pro forma disclosures either (a) all prior
periods presented or (b) prior interim periods of the year of
adoption.
F-22
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
AB. Recently Issued Accounting Pronouncement (cont.):
In April 2005, the Securities and Exchange Commission postponed the
required adoption date of SFAS 123(R) from no later than July 1, 2005 to
no later than January 1, 2006. Early adoption will be permitted in periods
in which financial statements have not yet been issued. The Company
expects to adopt SFAS 123(R) on January 1, 2006. The Company plans to
adopt SFAS 123(R) using the modified-prospective method.
In December 2004, the FASB issued SFAS No. 153, "Exchange of Non-monetary
Assets - An Amendment of APB Opinion No. 29, Accounting for Non-monetary
Transactions." ("SFAS No. 153"). SFAS No. 153 eliminates the exception
from fair value measurement for non-monetary exchange of similar
productive assets in paragraph 21(b) of APB Opinion No. 29, "Accounting
for non-monetary Transactions," and replaces it with an exception for
exchanges that do not have commercial substance. SFAS No. 153 specifies
that a Non-monetary exchange has commercial substance if the future cash
flows of the entity are expected to change significantly as a result of
the exchange. SFAS No. 153 is effective for the fiscal periods beginning
after June 15, 2005. The adoption of SFAS No. 153 is not expected to have
a material impact on the Company financial statements or its results of
operations.
In March 2004, the FASB approved the consensus reached on the Emerging
Issue Task Force (EITF) Issue No. 03-1. "The meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments." The issue's objective is to provide guidance for identifying
other-than-temporarily impaired investments. EITF 03-1 also provides new
disclosure requirements for investments that are deemed to be temporarily
impaired. In September 2004, the FASB issued a FASB Staff Position (FSP)
EITF 03-1-1 that delays the effective date of the measurement and
recognition guidance in EITF 03-1 until further notice. The disclosure
requirements of EITF 03-1 are effective with this annual report for fiscal
2004. Once the FASB reaches a final decision on the measurement and
recognition provisions, the Company will evaluate the impact of the
adoption of the accounting provisions of EITF 03-1.
In November 2004, the FASB issued FAS No. 151, "Inventory Costs - an
amendment of ARB 43, Chapter 4", ("FAS 151"). This statement amends the
guidance in ARB No. 32, Chapter 4, "Inventory Pricing", to clarify the
accounting for abnormal amounts of idle facility expense, freight,
handling costs, and wasted material. This statement requires that those
items be recognized as current-period charges, In addition, this Statement
requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities.
This statement will be effective for inventory costs incurred during
fiscal years beginning after June 15, 2005 (January 1, 2006 for the
Company). Earlier application of FAS 151 is permitted. The provisions of
this statement shall be applied prospectively. The Company does not expect
this statement to have a material effect on the Company's financial
statements or its results of operations.
F-23
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies (cont.):
AB. Recently Issued Accounting Pronouncement (cont.):
In July 2004, the FASB issued EITF Issue No. 02-14, "Whether an Investor
Should Apply the Equity Method of Accounting to Investments Other Than
Common Stock." EITF Issue No. 02-14 addresses whether the equity method of
accounting applies when an investor does not have an investment in voting
common stock of an investee but exercises significant influence through
other means. EITF Issue No. 02-14 states that an investor should only
apply the equity method of accounting when it has investments in either
common stock or in substance common stock of the investee, provided that
the investor has the ability to exercise significant influence over the
operating and financial policies of the investee. The provisions in EITF
Issue No. 02-14 are effective for reporting periods beginning after
September 15, 2004 (October 1, 2004 for the Company). The adoption of EITF
02-14 by the Company did not have any effect on the Company's financial
statements or its results of operations.
Note 2 - Certain Transactions:
A. In August 2001, Formula entered into an agreement with Matrix, formerly
Romtec Electronics Ltd. and its former controlling shareholders. According
to the agreement, Matrix allotted to Formula 23,788,151 ordinary shares of
Matrix, representing 85% of Matrix's outstanding share capital, in
consideration for 13,045,870 ordinary shares of ForSoft. It was agreed,
inter-alia, that at the date of the closing of the transaction, Matrix's
shareholders' equity will be $8,000,000 consisting of liquid assets,
and that Matrix will be devoid of any activity and/or assets, except for
those mentioned above.
In connection with this transaction, Formula agreed to guarantee a loan
in the amount of $8.34 million extended by a commercial bank to the
principal shareholders of Matrix. In addition, the borrowers pledged to
the bank the shares they hold in Matrix. During the three-year loan
period, the borrowers are prohibited from selling Matrix's shares to their
affiliated parties. Formula undertook to pay to the bank at the
termination of the loan period, the difference, if any, between the loan
amount and the sale proceeds of the pledged Matrix shares. An unrealized
gain in the amount of $3,078,000 was created and it was realized at
the earlier of a decrease in Formula's guarantee or the end of 3 years
from the time of the transaction.
In December 2004, the bank released Formula of the above guarantee, and
Formula recognized the unrealized gain.
F-24
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Certain Transactions (cont.):
B. In November 2001, Formula Vision exercised the option granted by Formula
in July 2001, to acquire the entire interest held by Formula in privately
held companies. Under this transaction, Formula transferred to Formula
Vision its entire interest, including related obligations, in the
following companies: 51% interest in F.I.S. Software Ltd., 78.0% interest
in Formula Retail Solutions Ltd., 50.1% interest in F.T.S. - Formula
Telecom Solutions Ltd., 72.0% interest in N.I.P. Nikuv International
Projects Ltd., 36.0% interest in Enformia Software Ltd., 1.0% interest in
Babylon Ltd., 0.85% interest in Demantra Ltd., 100.0% interest in Forsoft
Export (1999) Ltd., 80.3% interest in Airport Systems Technologies Ltd.,
68.0% interest in Transtech, 50.0% interest in ESI, 34.0% interest in
GeoSim System Ltd., 100.0% interest in Shandol, its interest in the first
and second venture capital funds, Formula Ventures and its 100.0% interest
in the funds' management company and in Formula Ventures Ltd.
The aggregate consideration paid by Formula Vision was $58.9 million,
reflecting the book value of the transferred companies as of June 30,
2001, plus amounts invested by Formula prior to the closing of the
transaction.
Under the terms of the agreement with Formula Vision, Formula Vision
issued to Formula, in December 2001, a series of debentures of $58.9
million in the aggregate, linked to the Israeli Consumer Price Index
("CPI") and bearing an interest at an annual rate of 5%. Formula Vision is
required to repay the debentures in five annual installments, subject to
adjustments, based on the income of Formula Vision during each of the five
years. The payments on account of the debentures plus linkage differences
will be no less than 30% and no more than 70% of the income arising from
the sale of the transferred companies in any calendar year.
"Income" for these purposes is defined as the amounts received by Formula
Vision, if any, in consideration for a sale of any of the transferred
companies in any given calendar year, less selling expenses, as well as
amounts received by Formula Vision from distributions to be made by any of
the transferred companies in any given calendar year. Payments to be made
on account of the debentures, in any given calendar year, shall be no less
than 20% of the annual profit as recorded in the financial statements of
Formula Vision. Any amounts which remain outstanding will be payable at
the end of the 5-year period. In connection with this transaction, Formula
lent to Formula Vision on March 31, 2002 an additional $19.4 million and
Formula Vision issued to Formula an additional series of debentures in
that amount, with similar terms to the debentures issued in December 2001.
F-25
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Certain Transactions (cont.):
B. (cont.):
During 2002, Formula Vision repaid $2.9 million as principal and $8.1
million as interest and linkage differences on the debentures.
During 2003, Formula Vision repaid $0.3 million as principal and $2.5
million as interest and linkage differences on the debentures.
In the event that during the term of the indebtedness, Formula Vision
issues to a third party convertible debentures, Formula is entitled to
convert the indebtedness into the same class of convertible debentures,
having the same terms as the convertible debentures issued to the third
party.
As part of the agreement between Formula and Formula Vision, Formula
transferred to Formula Vision its rights and obligations with respect to
the transferred companies under its agreement with each of Shamrock, FIMI
and IDB. If either of Shamrock, FIMI or IDB exercises the option to
exchange the securities in the transferred companies for Formula's shares
and to the extent exercised, Formula Vision assumed all the rights and
undertakings in connection with the exercise of the option.
In January 2004, Formula exchanged approximately $35 million of the
aggregate amount of the debentures for 38,000,000 shares of Formula Vision
issued to Formula and constituting 59.4% of the outstanding share capital
of Formula Vision. The price per share was NIS 4.11 ($0.93) which reflects
the average closing price of Formula Vision's shares on the TASE during
the 30 days preceding Formula's resolution approving the transaction,
which was relative closed to the average of the market price.
All unrealized gains which were resulted out of the original transaction
in 2001, were eliminated during the 2004 transaction.
Formula Vision is a managing and holding company, guiding a group of
privately held IT companies with innovative, proprietary technologies and
solutions targeting international markets. Formula Vision holds a
controlling interest in some of these privately held companies and a
minority interest in the other members of the group.
The results of operations of Formula Vision are included in the results of
operations of the Company for all of 2004.
F-26
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Certain Transactions (cont.):
B. (cont.):
Following are the amounts assigned to major components of 2004
acquisitions balance sheets in the aggregate as of the date of purchase
(in thousands):
(U.S. $ in
thousands)
----------
Current assets 35,883
Investment and other assets 30,666
Property and Equipment 3,893
-------
Total tangible assets acquired 70,442
Goodwill 57,144
Customer related intangible asset (1) 967
Technology (2) 5,579
-------
Total tangible and intangible assets acquired 134,132
Current liabilities 29,523
Debenture 45,336
Other long term liabilities 13,888
-------
Total liabilities 88,747
Minority interest 9,131
-------
Net assets acquired 36,254
=======
(1) The value assigned to customer related intangibles is being
amortized over 8 years.
