Formula Systems (1985) Ltd. — FY 2017 Form 20-F
Reporting period: Fiscal year ended December 31, 2017. This is an annual report, not a standalone fourth-quarter filing; separate Q4 financial results are not clearly provided. Financial statements are prepared under IFRS and presented in U.S. dollars. Unless noted otherwise, amounts below are in millions.
Business context
Formula is an IT services and software holding company. Its principal consolidated businesses include Matrix, Sapiens, Magic Software, InSync and, from January 2017, Michpal. TSG is a 50%-owned joint venture accounted for using the equity method. Formula’s results therefore reflect the operations of its subsidiaries, including substantial non-controlling interests.
Key financial metrics
| Metric | FY 2016 | FY 2017 | Change |
|---|---|---|---|
| Revenue | $1,108.6 | $1,355.1 | +22.2% |
| Gross profit | $258.8 | $296.8 | +14.7% |
| Operating income | $88.5 | $72.9 | Down |
| Net income | $56.1 | $39.4 | -29.7% |
| Net income attributable to Formula shareholders | $22.4 | $10.4 | -53.9% |
| Basic / diluted EPS | $1.58 / $1.49 | $0.72 / $0.68 | Down |
| Operating cash flow | $75.0 | $81.0 | Up |
| Cash and cash equivalents at year-end | $238.2 | $245.9 | Up |
Margins: Gross margin narrowed to 21.9% from 23.3%; operating margin fell to 5.4% from 8.0%; net margin declined to 2.9% from 5.1%. The filing’s audited income statement reports FY 2017 operating income of $72.854 million; another selected-data table shows $73.854 million, so investors should verify this inconsistency against the audited statements.
Revenue mix and geography: Software services revenue grew 21.4% to $1,013.8 million; proprietary software products and related services grew 24.9% to $341.4 million. Israel generated $846.3 million, or about 62% of revenue; international markets contributed about 38%.
Liquidity, debt and investment: Current assets were $694.8 million and current liabilities $432.9 million, implying a current ratio of about 1.60. Cash, cash equivalents and short-term marketable securities totaled about $260.1 million at year-end. Bank and other borrowings were approximately $206.4 million, and debentures approximately $138.6 million; together, these were about $345.0 million. Net cash from investing activities was negative $102.5 million, including $119.1 million of net acquisition spending. Financing activities provided $16.4 million; cash increased $7.8 million during the year.
Total assets rose to $1,563.6 million and equity to $772.9 million. Goodwill and net intangible assets totaled approximately $781.3 million. No impairment was recorded for goodwill or the relevant intangible assets in 2017.
Material changes and unusual items
- Revenue growth was supported by acquisitions and subsidiary growth, but profitability weakened as costs rose faster than sales. Cost of revenue increased 24.5%; gross margin declined by about 1.4 percentage points.
- Sapiens’ revenue rose 24.5% to $269.2 million, including $64.3 million from acquired businesses. A significant customer project cancellation reduced revenue by $26.5 million versus prior expectations; Sapiens also incurred $8.1 million in restructuring and cost-reduction expenses and reduced non-insurance and financial-services activity in Japan.
- Major acquisitions included Sapiens’ StoneRiver purchase for about $101.4 million and Formula’s Michpal purchase for about $22.1 million. Sapiens also acquired KnowledgePrice near year-end. Acquisitions increased goodwill and intangible assets and contributed to higher amortization.
- Net financial expenses increased to $21.2 million, primarily reflecting foreign-exchange effects on shekel-linked Formula debt, higher Magic interest costs and Sapiens’ debt financing. The shekel appreciated 9.8% against the U.S. dollar during 2017. Foreign-currency translation contributed $41.6 million to other comprehensive income.
- Income taxes were $13.4 million, including a material one-time benefit from remeasuring U.S. deferred tax liabilities following the U.S. tax law change. The company stated that accounting for some effects of the U.S. tax legislation remained provisional.
- Formula paid a $0.34-per-share dividend, approximately $5.0 million in aggregate. Formula reported that it was in compliance with its financial covenants at year-end.
Outlook, risks and contingencies
Management said existing cash, subsidiary cash distributions and available credit should cover working-capital needs for at least 12 months at the then-current operating level. The filing provides no quantified consolidated revenue or earnings guidance. Management expected Jewish holiday timing to weigh on 2018 second- and third-quarter activity. IFRS 15, adopted January 1, 2018, was expected to reduce deferred revenue by about $1.5 million, recognize a $0.6 million asset for contract-acquisition costs and reduce non-controlling interests by about $0.5 million; management expected no other material change in revenue-recognition patterns.
Key risks include competitive and technological change, long and complex project delivery, fixed-price contract estimation, customer concentration, acquisition integration and impairment risk, cybersecurity and privacy obligations (including GDPR), Israeli political and economic conditions, foreign-exchange exposure, and restrictive debt covenants. Goodwill and intangible assets are substantial, making future impairment a risk.
Legal matters include a pending damages claim against Magic following an earlier arbitration award of $2.4 million; the company said the later claim’s outcome could not be reliably assessed. A Matrix subsidiary and an employee faced an Israeli antitrust indictment; the filing’s description of the tender amount is unclear. Other proceedings were described as ordinary-course, with no material additional losses considered reasonably possible based on management’s assessment. The auditors issued unqualified opinions on the IFRS financial statements and internal control over financial reporting; controls at StoneRiver and KnowledgePrice were excluded from management’s assessment because of their recent acquisitions.
Investor verification priorities
- Reconcile the $72.854 million audited operating-income figure with the $73.854 million figure in selected financial data.
- Assess recurring profitability and cash conversion separately from acquisition contributions, restructuring charges, tax benefits and foreign-exchange effects.
- Review acquisition purchase-price allocations, integration progress, contingent consideration and the carrying value of goodwill and intangible assets.
- Check debt maturities, covenant headroom, collateral pledges and restrictions on dividends; distinguish Formula-level liquidity from cash held in subsidiaries.
- Follow the Sapiens customer dispute and Magic and Matrix legal proceedings, and assess the effects of customer concentration and the Japan business transition.