Formula Systems (1985) Ltd. — FY 2018 Form 20-F
Reporting period: Year ended December 31, 2018. This is an annual report, not a standalone fourth-quarter filing. Formula is an Israeli IT holding company whose results principally consolidate Matrix, Sapiens, Magic Software, Michpal and InSync; its 50%-owned TSG is accounted for using the equity method. Financial statements are in U.S. dollars and prepared under IFRS.
Financial performance and position
Amounts below are U.S. dollars; financial statement amounts are in millions unless stated otherwise.
| Metric | FY 2018 / year-end | FY 2017 / comparison |
|---|---|---|
| Revenue | $1,492.988 million | $1,355.139 million; up 10.2% |
| Gross profit / margin | $333.312 million / 22.3% | $296.823 million / 21.9% |
| Operating income / margin | $109.617 million / 7.3% | $72.806 million / 5.4% |
| Net income | $77.395 million | $39.440 million |
| Net income attributable to Formula shareholders | $32.365 million; basic EPS $2.20, diluted EPS $2.14 | $10.352 million; basic EPS $0.72, diluted EPS $0.68 |
| Cash from operations | $82.595 million | $81.095 million |
| Cash used in investing | $90.452 million | $107.122 million |
| Cash from financing | $40.967 million | $19.012 million |
| Cash and cash equivalents | $268.492 million | $245.947 million |
| Current assets / current liabilities | $781.033 million / $525.713 million | $694.801 million / $432.947 million |
| Total assets / total equity | $1,664.161 million / $805.397 million | $1,563.637 million / $772.922 million |
- Cash, short-term deposits and marketable securities totaled approximately $295.3 million at year-end. Interest-bearing bank and other borrowings plus debentures were approximately $381.9 million, based on the detailed balance sheet; reported liquidity and debt summaries elsewhere in the filing give slightly different rounded totals. The filing says the Group was in compliance with its financial covenants.
- Software services generated $1,123.0 million of revenue, up 10.8%; proprietary software products and related services generated $370.0 million, up 8.4%. About 60% of revenue came from Israel; U.S. revenue rose to $418.1 million from $322.9 million.
- Formula declared a $0.34-per-share dividend in December 2018, approximately $5.0 million in total, paid in January 2019. A further $0.34-per-share dividend was paid in June 2018.
Material changes versus FY 2017
- Revenue rose 10.2%, while operating income increased approximately 50.6% and net income approximately 96.2%. Formula-attributable income increased to $32.4 million from $10.4 million.
- Gross margin improved slightly to 22.3% from 21.9%; operating margin rose to 7.3% from 5.4%. Selling, marketing, general and administrative expense declined to $182.5 million from $184.2 million, including the absence of Sapiens’ $8.1 million 2017 reorganization charge.
- Net financial expense fell materially: the filing reports financial expenses of $15.9 million and financial income of $7.6 million in 2018, versus $29.9 million and $8.8 million, respectively, in 2017. Currency-related revaluations were an important driver.
- Income tax expense rose to $24.3 million from $13.4 million. The prior year included a one-time U.S. deferred-tax benefit following the U.S. tax-law change.
- Operating cash flow was nearly flat despite higher earnings. Trade receivables increased by $66.1 million, a significant use of operating cash.
- Acquisitions included Sapiens’ Adaptik, Matrix’s Alius, PVBS, Cambium, Integrity and Noah, and Michpal’s acquisition of Effective Solutions. Acquisition cash outflow, net of cash acquired, was $49.1 million, down from $119.1 million in 2017.
Outlook, risks and unusual items
- Management stated that existing cash, expected distributions from subsidiaries and available credit should cover working-capital needs for at least 12 months at the then-current operating level. The filing does not provide consolidated revenue or earnings guidance. Sapiens described 2018 as a moderate-growth year and said it was building a foundation for 2019 and beyond.
- About $94.4 million of remaining performance obligations were disclosed under IFRS 15; the company expected to recognize approximately 58% in 2019. This is contracted consideration, not a forecast of total revenue.
- IFRS 15 was adopted from January 1, 2018 using the modified retrospective method, without restating comparative periods. Opening equity increased by $1.8 million; the standard increased reported 2018 revenue by $4.6 million and Formula-attributable net income by $2.1 million versus the prior policy. Period comparisons therefore include an accounting-policy change.
- IFRS 16 was expected to increase assets by approximately $108.8 million and liabilities by approximately $111.1 million from January 1, 2019, and reduce equity by $2.3 million. Management expected no effect on debenture covenant compliance.
- Goodwill and intangible assets totaled approximately $790.9 million at year-end. No impairment was recorded in 2018, but future impairment could materially affect earnings.
- Risks highlighted include intense competition and technology change; long sales and implementation cycles and fixed-price project overruns; customer concentration and cancellations; cyber, privacy and GDPR compliance; acquisitions and integration; foreign-exchange exposure; Israeli economic, political and security conditions; and restrictive debt covenants. Roughly 60% of revenue was generated in Israel.
- Material litigation disclosures include a Magic Software dispute seeking NIS 34.1 million, for which the company said it could not reliably estimate its ability to defend; and a customer’s counterclaims against Magic subsidiary Comm-IT, whose potential liability was described as difficult to assess. Other legal provisions were stated to be immaterial.
- Following year-end, Formula repaid the remaining Series B convertible debentures at maturity in March 2019 and issued NIS 300 million of Series C secured debentures, with gross proceeds of approximately $82.2 million. These are subsequent events, not 2018 year-end borrowings.
- The independent auditor issued an unqualified IFRS opinion and an unqualified internal-control opinion. The control assessment excluded Adaptik, acquired in March 2018, representing approximately 0.5% of assets and 1.0% of 2018 revenue.
Most important facts for investors to verify
- Reconcile reported debt, cash and liquidity figures across the filing, including the classification and maturity of bank debt and debentures.
- Assess whether receivables growth and the relatively modest increase in operating cash flow are sustainable; review customer collections and working-capital trends.
- Separate organic growth from revenue added by acquisitions, and evaluate integration, contingent consideration and acquisition-related goodwill.
- Review IFRS 15’s effect on 2018 results and compare periods on a consistent accounting basis where possible.
- Monitor the outstanding litigation, tax uncertainties and IIA royalty exposure; the filing identifies approximately $6.2 million of contingent IIA royalties.
- Check covenant headroom, pledged subsidiary shares, debt maturities and restrictions on dividends or asset transactions.
- Evaluate Formula’s effective control and consolidation of investees despite minority ownership, and Asseco’s reported voting influence.