(2) The value assigned to technology is being amortized over 5-10 years.
F-27
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Certain Transactions (cont.):
B. (cont.):
The following unaudited pro forma summary presents information as if the
acquisitions had occurred as of January 1, 2003. The pro forma
information, which is provided for informational purposes only, is based
on historical information and does not necessarily reflect the results
that would have occurred, nor is it necessarily indicative of future
results of operations of the consolidated entity. None of the goodwill is
tax deductible. All goodwill was allocated to the proprietary software
products segment.
Year ended
----------------------
December 31, 2003
(U.S.$ in thousands,
except per share data)
(unaudited)
Revenues 378,873
Net loss (4,763)
Loss per share - basic (1.54)
Loss per share - diluted (1.57)
C. On May 30, 2002, Formula consummated a public offering in Israel of $14.8
million of debentures. Options to purchase an aggregate of 2,000,000
ordinary shares of Formula were attached to the debentures. The proceeds
from the public offering were $14.9 million of which $13.8 million were
allocated to the debentures and $1.1 million were allocated to the
options. The allocation was made on the basis of the average market price
of the options in the first 3 trading days.
The debentures are repayable in a lump sum in three years, but can be
redeemed earlier by the holders at a predetermined redemption price. The
nominal interest rate for each year of the three-years is approximately
5.77%, payable only after 3 years. Principal and interest on the
debentures are linked to the CPI. In June 2003, Formula repurchased $2.4
million aggregate principal amount of the debenture, leaving $14.50
million aggregate principal amount of debentures outstanding.
The associated options were for a term of one year and were exercisable at
a price of $15.8 per ordinary share. The exercise price of the options was
also linked to the CPI. The options expired on May 30, 2003.(see Note
19(3))
D. On July 30, 2002, Matrix consummated a public offering in Israel of $21
million debentures linked to the CPI and bearing interest at an annual
rate of 4.95%, to be repaid on August 5, 2005. The debentures are
convertible into ordinary shares of Matrix at any time until July 17,
2005. Matrix received a request for 96,194 packages in the aggregate
amount of $19.6 million of which 30,000 packages were requested by Matrix
I.T. Systems Ltd. (a subsidiary of Matrix).
Options to purchase an aggregate of 10,000,000 ordinary shares of Matrix,
were attached to the debentures.
F-28
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Certain Transactions (cont.):
D. (cont.):
The associated options have a term of 3 years and are exercisable at a
price of $1.69 (linked to the CPI) per Matrix ordinary share.
The proceeds from the public offering were $13.4 million, of which $12.3
million were allocated to the debentures and $1.1 million were allocated
to the options. The allocation was done on the basis of the average market
price of the option in the first 3 trading days.
The debentures were issued at a discount, which is being amortized over
the life of the debentures. During 2003, Matrix IT Systems Ltd. sold all
of Matrix's convertible debentures held by it for an aggregate
consideration of $4.5 million.
E. In December 2003, Sapiens completed an offering of securities in Israel,
resulting in gross proceeds to Sapiens of approximately $17.1 million. In
this offering, Sapiens sold 100,000 units of securities, each unit
consisting of 800 unsecured convertible debentures (Series A), two options
(Series A) exercisable into debentures (Series A) and six warrants (Series
1) exercisable into common shares of Sapiens. The debentures are linked to
the dollar and bear interest at an annual rate of 6%. The debentures are
convertible into Sapiens common shares until November 21, 2009. Each NIS
27 (currently approximately $5.90) amount of debentures may be converted
into one common share of Sapiens, subject to adjustments. Each warrant
(Series 1) is exercisable into one common share of Sapiens at an exercise
price of approximately $6.14. The warrants are exercisable until November
21, 2007.
F. In April 2000, Sapiens completed a private placement of 600,000 shares of
Common stock ("investors' shares") in its wholly owned subsidiary,
eZoneXchange.com, Inc. ("eZoneXchange"), for $15 million. The investors
also received a warrant to purchase an additional 2.25% of the Common
Stock of eZoneXchange at the same private placement share price of $25 per
share. As part of the transaction, the subsidiary entered into a Put/Call
Agreement pursuant to which the investors were granted the right
(exercisable in whole or in part) to cause the subsidiary during the put
option exercise period (May 4, 2004 through May 3, 2005) to repurchase the
investors' shares at the principal amount of the investors' investment
plus 5% annual interest accrued thereon from May 4, 2000.
F-29
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Certain Transactions (cont.):
F. (cont.):
The Put/Call Agreement provides that 50% of the consideration from the
investors' shares will be paid in cash and 50% in the Subsidiary's Common
shares to be valued according to the average closing market price of the
Subsidiary's Common share over the 14-day trading period preceding the
date of issuance of the put consideration. The agreement also included a
call option which grants the subsidiary the option to purchase the
investors' shares at a price of $30 in the first two years after the
investment date, $37.5 in the third year, and $45 in the fourth year. The
purchase price will be multiplied by the percentage of shares purchased.
The exercise period will last until the earlier of the fifth anniversary
of the investment date, an acquisition of eZoneXchange, or an IPO by
eZoneXchange.
During February 2001, the subsidiary decided to close the operations of
eZoneXchange, and repurchased 173,100 of the investors' shares with a cash
repayment of $4.5 million for principal and interest, according to an
amendment to the Put/Call Agreement. As a result, the amount of the
principal portion of the redeemable shares in a subsidiary to be repaid in
cash was decreased by $4.2 million, net of expenses.
In addition, in accordance with the amendment, if the market price of the
subsidiary Common share reaches $10 per share, the investors will have the
right to put 192,333 shares of its eZoneXchange stocks in return for the
subsidiary's 363,776 Common shares at a price of $13.75 per share. No
interest is accrued for the amended portion of the investment. The
remaining portion of the investment to be repaid in shares (approximately
$2.5 million) will continue to be subject to the original terms of the
Put/Call Agreement. The amendment terminated the subsidiary's call option.
As of March 16, 2004, the balance of the Redeemable Shares in eZoneXchange
totaled approximately $11.6 million, including interest accrued through
that date.
On March 16, 2004, the subsidiary and the investors signed an agreement
according to which, among other terms specified in the agreement, the
subsidiary would redeem the remaining eZoneXchange Common shares and
eZoneXchange warrants held by the investors by three means:
a. Issuance of shares: a subsidiary issued to the investors an
aggregate of 750,000 of the subsidiary's Common shares on March 26,
2004.
In addition, the investors were granted a right to demand the
registration of the shares, such right to be effective no earlier
than March 31, 2005. The Common shares issued were valued at
approximately $2.7 million, based on the subsidiary's stock market
price on the date of issuance (March 26, 2004).
F-30
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Certain Transactions (cont.):
F. (cont.):
b. Loan payable: the subsidiary agreed to pay an amount of $8.6 million
to the investors, bearing annual interest of 7.5% compounded
annually on the outstanding principal from January 1, 2004 to be
paid semi-annually, with principal payments of $4.6 million by no
later than May 1, 2004, and $4.0 million by no later than May 1,
2005. The May 1, 2004 payment was made by the subsidiary on
schedule.
The 7.5% interest rate is considered the market interest rate for
debt with similar risk, and accordingly, the fair value of the loan
payable was determined to be its carrying value.
c. Warrants: the subsidiary issued to the investors warrants to
purchase 350,000 shares of Common Stock of the subsidiary at an
exercise price of $4.00 per common share of the subsidiary,
exercisable at any time and from time to time during the period from
issuance to December 31, 2007.
The warrants were valued at $560,000 using the Black-Scholes pricing
model with the following assumptions: exercise price $4, fair value
of the underlying shares $3.65, interest rate 2.5%, dividend yield -
0% and volatility of 60%.
The difference between the fair value of the new debt, equal to
$11,868,000, and the carrying amount of the liability before the
modification of $11,569,000, in the amount of $299,000, was recorded
as a settlement of redeemable shares in a subsidiary and deemed to
be a dividend in the 2004 consolidated statements of operations.
Pursuant to an evaluation of the terms of the agreement under the
provisions of EITF 00-19, "Accounting for Derivative Financial
Instruments Indexed to, and potentially settled in, a Company's own
Stock", the Company has classified all of the above derivative
financial instruments issued in connection with the private
placement as liabilities.
On May 29, 2005, the subsidiary entered into an agreement with the
investors in eZoneXchange regarding the payment of the remaining $4.0
million due to the investors originally due on May 1, 2005. The subsidiary
agreed to pay $2.0 million on May 1, 2005, $1.0 million on April 1, 2006
and $1.0 million on August 1, 2006. The investors may, at their sole
discretion, convert all or any portion of the $1.0 million payable on
August 1, 2006 into the subsidiary's Common shares, at a conversion price
per each share of $3.20. In addition, the interest due on the remaining
amount was changed to Libor+2.5%. The first installment of $2.0 million
was paid as required at the beginning of May 2005.
G. In March 2004, a subsidiary, as part of a private placement, issued
convertible debentures and warrants to four institutional investors in a
total amount of approximately $5 million.
F-31
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Certain Transactions (cont.):
H. On September 23, 2004, F.V.T. and Transtech Control Ltd. ("Transtech") a
subsidiary of F.V.T, entered into an agreement with funds under which the
Funds and F.V.T. invested in Transtech $19 million (of which $14 million
were invested by Giza and Accel) for preferred shares representing 47% in
the equity of Transtech. The Funds were also granted an option to purchase
50% of their original investment for a price of 150% of the current
purchase price. The option is for 5 years. Furthermore, the Funds were
granted an option for 3 months to increase the total investment to $25
million under the above terms.
No gain or loss arose from the transaction since the preferred shares
cannot be treated as an investment in common shares (per SAB 51).
Pursuant to the transaction, F.V.T. held 36.7% of Transtech voting rights.
In February 2005, the Funds exercised their option and invested an
additional $6 million. Following the investment, F.V.T. holds 31.14% of
Transtech voting rights.
Note 3 - Short-term Investments:
A. Comprise:
Interest rate
-----------------
December 31, December 31,
---------------------------
2004 2004 2003
----------------- ---------------------------
% (U.S. $ in thousands)
----------------- ---------------------------
Trading securities - 13,556 7,773
Available-for-sale securities - 16,380 -
Short-term deposits - - 1,000
Restricted deposits 0.75-3.52 9,137 -
------- ------
Total 39,073 8,773
======= ======
F-32
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Short-term Investment (cont.):
B. The following is a summary of marketable debt securities which are
classified as available-for-sale:
December 31,
---------------------------------------------------------------------------------
2004 2003
------------------------------------------ ---------------------------------
(U.S. $ in thousands)
---------------------------------------------------------------------------------
Unrealized
Amortized Unrealized Market Amortized gains Market
cost gains (losses) value costs (losses) value
--------- -------------- ------ --------- ---------- ------
Available-for-sale:
Government
debentures 3,513 (11) 3,502 -- -- --
Commercial
debentures 11,960 (103) 11,857 -- -- --
Equity funds 980 41 1,021 -- -- --
------ ------ ------ ------ ------ ------
Total
available-for-sale
marketable
securities 16,453 (73) 16,380 -- -- --
====== ====== ====== ====== ====== ======
During 2004, the Company recorded proceeds from sales of marketable
securities in the amount of $3,130,000 and related gains of $11,000 in
financial income, net. Since the Company has the ability and intent to
hold these investments until a recovery of fair value, the Company does
not consider these investments to be other than temporarily impaired as of
December 31, 2004. In addition, these securities have been in a continuous
unrealized losses position for a period not more than 12 months.
The estimated fair value of available-for-sale investments as of December
31, 2004, by contractual maturity, are as follows:
December 31,
---------------------------------------------------
2004 2003
---------------------------------------------------
(U.S. $ in thousands)
---------------------------------------------------
Market Amortized Market
Cost value costs value
--------- -------- ----------- ---------
Available-for-sale:
Matures in one year 980 1,021 - -
Matures in one to five years 9,835 9,684 - -
Matures in more than five years 5,638 5,675 - -
------ ------ ------ ------
16,453 16,380 - -
====== ====== ====== ======
F-33
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4 - Loans and Other Investments:
Comprise:
December 31,
--------------------------
Interest rate Linkage 2004 2003
---------------- -------------- ----------
% basis (U.S. $ in thousands)
---------------- ------------ --------------------------
Cost of shares (1) 1,788 *1,760
------ ------
Long-term prepaid expenses 640 1,082
------ ------
Restricted deposit - Dollar 1,532 -
Deposit - Dollar 55 -
Deposit - CPI 348 250
Deposit 0-3 Yen 378 -
Loan (2) - CPI 506 -
------ ------
2,819 250
------ ------
Total 5,247 3,092
====== ======
(1) During 2004 and 2003 impairment losses on cost investments have been
identified in the amounts of $93,000 and $862,000 respectively.
(2) No repayment date has been set.
F-34
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 5 - Investments in Affiliates:
A. The Investments are composed and presented as follows:
December 31,
--------------------------
2004 2003
--------- ---------
(U.S. $ in thousands)
--------------------------
Investment in shares:
Cost 28,188 6,503
Goodwill and allocated original excess cost *** (12,174) (272)
------- -------
Net asset value as of acquisition date 16,014 6,231
Equity in post-acquisition undistributed retained losses, net (4,159) (5,982)
------- -------
Net asset value as of the balance sheet date 11,855 249
Balance of goodwill 12,297 --
------- -------
24,152 249
======= =======
Loans to affiliates:
Index-linked and interest-free * 117 196
Linked to the dollar and bearing annual interest of 3.71%* 120 --
Linked to the dollar and interest-free, repayment on January 2007 -- 400
Linked to the dollar and interest-free** -- 761
Linked to the dollar and bearing annual interest of LIBOR + 1%,
repayment on February 2007 -- 1,767
------- -------
Total 24,389 3,373
======= =======
* No repayment date has been set
** 3 equal installments beginning May 2006 or when the current ratio of the
affiliates exceeds 1.25.
*** As from January 1, 2002, the investment is being tested for impairment on
an annual basis rather than amortizing the goodwill as required by
previous accounting standards (see Note 1H).
B. Following are details relating to the financial position and results of
operations of investees in the aggregate:
December 31,
-----------------------------
2004 2003
-------------- -------------
(U.S. $ in thousands)
-----------------------------
Total assets 92,849 17,105
======= =======
Total liabilities (31,984) (13,319)
======= =======
Net income (loss) (7,784) (1,858)
======= =======
F-35
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 6 - Property and Equipment:
Comprise:
December 31,
-----------------------
2004 2003
--------- --------
(U.S. $ in thousands)
---------------------
Cost:
Computers and equipment 63,228 52,041
Motor vehicles 5,538 8,371
Buildings 11,614 10,078
Leasehold improvements 8,434 6,396
--------- --------
88,814 76,886
--------- --------
Accumulated Depreciation:
Computers and equipment 51,933 41,485
Motor vehicles 2,058 3,996
Buildings 2,973 2,283
Leasehold improvements 5,321 3,366
--------- --------
62,285 51,130
--------- --------
Depreciated balance 26,529 25,756
========= ========
Depreciation expense totaled $7,810,000, $7,251,000 and $7,536,000 for the
years ended December 31, 2004, 2003 and 2002, respectively. See Note 14
with respect to pledges.
Note 7 - Goodwill:
The changes in the carrying amount of goodwill for the year ended December 31,
2004 are as follows:
U.S. $ in
thousands
-----------
Balance as of January 1, 2004 142,214
Acquisition of additional interest in subsidiaries 6,357
Realization and decrease in shareholding percentage (5,598)
Acquisition of newly-consolidated subsidiaries 60,524
Realization of previously consolidated subsidiaries (7,756)
Foreign currency translation adjustments 1,180
--------
Balance as of December 31, 2004 196,921
========
F-36
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8 - Other Assets, Net:
Comprised as follows:
December 31,
---------------------
2004 2003
-------- --------
(U.S. $ in thousands)
---------------------
A. Original amounts:
Capitalized software development costs 113,135 *86,485
Deferred expenses and others 13,369 *8,764
Deferred tax asset 5,467 5,184
-------- -------
131,971 100,433
-------- -------
Accumulated amortization:
Capitalized software development costs 62,045 50,001
Deferred expenses and others 5,488 4,319
67,533 54,320
-------- -------
Total 64,438 46,113
======== =======
B. Amortized expenses totaled $11,496,000, $10,573,000 and $5,370,000 for the
years ended December 31, 2004, 2003 and 2002, respectively.
As for impairments of software development cost, see Note 1K.
C. Estimated deferred expenses and other intangible assets amortization
expenses for the years ended:
(U.S. $ in
thousands)
----------
December 31,
------------
2005 1,769
2006 1,285
2007 1,246
2008 1,119
2009 and thereafter 1,986
Note 9 - Debentures:
December 31,
--------------------------
Interest 2004 2003
---------- ----------
Linkage rate (U.S. $ in thousands)
-------------- ----------- --------------------------
Debenture (see note 2C) CPI 5.77% 15,875 14,160
Convertible debenture (see note 2D) CPI 4.95% 14,139 -
Convertible debenture Dollar 5% 2,360 1,180
Total 32,374 15,340
F-37
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 10 - Liabilities to Banks and Others:
A. Composition:
Total long-term Total long-term
Linkage Long-term Current liabilities net of liabilities net of
Interest rate basis liabilities maturities current maturities current maturities
------------- ------- ----------- ---------- ------------------ ------------------
December 31,
2004 December 31, 2004 December 31, 2003
------------- -------------------------------------------------- -------------------
% (U.S. $ in thousands) (U.S. $ in thousands)
------------- -------------------------------------------------- -------------------
3-7.5 Dollar 26,352 13,315 13,037 19,800
4.32-7.66 CPI 4,129 1,920 2,209 1,911
0-9.35 Others 6,337 2,114 4,223 189
------- ------- ------- -------
36,818 17,349 19,469 21,900
======= ======= ======= =======
Warrants 320 - 320 -
------- ------- ------- -------
Total 37,138 17,349 19,789 21,900
======= ======= ======= =======
B. Maturity Dates:
December 31,
-------------------------
2004 2003
---------- ---------
(U.S. $ in thousands)
-------------------------
First year (current maturities) 17,349 7,819
Second year 17,909 16,761
Third year 1,404 4,975
Fourth year 102 42
Fifth year 27 30
Sixth year and thereafter 347 92
------- -------
Total 37,138 29,719
======= =======
C. For details of liens and guarantees, see Note 14.
Note 11 - Debentures:
Comprised as follows:
December 31,
--------------------------
Linkage Interest rate 2004 2003
---------- ---------------- ------------- -----------
(U.S. $ in thousands)
--------------------------
Convertible debenture (see Note 2G) Dollar Six-month 5,149 -
Libor
Convertible debenture (see Note 2D) CPI 4.95% 17,363 21,221
Convertible debenture Dollar 5% 4,720 4,720
Convertible debentuere (see Note 2E) Dollar 6% 18,246 16,672
Convertible debentuere (see Note 2F) Dollar 5% - 11,505
------- -------
45,478 54,118
Deferred issuance expenses, net 1,894 1,955
------- -------
43,584 52,163
Current maturities 2,360 1,180
Current maturities (see note 2D) 14,139 -
------- -------
27,086 50,983
======= =======
F-38
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 - Employee Option Plans in Subsidiaries:
Certain subsidiaries granted options to their employees to purchase shares in
the respective companies. The options were mainly granted in the years
1999-2003. In general, the options are exercisable 2-3 years after the date of
grant and expire 7-10 years after grant. Most of the options were granted as
part of plans that were adopted in accordance with the provisions of Section 102
of the Israeli Income Tax Ordinance, which stipulate, inter alia, that the
subsidiaries will be able to claim the benefit that was charged to the employees
as an expense for tax purposes, if and when the employees become liable for tax
on the said benefit. For further information with respect to expenses relating
to the benefit to the employees, and additional disclosure required by FAS 123,
see Note 1X.
A. The following is a summary of the status of options plans in BluePhoenix
as of December 31, 2004, 2003 and 2002 and changes during the years then
ended:
Year ended Year ended Year ended
December 31, 2004 December 31, 2003 December 31, 2002
---------------------------- ---------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
options Price options Price options Price
------------- -------------- ------------- -------------- ------------- ------------
$ $ $
-------------- -------------- ------------
Options outstanding at 2,159,993 4.99 1,347,260 6.56 1,193,650 7.55
the beginning of the
year
Changes during the year:
Granted 163,721 6.00 923,000 3.03 353,560 3.00
Exercised (33,767) 3.56 (35,267) 2.33 (90,000) 3.57
Forfeited (157,360) 6.29 (75,000) 9.46 (109,950) 8.9
--------- ---------- ----------
Options
outstanding
at the end of
the year 2,132,587 5.00 2,159,993 4.99 1,347,260 6.56
========== ========== ==========
Options exercisable at
year-end 877,049 6.08 1,233,575 6.04 888,333 7.63
========== ========== ==========
Weighted-average fair
value of options granted
during the year* 1.71 0.54 1.09
====== ===== =====
* The fair value of each option that was granted is estimated on the
date of grant, using the Black-Scholes option-pricing model with the
following weighted average assumptions: dividend yield of 0% for all
years; expected volatility: 2004 - 26%, 2003 - 28%, 2002 - 33%,
risk-free interest rate 2004 - 2.78%, 2003 - 2.1%, 2002 - 3.1% and
expected life: 2004, 2003 and 2002 -3 years.
F-39
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 - Employee Option Plans in Subsidiaries (cont.):
A. (cont.):
The following table summarizes information in respect of outstanding
options as of December 31, 2004.
Options Outstanding Options Exercisable
------------------------------------------------------------ ------------------------------------
Number Number
Range of Outstanding at Weighted Average Exercisable at
Exercise December 31, Remaining Weighted Average December 31, Weighted Average
Prices 2004 Contractual Life Exercise Price 2004 Exercise Price
--------------- --------------- --------------------- --------------------- ---------------- ------------------
$ Years $ $
--------------- --------------------- --------------------- ------------------
2.25 416,000 8.25 2.25 41,000 2.25
3.00 116,000 8.50 3.00 36,000 3.00
3.00 183,250 7.50 3.00 122,167 3.00
3.00 80,000 7.09 3.00 53,333 3.00
3.50 70,000 8.50 3.50 - 3.50
3.50 20,500 8.75 3.50 - 3.50
4.00 200,000 8.83 4.00 83,333 4.00
4.50 39,483 6.50 4.50 39,483 4.50
4.50 10,000 8.25 4.50 10,000 4.50
5.20 139,500 1.75 5.20 139,500 5.20
5.50 13,000 5.83 5.50 13,000 5.50
6.00 28,000 9.00 6.00 - 6.00
6.00 163,721 9.42 6.00 - 6.00
6.50 311,900 1.21 6.50 - 6.50
6.50 2,000 9.00 6.50 - 6.50
8.00 92,000 4.50 8.00 92,000 8.00
9.00 10,000 4.75 9.00 10,000 9.00
9.63 70,000 5.25 9.63 70,000 9.63
10.50 167,233 6.25 10.50 167,233 10.50
--------- -------
2,132,587 877,049
========= ========
B. The following table is a summary of the status of option plans in Magic as
of December 31, 2004, 2003 and 2002:
F-40
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 - Employee Option Plans in Subsidiaries (cont.):
B. (cont.):
Year ended Year ended Year ended
December 31, 2004 December 31, 2003 December 31, 2002
----------------------------- ----------------------------- ------------------------------
Weighted Weighted Weighted
Number of Average Number of Average Number of Average
Options Exercise Price Options Exercise Price Options Exercise Price
-------------- -------------- ------------- -------------- -------------- --------------
$ $ $
-------------- -------------- --------------
Options outstanding at 3,346,406 2.26 2,751,937 2.31 3,711,655 3.22
the beginning of the year
Granted 406,601 4.84 1,924,283 2.57 195,773 1.28
Exercised (973,551) 1.28 (775,284) 1.17 (55,169) 1.38
Cancelled - - - - (375,207) 8.16
Forfeited (266,219) 3.6 (554,530) 3.35 (725,115) 3.01
--------- ------ ---------- ------ --------- -----
Outstanding at the end
of the year 2,513,237 2.95 3,346,406 2.26 2,751,937 2.31
========= ====== ========== ====== ========= =====
Exercisable at the end
of the year 1,423,970 2.28 1,304,338 1.92 2,103,941 2.35
========= ====== ========== ====== ========= =====
Weighted average fair
value of options
granted during the
year * 2.2 1.28 0.67
====== ===== =====
* The fair value of each option granted is estimated on the date of
grant, using the Black-Scholes Option Valuation Model, with the
following weighted-average assumptions for each of the three years
in the period ended December 31, 2004: expected volatility of 67.3%,
66.6% and 99.6%, respectively, risk-free interest rates of 2.8%,
1.5% and 1.5% respectively, dividend yields of 0% for each year, and
a weighted average expected life of the option of four years for
each year.
The following table summarizes information regarding options outstanding
as of December 31, 2004:
Options Outstanding Options Exercisable
-------------------------------------------------- ----------------------------------
Weighted
Number Average Number
Outstanding at Remaining Weighted Exercisable at Weighted
Range of December 31, Contractual Average December 31, Average
Exercise Price 2004 Life Exercise Price 2004 Exercise Price
---------------- --------------- --------------- --------------- ----------------- --------------
$ Years $ $
---------------- --------------- --------------- --------------
0-1 313,915 7 0.86 263,812 0.84
1-2 824,090 6 1.16 706,859 1.17
2-3 15,900 5 2.45 14,567 2.42
3-4 665,213 9 3.91 234,862 3.93
4-5 484,958 9 4.12 150,209 4.13
5-6 155,500 9 5.95 - -
6-7 1,011 5 6.14 1,011 6.14
10-11 43,650 5 10.16 43,650 10.16
18-19 9,000 5 18.79 9,000 18.79
--------- ----- ------ --------- -----
2,513,237 9 2.95 1,423,970 2.28
========= ===== ====== ========= =====
F-41
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 - Employee Option Plans in Subsidiaries (cont.):
C. The following is a summary of the status of option plans in Matrix as of
December 31, 2004 and 2003 and changes during the years then ended:
Year ended Year ended
December 31, 2004 December 31, 2003
---------------------------------- -----------------------------------
Weighted Weighted
Number of Average Number of Average
options Exercise Price options Exercise Price
--------------- ----------------- ---------------- -----------------
$ $
----------------- -----------------
Options outstanding at the beginning of
the year 5,665,002 1.62 3,183,840 1.48
Changes during the year:
Granted 1,359,000 2.26 2,483,562 1.65
Exercised (890,831) 1.6 - -
Forfeited (101,791) 1.64 (2,400) 1.60
---------- ------ ---------- -----
Options outstanding at the end of the
year 6,031,380 1.8 5,665,002 1.62
========== ====== ========== =====
Options exercisable at end of year 1.65 2,995,699 1.61
====== ========== =====
3,689,752
==========
Weighted average fair value of
options granted during the year(*) 1.15 5.43
===== =====
F-42
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 - Employee Option Plans in Subsidiaries (cont.):
C. (cont.):
* The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model, with the following weighted
average assumptions used for grants: dividend yield of 0% for all the
years; expected volatility: 2004 - 31.3%, 2003 - 47.31%, 2002 - 56.7%,
risk-free interest rate (in NIS terms) of 3.5% in 2004, 5.5% in 2003 and
3.5% in 2002, and expected lives: 2004 - 9.98 years, 2003 - 7.1 years and
2002 - 7 years.
The following table summarizes information in respect of options
outstanding as of December 31, 2004:
Options Outstanding Options Exercisable
------------------------------------------------------------- -----------------------------------
Number Number
Range of Outstanding at Weighted Average Exercisable
Exercise December 31, Remaining Weighted Average at December Weighted Average
Prices 2004 Contractual Life Exercise Price 31, 2004 Exercise Price
--------------- --------------- --------------------- --------------------- -------------- ------------------
$ Years $ $
--------------- --------------------- --------------------- ------------------
1.39 509,924 5.67 1.39 475,124 1.39
1.62 3,159,456 4.56 1.62 2,295,302 1.62
1.86 1,122,000 5.67 1.86 919,326 1.86
2.32 1,240,000 9.67 2.32 - 2.32
--------- ---------
6,031,380 3,689,752
========= =========
D. The following is a summary of the status of options plans in Sapiens as of
December 31, 2004, 2003 and 2002 and changes during the years then ended:
Year ended Year ended Year ended
December 31, 2004 December 31, 2003 December 31, 2002
------------------------------- ------------------------------- -----------------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
options Price options Price options Price
---------------- -------------- --------------- -------------- --------------- ------------
$ $ $
-------------- -------------- ------------
Options outstanding at 1,558,495 10.25 **1,580,713 11.25 **1,569,698 12.50
the beginning of the
year
Changes during the year:
Granted 321,539 4.05 157,600 4.06 274,300 4.70
Exercised (5,000) 4.07 (6,820) 3.91 (55,080) 0.20
Forfeited (234,163) 10.23 (172,998) 14.05 (208,205) 15.70
--------- ---------- ---------
Options
outstanding
at the end of
the year **1,640,871 9.05 **1,558,495 10.25 **1,580,713 11.25
========== ========== =========
Options exercisable at
year-end 1,143,432 11.24 1,095,779 11.86 908,784 12.85
========= ========== =========
Weighted-average fair
value of options granted
during the year* 1.46 2.30
====== =====
F-43
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 - Employee Option Plans in Subsidiaries (cont.):
D. (cont.):
* The fair value of each option granted is estimated on the date of grant,
using the Black-Scholes option-pricing model with the following weighted
average assumptions: dividend yield of 0% for all years; expected
volatility: 2004 - 65%, 2003 - 83%, 2002 - 97%, risk-free interest rate
2004 - 3.74%, 2003 - 2%, 2002 - 2% and expected life: 2004 -2.5 years,
2003 - 3.5 years and 2002 - 6 years.
** Including 102,100, repriced to zero, as of December 31, 2002, 2003 and
2004.
The following table summarizes information in respect of options
outstanding as of December 31, 2004:
Options Outstanding Options Exercisable
------------------------------------------------------------- -----------------------------------
Number Number
Range of Outstanding at Weighted Average Exercisable
Exercise December 31, Remaining Weighted Average at December Weighted Average
Prices 2004 Contractual Life Exercise Price 31, 2004 Exercise Price
--------------- --------------- --------------------- --------------------- -------------- ------------------
$ Years $ $
--------------- --------------------- --------------------- ------------------
- 102,100 5.98 - 102,100 -
1.86-2.63 135,650 9.37 2.57 - -
3.25-3.75 188,500 7.37 3.57 120,425 3.49
4.06-5.70 863,812 6.71 4.53 570,098 4.43
11.25-16.875 153,810 0.88 11.81 153,810 11.81
19.375-29.375 48,600 5.56 28.91 48,600 28.91
32.5-47.5 110,799 4.13 37.35 110,799 37.35
61.25-69.375 37,600 5.03 67.78 37,600 67.78
---------- ------ ---------- ------
1,640,871 9.05 1,143,432 11.24
========== ===== ========== ======
F-44
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 - Employee Option Plans in Subsidiaries (cont.):
E. The following is a summary of the status of options plans in Formula
Vision as of December 31, 2004 and changes during the year then ended:
Year ended December 31, 2004
----------------------------
Weighted
Number of Average
options Exercise price
------- --------------
$
--------------
Options outstanding at beginning of the year 1,930,000 0.3
Changes during the year:
Exercised (130,500) 0.3
Forfeited (20,000) 0.3
--------- ----
Options outstanding at the end of the year 1,779,500 0.3
========= ====
Options exercisable at year-end
Weighted-average fair value of options granted during the year* -
=========
* The fair value of each option granted is estimated on the date of grant,
using the Black-Scholes option-pricing model with the following weighted
average assumptions: dividend yield of 0% for all years; expected
volatility: 2004 - 37%, risk-free interest rate: 2004 - 3.5% and expected
life: 2004 - 6.7 years.
F. The following table summarizes information in respect of options
outstanding as of December 31, 2004:
Options Outstanding Options Exercisable
------------------------------------------------------------- -----------------------------------
Number Number
Range of Outstanding at Weighted Average Exercisable
Exercise December 31, Remaining Weighted Average at December Weighted Average
Price 2004 Contractual Life Exercise Price 31, 2004 Exercise Price
--------------- --------------- --------------------- --------------------- -------------- ------------------
$ Years $ $
--------------- --------------------- --------------------- ------------------
0.3 1,779,500 4 0.3 1,779,500 0.3
========= =========
F-45
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 13 - Unrealized Gains:
The unrealized gains are composed of the following:
December 31,
--------------------------
2004 2003
------------ ----------
(U.S. $ in thousands)
--------------------------
Gain resulting from the sale of certain companies
to Formula Vision - Note 2B - 1,147
Gain resulting from a reverse acquisition
of Matrix - Note 2A - 2,975
Gain resulting from Sintec Media Ltd. - 227
Gain resulting from T-Soft - 110
------ ------
- 4,459
====== ======
Note 14 - Commitments and Contingencies:
A. Commitments:
Some of the Company's subsidiaries have commitments to the Chief Scientist
in the Ministry of Industry and Trade and to the Marketing Promotion Fund,
to pay royalties at a rate of 3%-3.5% of the proceeds from the sale of
software products which were developed with the assistance of the Chief
Scientist and marketed with the assistance of the Marketing Promotion
Fund. The amount of royalties is limited to 100%-150% of the amount
received. The subsidiaries are only obliged to repay the grants received
from the Office of the Chief Scientist if revenue is generated from the
sale of the said software products. The balance of the contingent
liability in respect of the aforesaid, amounted to approximately $11.3
million as at December 31, 2004.
B. Liens:
1. Some of the subsidiaries have liens on leased vehicles, leased
equipment and other assets in favor of the leasing companies.
2. Some of Formula's assets are pledged to banks as support for credit
facilities of approximately $43 million. These assets consist of
Formula's entire shareholdings in BluePhoenix and a portion of
Formula's shareholdings in Matrix and Magic.
3. Some of subsidiaries have given floating charges in favor of banks
and other financial institusions
C. Guarantees:
1. Subsidiaries have provided bank guarantees in the amount of
approximately $11.8 million as security for the performance of
various contracts with customers. If the subsidiaries were to breach
certain terms of
F-46
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
such contracts, the customers could demand that the banks providing
the guarantees pay amounts claimed to be due.
2. Sapiens and Formula Vision ("the guarantors") have provided
guarantees to banks in support of the credit facilities given to
their subsidiaries. In the case of Sapiens the guarantees are for
$351,000 and in the case of Formula Vision the guarantees are for
$18.65 million. Each such guarantee is provided for the term of the
credit facility, such term being generally one year. If a subsidiary
whose credit line has been guaranteed by the guarantors were to
breach certain terms of its credit agreement, the lending bank could
demand that the guarantor pay amounts claimed to be due. Liraz a
subsidiary of BluePhoenix is liable for losses of a subsidiary it
had consolidated until the second quarter of 2001. The provision for
such liability at December 31,2004 and December 31, 2003, was
accounted for under SFAS No.5 and amounted to $2 million,
representing the maximum potential amount Liraz guaranteed to secure
a bank loan of the said subsidiary.
3. Subsidiaries have provided bank guarantees in the amount of $760,000
as security for rent to be paid for their offices. If the
subsidiaries were to breach certain terms of their lease, the lessor
could demand that the banks providing the guarantees pay amount
claimed to be due.
F-47
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 14 - Commitments and Contingencies (cont.):
D. Others:
1. In connection with credit facilities the Company have entered into a
bank agreement with various banks, accordingly the Company
committed, among other things:
a. To maintain certain financial ratios.
b. Not to grant a security interest in all or substantially all
their respective assets.
c. Not to distribute dividends.
d. To repay the loans provided by the banks, if so required by
the banks, at the discretion of the banks, in the event that
Dan Goldstein or Gad Goldstein cease to serve in their current
positions in Formula.
In connection with one of the Company credit facilities, Formula
committed, among other things, not to distribute dividends. The bank
did not object to the distribution of the dividend made by Formula
in June 2005.
2. Under Israel's Stamp Tax on Documents Law, certain documents are
subject to stamp tax. Recently promulgated regulations provide for a
gradual phase-out of the stamp tax by 2008. In 2004, however, the
tax authorities began an enforcement campaign involving extensive
audits of companies' compliance with the stamp tax obligation with
respect to all agreements which had been signed since June 2003.
Formula and certain subsidiaries have received legal advice that
there are a variety of defenses relating to its obligation to pay
stamp tax or the amount to be paid. The Group's management believes
that the applicable provision in its financial statements as of
December 31, 2004 is adequate to cover probable costs arising from
this law.
3. On February 13, 2004 there were public reports that a leak of
Microsoft source code had occurred on the Internet. These reports
indicated that the source code contained trace references to a
subsidiary of a subsidiary (Mainsoft) servers and personnel.
Mainsoft's management team immediately adopted a policy of full
cooperation with local authorities, the FBI, and Microsoft in their
respective investigation. The FBI has confirmed to the Company that
its investigation was continuing as of December 31, 2004. While
Mainsoft believes its relationship with Microsoft will continue on
terms acceptable to Mainsoft, a change in the relationship could
materially adversely affect Mainsoft's business, results of
operation, and financial condition.
F-48
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 14 - Commitments and Contingencies (cont.):
E. Legal Proceedings:
In July 2003, a former Liraz Systems Ltd. Or Liraz shareholders filed an
application with the Tel Aviv Jaffa District Court to approve a claim
filed by him against BluePhoenix, as a class action. The claim relates to
the acquisition of Liraz shares, which BluePhoenix completed in March
2003. The shareholder alleges that the share price BluePhoenix 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 $5.8 million in the aggregate . In the
lawsuit, the plaintiff has applied for the court's approval to represent
all of the shareholders of Liraz who sold their shareholdings pursuant to
the tender offer and the mandatory acquisition. No hearing has been
scheduled for this lawsuit. Based on BluePhoenix's analysis of the
statement of claim, including and 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, the Company believes that the
allegations against BluePhoenix in this proceeding are without merit and
intend to vigorously defend the claim and contest the allegations made
therein.
F. Lease Commitments:
The following are details of the future minimum lease commitments under
non-cancelable operating leases as of December 31, 2004:
U.S. $ in
thousands
-------------
2005 11,976
2006 8,719
2007 6,425
2008 4,136
2009 and thereafter 4,446
-------
35,702
=======
Rent expenses for the years ended December 31, 2004, 2003 and 2002, were
approximately $10,215,000, $10,293,000 and $7,418,000, respectively.
Note 15 - Shareholders' Equity:
A. Share Capital Authorized, Issued and Outstanding:
December 31, 2004 December 31, 2003
--------------------------------------------- --------------------------------------------
Authorized Issued Outstanding Authorized Issued Outstanding
-------------- -------------- -------------- -------------- -------------- -------------
NIS NIS NIS NIS NIS NIS
-------------- -------------- -------------- -------------- -------------- -------------
Ordinary shares, NIS 1 par
value each 25,000,000 10,824,780 10,800,000 25,000,000 10,824,780 10,800,000
========== ========== ========== ========== ========== ==========
F-49
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 15 - Shareholders' Equity (cont.):
A. Share Capital Authorized, Issued and Outstanding (cont.):
1. The shares are traded on the TASE and through ADSs, each
representing one ordinary share of NIS 1 par value, quoted on the
NASDAQ National Market in the United States. The closing price of
the share on the TASE as of December 31, 2004, was NIS 73.03. The
closing price of the ADS on the NASDAQ National Market on that date
was $17.
2. On June 25, 1998, Formula completed a public offering of its shares
on the over-the-counter market in the U.S. Formula received $56
million, net, in exchange for 1,600,000 ADSs. The offering price was
$35 per share.
3. In November 1998, Formula raised approximately $3 million in a
private placement of 107,100 of Formula's shares.
4. Formula's General Meetings, in September 1999 and in August 2000,
approved the allotment of options to purchase 1,000,000 and 500,000
ordinary shares of Formula, respectively, to Shandol Ltd. (a company
transfered to Formula Vision within the framework of the the
companies transferred from the Company to Formula Vision - see Note
2B), a wholly-owned subsidiary. The 1,000,000 options were issued in
order to assure the availability of Formula's shares in the event of
a request from Shamrock to exercise their option. The 500,000
options were issued in order to assure the availability of Formula's
shares so long as the convertible options are outstanding, with no
need for additional action in the future. The exercise price of the
options is equal to Formula's share market price.
5. In November 2001, Shandol exercised options to purchase 1,000,000
shares of Formula for a consideration of $12 million.
6. In November 2001 and January 2002, Shamrock exercised its exchange
option for Formula's shares with respect to companies transferred to
Formula Vision, Transtech and Airport Intersystems. In consideration
for the shares in the said companies, Shandol transferred to
Shamrock 1,000,000 ordinary shares of Formula.
7. During 2002, Formula repurchased 324,780 of its ordinary shares in
the open market for an aggregate of $3.4 million. During 2003,
Formula sold 300,000 of its ordinary shares for an aggregate of $4.8
million.
8. In December 2003, Formula issued 500,000 ordinary shares consequent
to the exercise of options to acquire 500,000 ordinary shares. The
options were granted by Formula to Shandol on August 2000.
F-50
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 15 - Shareholders' Equity (cont.):
B. Details of Share Options Granted to Employees:
In November 2000, Formula's Board of Directors adopted an option plan
pursuant to which Formula may grant options to employees of Formula to
purchase up to a total of 300,000 ordinary shares. In accordance with this
plan, employees of Formula and its subsidiaries were granted, for no
consideration, 64,500 options, each of which may be exercised into one
ordinary share of Formula at an exercise price of $30.8 per share, linked
to the CPI. Any option not exercised within five years will expire.
The options will be exercisable as follows: In the period from the end of
one year after the grant of the options until the end of three years from
the time of grant, each grantee will be entitled to exercise one third of
the options granted to him, at the end of each year. The above mentioned
option plans comply with the provisions of Section 102 of the Israeli
Income Tax Ordinance, which provides, inter alia, that Formula will be
able to claim the benefit charged to employees for tax purposes as a
tax-deductible expense, if and when the employees become liable for tax on
such benefit.
The following is a summary of the status of Formula's option plans as of
December 31, 2004, 2003 and 2002 and for the years then ended:
Year ended Year ended Year ended
December 31, 2004 December 31, 2003 December 31, 2002
------------------------------- ------------------------------- -----------------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
options Price options Price options Price
---------------- -------------- --------------- -------------- --------------- ------------
$ $ $
-------------- -------------- ------------
Outstanding options at
the beginning of the
year 64,500 30.8 64,500 30.8 122,850 25
Changes during the
year:
Granted - - - - - -
Exercised - - - - - -
Expired and
forfeited - - - - (58,350) 18.6
------- ------- ------- ------ ------- -----
Outstanding options at
the end of the
year 64,500 30.8 64,500 30.8 64,500 30.8
======= ======= ======= ====== ======= =====
Exercisable options at
the end of the year 64,500 30.8 64,500 30.8 43,000 30.8
======= ======= ======= ====== ======= =====
Weighted avarage fair
value of options
granted during the
year - - -
====== ===== =====
F-51
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 15 - Shareholders' Equity (cont.):
B. Details of Share Options Granted to Employees (cont.):
The following table summarizes information in respect of outstanding options as
at December 31, 2004:
Options Outstanding Options Exercisable
------------------------------------------------------------- -----------------------------------
Number Number
Range of Outstanding at Weighted Average Exercisable
Exercise December 31, Remaining Weighted Average at December Weighted Average
Price 2004 Contractual Life Exercise Price 31, 2004 Exercise Price
--------------- --------------- --------------------- --------------------- -------------- ------------------
$ Years $ $
--------------- --------------------- --------------------- ------------------
30.8 64,500 0.92 30.8 64,500 30.8
====== ======
C. Dividends:
Formula has not paid any cash dividends on its ordinary shares in the
past. Subsequent to December 31,2004 the Company distributed a cash
dividend of $53 million (see Note 19A).
Note 16 - Taxes on Income:
A. Tax Laws in Israel:
1. Tax benefits under the Israeli Law for the Encouragement of Capital
Investments, 1959 (hereafter - the "Law"): Some operations of
certain subsidiaries have been granted "Approved Enterprise" status
under the Law. Since the subsidiaries have elected to receive
"alternative benefits" under the Law (i.e. waiver of grants in
exchange for a tax exemption for a limited period), the following
tax rates will apply to its income from the Approved Enterprise
(which will be determined based on the increase in the revenue of
the subsidiaries during the year, in relation to the revenue in the
year preceding the first year of their having the above-mentioned
status):
Tax exemption for 2 years, commencing in the first year it generates
taxable income. For the remainder of the benefit period - 5 years -
a reduced tax rate of 25%. For some subsidiaries, the percentage of
its share capital held by foreign shareholders has exceeded 25%.
Therefore its Approved Enterprises qualify for reduced tax rates for
an additional three years after the seven years mentioned above. The
period of tax benefits described above will terminate after 7-10
years elapse from the first year in which the subsidiaries have
taxable income and 14 years elapse since the Approved Enterprise was
granted and 12 years after the commencement of the Approved
Enterprise.
F-52
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 - Taxes on Income (cont.):
A. Tax Laws in Israel (cont.):
1. Tax benefits under the Israeli Law for the Encouragement of Capital
Investments, 1959 (hereafter - the "Law") (cont.):
The entitlement to the above benefits is subject to final
ratification by the Investment Center in the Ministry of Industry
and Trade, such ratification being conditional upon fulfillment of
all terms of the approved program.
In the event of a distribution of a cash dividend out of retained
earnings, which are tax exempt due to the above benefits, the
subsidiaries would have to pay tax with respect to the amount
distributed. Deferred taxes for such taxes were not provided because
such undistributed earnings are essentially permanent in duration
and could be distributed to shareholders tax free in liquidation,
subject to certain conditions.
The Law also provides that an Approved Enterprise is entitled to
accelerated depreciation on its property and equipment that is
included in an approved investment program.
In the event the subsidiaries fail to comply with the approved
program terms, the tax benefits may be canceled and the subsidiaries
may be required to refund the amount of the benefits they utilized,
in whole or in part, with the addition of linkage differences and
interest.
2. Measurement of results for tax purposes under the Income Tax
(Inflationary Adjustments) Law, 1985 (hereafter - the "Inflationary
Adjustments Law"):
Results for tax purposes in Israel are measured and reflected in
real terms in accordance with the change in the CPI. The
consolidated financial statements are presented in dollars. The
differences between the change in the Israeli CPI and in the
NIS/dollar exchange rate causes a difference between taxable income
or loss and the income or loss before taxes reflected in the
consolidated financial statements. In accordance with paragraph 9(f)
of SFAS No. 109, "Accounting for Income Taxes" (SFAS No. 109"), the
Company has not provided deferred income taxes on this difference
between the reporting currency and the tax bases of assets and
liabilities.
3. Tax benefits under the Law for the Encouragement of Industry
(Taxation), 1969:
Some subsidiaries currently qualifies as an "Industrial Company" as
defined by this law, and as such is entitled to certain tax benefits
including, inter alia, depreciation at increased rates as stipulated
by regulations published under the Inflationary Adjustments Law and
the right to deduct for tax purposes, over a period of 3 years,
expenses relating to public issue of shares. If realized, any tax
benefit relating to issuance expenses is credited to capital
surplus.
F-53
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 - Taxes on Income (cont.):
A. Tax Laws in Israel (cont.):
4. Tax Rates Applicable to Income from Other Sources in Israel: Income
not eligible for "Approved Enterprise" benefits mentioned in 1.
above is taxed at the regular corporate tax rate of 35% in 2004, 34%
in 2005, 32% in 2006 and 30% in 2007 and thereafter.
B. Subsidiaries Outside Israel:
Subsidiaries that are not an Israeli resident are taxed in the countries
in which they are resident, according to the tax laws in those countries.
C. Cumulative Tax Losses:
The Company have cumulative operating losses for tax purposes as of
December 31, 2004 totaling approximately $323,995 thousand, of which
$229,091,000 is in respect of Companies in Israel (December 31, 2003 -
$127,183,000), and approximately $94,904,000 in respect of Companies
abroad (December 31, 2003 - $63,796,000). The likelihood of the
utilization of most of these losses in the future is low. Therefore, no
deferred tax asset has been recorded in respect of such losses.
D. Income Tax Assessments:
Formula received final tax assessments through the tax year 2000.
E. Deferred Taxes:
1. Composition:
December 31,
-----------------------------------------
2004 2003 2002
--------- ------- --------
(U.S. $ in thousands)
-----------------------------------------
Net operating losses carried forward 98,756 85,560 71,795
Software development costs 2,329 1,080 324
Allowances and reserves 4,865 5,465 6,633
-------- -------- --------
105,950 92,105 78,752
Valuation allowance (97,690) (85,335) (76,105)
-------- -------- --------
Total 8,260 6,770 2,647
======== ======== ========
F-54
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 - Taxes on Income (cont.):
E. Deferred Taxes (cont.):
1. Composition (cont.):
Most of the valuation allowances, the Company and its subsidiaries
provided,are against the deferred tax assets in respect of its tax
losses carryforward. As a result most of the valuation allowance is
for long term. Valuation allowances relating to the acquisition of
Formula Vision totaled $22 million as of December 31, 2004. If this
valuation allowance is decreases, the reversal will reduce the
goodwill that was established in the acquisition.
As a result of Formla Vision acquisition, the Company's valuation
allowance increased by $22 million which was offset by a decrease in
Matrix valuation allowance in the amount of $9 million due to the
use of net oparating loss caryforward.
2. Presentation in balance sheets:
December 31,
----------------------------
2004 2003
-------------- ------------
(U.S. $ in thousands)
----------------------------
Stated in current assets 3,751 2,528
Stated in other assets 5,467 5,184
Stated in long term liabilities (958) (942)
------- ------
Total included in balance sheets 8,260 6,770
======= ======
F. Income (Loss) Before Taxes on Income:
Year ended December 31,
--------------------------------------
2004 2003 2002
---------- ----------- -----------
(U.S. $ in thousands)
Domestic 25,205 2,498 (178)
Foreign (7,472) 8,351 (335)
------- ------ ----
Total 17,733 10,849 (513)
======= ====== ====
F-55
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 - Taxes on Income (cont.):
G. Taxes on Income Included in Statements of Operations:
Year ended December 31,
-------------------------------------------
2004 2003 2002
------------- -------------- ------------
(U.S. $ in thousands)
-------------------------------------------
Current taxes:
In Israel 4,445 1,584 2,112
Abroad 798 924 1,221
------- ------ ------
(5,243) (2,508) (3,333)
Taxes in Israel in respect of prior years (184) (795) (954)
Deferred taxes, net (796) (827) (365)
------- ------ ------
Total
(4,631) (2,540) (2,014)
======= ====== ======
H. Theoretical Tax:
The following is a reconciliation between the theoretical tax expense,
assuming that all income was taxed at ordinary tax rates, and the actual
income tax expense, as recorded in the statement of operations:
Year ended December 31,
--------------------------------------------
2004 2003 2002
----------- ------------ ----------
(U.S. $ in thousands)
--------------------------------------------
Income (loss) before taxes on income, as per the statement
of operations 17,733 10,849 (513)
Statutory tax rate in Israel 35% 36% 36%
------ ------ ------
Theoretical tax expense (benefit) 6,207 3,906 (185)
Additional tax (tax savings) in respect of:
Non-deductible expenses 1,727 (162) 421
Tax-exempt income (mainly relating to decrease in
shareholdings) (2,677) (71) (2,117)
Tax-exempt income and reduced tax rates in companies which
have approved enterprises (461) (74) 228
Losses and temporary differences for which deferred taxes
were not recorded 66 (55) 5,083
Taxes in respect of previous years 118 (795) (954)
Effect of the Inflationary Adjustments Law (140) 41 (717)
Other (209) (250) 255
----- ------ ------
Taxes on income as per the statement of operations 4,631 2,540 2,014
===== ====== ======
Effective tax rate - in % 26.1 23.4 --
===== ====== ======
F-56
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 - Taxes on Income (cont.):
I. Tax reform:
On January 1, 2003, a comprehensive tax reform took effect in Israel.
Pursuant to the reform, resident companies are subject to Israeli tax on
income accrued or derived in Israel or abroad. In addition, the concept of
"controlled foreign corporation" was introduced, according to which an
Israeli Company may become subject to Israeli taxes on certain income of a
non-Israeli subsidiary if the subsidiary's primary source of income is
passive income (such as interest, dividends, royalties, rental income or
capital gains). The tax reform also substantially changed the system of
taxation of capital gains. The Company's management cannot estimate at
present whether the reform will have an effect on the Group's future
results of operations.
Note 17 - Supplementary Financial Statement Information:
Balance Sheet:
A. Other Current Assets:
Composition:
December 31,
-------------------------
2004 2003
---------- ----------
(U.S. $ in thousands)
-------------------------
Government departments 6,510 5,380
Employees (1) 1,064 1,084
Prepaid expenses and advances to suppliers 12,489 6,753
Deferred taxes 3,751 2,528
Affiliates 109 646
Accounts receivable resulting from realization
of holdings in affiliates - 312
Other 2,182 2,143
------- -------
Total 26,105 18,846
======= =======
(1) Some of these balances are linked to the CPI, and bear interest at an
annual rate of 4%.
F-57
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 17 - Supplementary Financial Statement Information (cont.):
B. Liabilities to Banks and Others:
Composition:
Interest
rate
-------------------- December 31,
December 31, ----------------------------
2004 2004 2003
-------------------- Linkage -------------- ------------
% basis (U.S. $ in thousands)
-------------------- -------------- ----------------------------
Bank overdraft 4.5 - 17.7 Unlinked 3,647 6,179
Short-term bank loans 4.7 - 9.9 Unlinked 49,633 15,224
Short-term bank loans 2.8 - 4.9 Dollar 32,759 19,215
Short-term bank loans 5 - 6.5 CPI 905 14,441
Short-term bank loans 4.03 Euro 682 3,665
Current maturities of long-term loans
from banks 17,349 *7,819
------- ------
Total 104,975 66,543
======= ======
* Reclassified.
C. Other Accounts Payable:
Composition:
December 31,
--------------------------
2004 2003
------------ ------------
(U.S. $ in thousands)
--------------------------
Employees and other wage and salary related liabilities 25,933 24,961
Government departments 11,156 10,179
Prepaid income and customer advances 32,676 18,809
Accrued expenses and other current liabilities 11,340 17,143
------- -------
Total 81,105 71,092
======= =======
F-58
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 17 - Supplementary Financial Statement Information (cont.):
D. Restructuring and Non-Recurring Costs:
Year ended December 31,
---------------------------------------------
2004 2003 2002
-------------- ------------- -------------
(U.S. $ in thousands)
---------------------------------------------
Wages and related expenses - - 1,169
Relocation expenses - - 396
Expenses relating to closing of branches - - 264
Other - - -
------ ----- ------
Total - - 1,829
====== ===== ======
Restructuring expenses were recorded by consolidated companies. During
2002, these companies announced the adoption of a restructurning plan in
order to reduce expenses and improve organizational and business
efficiency.
E. Financial (Expenses) Income, Net:
Composition:
Year ended December 31,
----------------------------------------------
2004 2003 2002
-------------- -------------- --------------
(U.S. $ in thousands)
----------------------------------------------
Financing income 4,047 4,726 12,621
Financing costs related to long-term credit (5,355) (3,347) (2,601)
Financing costs related to short-term credit and others (8,686) (6,046) (6,314)
Gain (loss) from marketable securities 1,090 991 (101)
------ ------ ------
Total (8,904) (3,676) 3,605
====== ====== ======
F. Other Expenses, Net:
Composition:
Year ended December 31,
--------------------------------------------
2004 2003 2002
------------ -------------- --------------
(U.S. $ in thousands)
--------------------------------------------
Gain (loss) on sale of fixed assets, net 60 26 (176)
Dividend received from another company 770 - -
Impairment in value of investment in affiliates
and other companies (471) (915) (1,656)
Other (691) 799 (268)
Total (332) (90) (2,100)
===== ===== ======
F-59
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - Supplementary Financial Statement Information (cont.):
G. Gain on Realization of Shareholdings, Net:
Composition:
Year ended December 31,
--------------------------------------------
2004 2003 2002
------------ -------------- --------------
(U.S. $ in thousands)
--------------------------------------------
Loss from realization of Compubyte Computers - - (609)
Gain from realization of investment in Level 8 171 376 5,466
Gain (loss) from sale and decrease in shareholding
percentage in Magic 1,151 294 (38)
Gain from realization of investment in the News Company 142 409 -
Gain from sale and decrease in shareholding percentage
in Formula Vision 383 - -
Gain from sale and decrease in shareholding percentage
in Matrix 3,557 1,131 915
Gain (loss) from sale and decrease in shareholding
percentage in New Applicom - (93) -
Realization of investment in warrants in Matrix - 300 -
Gain from decrease in shareholding percentage in Babylon 651 - -
Realization of unrealized gain in Matrix
(see Note 2A) 2,820 342 -
Gain (loss) on realization of other investments 18 (3) (1,066)
Total 8,893 2,756 4,668
====== ====== ======
H. Operating Segments:
The Company operates in two principal business segments, IT Services and
proprietary software solutions.
Software Services
The following is a list of the Group's principal activities: applications
development, systems integration, migration of IT platforms, IT
consulting, e-services, outsourcing, conversion services, application and
implementation of ERP & CRM systems, imported software products and a
training school.
The Group provides these IT services across the full system development
lifecycle, including the definition of business requirements, system
analysis, technical specifications, coding, testing, training,
implementation and maintenance. The Company performs its projects on-site
or at its own facilities.
F-60
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - Supplementary Financial Statement Information (cont.):
H. Operating Segments (cont.):
Proprietary Software Products
The Group designs, develops and markets proprietary software solutions for
sale in selected niche markets worldwide. The following is a list of the
proprietary software solutions that are marketed by the Group:
Modernization solutions, Magic-technology, Magic eMerchant, solutions for
law enforcement, Application software for long term care industry, car
rental solutions, solutions for banking and finance, solutions for
telecommunications, CRM systems, Sapiens eMerge, re-engineering and
AppBuilder, solutions for insurance industry such as Sapiens & Merge
technology.
All of the Company's subsidiaries, including IT services companies and
proprietary software solutions companies, recognize revenues from the
delivery of software services, and most of them recognize revenues in both
revenue categories. The Company's subsidiaries were classified into the
following categories in accordance with the category in which most of the
revenues of each subsidiary was earned.
The following is a list of the companies included in each operating
segment, as of December 31, 2004:
Software Services:
Matrix IT Ltd.
NextSource Inc.
Proprietary Software Products:
BluePhoenix Solutions Ltd.
Magic Software Enterprises Ltd.
Sapiens International Corporation N.V.
Formula Vision Technologies (F.V.T.) Ltd.
F-61
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - Supplementary Financial Statement Information (cont.):
H. Operating Segments (cont.):
The Company evaluates the performances of each segment, software services
and proprietary software products, based on operating income/loss.
Headquarters expenses are allocated proportionally between the segments:
Proprietary
Software Software
Services Products Total
-------------- --------------- ---------------
(U.S. $ in thousands)
-------------------------------------------------
Revenues:
2004 230,880 231,435 462,315
2003 196,782 170,048 366,830
2002 172,068 113,121 285,189
Inter-segment sales:
2004 3,618 2,087 5,705
2003 - - -
2002 726 1,153 1,879
Operating income (loss):
2004 15,017 3,059 18,076
2003 8,289 3,570 11,859
2002 (1,435) (5,251) (6,686)
Financial income (expenses):
2004 (3,504) (5,400) (8,904)
2003 (3,205) (471) (3,676)
2002 5,549 (1,944) 3,605
Net income (loss)
2004 12,178 (4,079) 8,099
2003 2,106 1,014 3,120
2002 (1,105) (1,301) (2,406)
F-62
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - Supplementary Financial Statement Information (cont.):
H. Operating Segments (cont.):
Proprietary
Software Software
Services Products Total
--------------- --------------- ---------------
(U.S. $ in thousands)
--------------------------------------------------
Identifiable assets:
2004 181,200 380,107 561,307
2003 *162,361 236,915 *399,276
Identifiable liabilities:
2004 133,458 230,203 363,661
2003 *132,078 116,179 *248,257
Depreciation and amortization:
2004 4,714 15,883 20,597
2003 5,602 12,945 18,547
2002 5,196 7,710 12,906
Investments in segment assets:
2004 1,877 3,841 5,718
2003 1,924 2,963 4,887
* Reclassified.
Reconciliation between the data on sales and income of the operating
segments and the data in the consolidated financial statements:
2004 2003 2002
-------------- -------------- --------------
(U.S. $ in thousands)
----------------------------------------------
Revenues:
Revenues as above 462,315 366,830 285,189
Less inter-segment transactions (5,705) - (1,879)
-------- ------- -------
Revenues as per statement of operations 456,610 366,830 283,310
======== ======= =======
F-63
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - Supplementary Financial Statement Information (cont.):
H. Operating Segments (cont.):
2004 2003
------------- --------------
(U.S. $ in thousands)
-----------------------------
Identifiable assets:
Total assets of operating segments 561,307 *399,276
Assets not identifiable to a particular segment 127,766 159,436
Elimination of inter-segment assets and other (48,053) (14,684)
-------- --------
Total assets as per consolidated balance sheet 641,020 544,028
-------- --------
Identifiable liabilities:
Total liabilities of operating segments 363,661 *248,257
liabilities not identifiable to a particular segment 42,030 65,730
Elimination of inter-segment liabilities and other (48,028) (14,214)
-------- --------
Total liabilities as per consolidated balance sheet 357,663 299,773
-------- --------
* Reclassified.
I. Geographical Information:
1. The Company's Long-Lived Assets are as follows:
December 31,
---------------------
2004 2003
-------- -------
(U.S. $ in thousands)
---------------------
Israel 64,032 51,656
U.S.A. 7,355 6,126
Others 6,231 4,458
------- -------
Total 77,619 62,240
======= =======
2. Revenues:
Revenues classified by geographic area:
Year ended December 31,
----------------------------------------------
2004 2003 2002
-------------- -------------- --------------
(U.S. $ in thousands)
----------------------------------------------
Israel 213,020 171,108 156,212
International:
United States 106,849 93,695 65,654
Other 136,741 102,027 61,444
------- -------- -------
243,590 195,722 127,098
------- -------- -------
Total 456,610 366,830 283,310
======= ======== =======
Classification was based on the location of the customers.
F-64
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - Supplementary Financial Statement Information (cont.):
J. Earnings (Loss) Per Share:
The following table presents the computation of basic and diluted net
earnings (loss) per share:
Year ended December 31,
-------------------------------------------
2004 2003 2002
---------- ----------- ----------
(U.S. $ in thousands)
-------------------------------------------
Amount for basic earnings (loss) per share -
income available to shareholders 7,884 2,909 (2,406)
====== ====== =======
Effect of dilutive securities of subsidiaries (885) (466) -
Amount for diluted earnings (loss) per share -
income available to shareholders 6,999 2,443 (2,406)
====== ====== =======
Weighted average shares outstanding
Denominator for basic net earnings (loss) per share 10,800 10,037 10,171
Effect of dilutive securities *)- 248 *) -
------ ------ -------
Denominator for diluted net earnings (loss) per share 10,800 10,285 10,171
====== ====== =======
Basic net earnings (loss) per share 0.73 0.29 (0.24)
====== ====== =======
Diluted net earnings (loss) per share 0.65 0.24 (0.24)
====== ====== =======
*) Anti dilutive.
Options to purchase 500,000 Formula shares in 2002, at market price were
outstanding, but were not included in the computation of the diluted EPS
because the options have an anti-dilution effect. Options to purchase
2,000,000 shares and employees' options to purchase 64,500 shares in the
year 2002 at an exercise price of $15.8 and $30.8, respectively, were
outstanding, but were not included in the computation of the diluted EPS
because the options have an anti-dilution effect.
F-65
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - Transactions with Related Parties:
A. In July 2001, Formula granted to Formula Vision, an option to purchase
Formula's interests in certain privately-held companies. On November 28,
2001, Formula Vision exercised the option. Accordingly, Formula
transferred to Formula Vision its entire interest, including related
obligations, in certain companies for aggregate consideration of $58.9
million. Under the agreement with Formula Vision, Formula Vision issued to
Formula in December 2001, a series of debentures in the amount of $58.9
million, linked to the CPI and bearing interest at an an annual rate of
5%. On March 31, 2002, Formula lent an additional amount of $19.4 million
to Formula Vision in consideration for a series of debentures with similar
terms to the debentures issued in December 2001. . This series of
transactions is considered a related party transaction since Dan and Gad
Goldstein serve as directors of Formula and Formula Vision. For more
information about the transaction between Formula and Formula Vision, see
Note 2B.
B. In November 2002, Formula completed a sale to Matrix of its entire
shareholdings in New Applicom, Sintec and Sivan, for an aggregate
consideration of $29.6 million.
C. In November 2002, Formula sold to BluePhoenix, in a share exchange
transaction, its 57.9% interest in Liraz. In consideration, BluePhoenix
issued to Formula BluePhoenix's ordinary shares representing 9% of
BluePhoenix's outstanding share capital. The exchange ratio was set at
1:1.67, which Formula believes reflects a fair ratio between the values of
the two companies.
F-66
FORMULA SYSTEMS (1985) LTD.
(An Israeli Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 19 - Subsequent Events:
A. On December 29, 2004, Formula announced that it had concluded negotiations
with FIMI, regarding a private placement of 2,400,000 Formula shares. The
shares were issued to an entity which was established by Dan Goldstein,
Formula's CEO and Chairman of the Board, and FIMI Opportunity Fund and
parties related to it, in equal parts. Prior to the private placement, Dan
Goldstein also transferred to the joint entity all of his 2,000,000 shares
of Formula.
The price per share in these transactions was $15.31 (the closing price of
Formula shares on December 28, 2004), for a total of $36 million that was
paid to Formula in the private placement.
Following the transactions, the joint entity holds a total of 4,400,000
Formula shares, which constitutes a controlling interest comprising of
approximately 33% of Formula's outstanding shares. The joint entity also
purchased Dan Goldstein's shares in Formula Vision.
On March 3, 2005, Formula issued the said shares and received $35.5
million.
B. On June 1, 2005, Formula distributed a cash dividend, in the amount of $53
million.
C. On June 20, 2005, Formula repaid the outstanding amount of the debentures
issued by it to the public in Israel, in May 2002 (see Note 2C). The
aggregate amount repaid by Formula to the debentures holders was
approximately $14.9 million.
F-67