Magic Software Enterprises Ltd. (NASDAQ:MGIC) Q1 2024 Earnings Call Transcript

Magic Software Enterprises Ltd. (NASDAQ:MGIC) Q1 2024 Earnings Call Transcript May 16, 2024

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises 2024 First Quarter Financial Results Conference Call. Magic’s first quarter 2024 earnings release was issued before the market opened this morning, and it has been posted on the company’s website at www.magicsoftware.com. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. With us on the line today are Magic’s CEO, Mr. Guy Bernstein; Magic’s CFO, Mr. Asaf Berenstin; and Magic’s CTO, Mr. Yuval Lavi. Before we start, I would like to remind everyone that projections or other forward-looking statements may be provided on this conference call. The safe harbor provision provided in the press release issued today also applies to the contents of this call.

Magic expressly disclaims any obligation to update or revise any of these forward-looking statements whether because of future events, new information, a change in its views or expectations or otherwise. Also, during the course of today’s call, management will refer to non-GAAP financial measures. A reconciliation schedule showing GAAP versus non-GAAP results has been provided in the press release issued before the market opened this morning. A replay of this call will be available after the call on the Investor Relations section of the company’s website. I will now turn the call over to Mr. Asaf Berenstin, CFO of Magic Software. Please go ahead.

Asaf Berenstin: Thank you, operator, and thank you, everyone, for joining us today as we report our first quarter 2024 financial results. During the call today, I will review highlights from our first quarter results and provide an overview of our outlook. Revenues in the first quarter of 2024 decreased to $130.7 million, down approximately 8.2% from the first quarter of 2023. As we already mentioned in past calls, the effect of the currency fluctuation on our revenues was still and is still significant compared to the corresponding quarters of last year. On a constant currency basis, calculated based on the average currency exchange rates for the three months ended March 31, 2023, revenues for the first quarter of 2024 would have decreased by approximately 6.4% compared to the first quarter of 2023 to $133.3 million, a $2.6 million higher than our reported revenue figure for the quarter.

On a sequential basis, revenues for the first quarter increased by 4.1%. As we described in the third quarter results conference call on November 14, 2023, the reduction in our revenues was caused primarily by two factors: currency headwinds caused by the significant deterioration of the new Israeli shekel relative to the U.S. dollar in 2023, reaching 3.6% for this quarter, which has hurt our Israeli shekel denominated operation by $2.56 million for the first quarter, and a substantial and unexpected decline in the demand for our professional services for several of our important U.S.-based blue-chip customers, which without any advanced certification and due to internal reason unrelated to our software services, decided during the second half of the third quarter of 2023 and going forward to immediately suspend significant parts of their active time and material based projects.

Behind the results also lies the ongoing challenging macroeconomic climate, which did not help our ability to overcome the primary adverse factors that weigh against us. Despite these difficulties working against us, we continue to plow forward with our worldwide dedication and confidence that we can continue to execute on sales of our world-class suite of products and in providing related services. Our AI low-code, no-code and services offerings are critical as customers continue to automate and digitize their systems and products. And while some of our U.S. customers are facing macro and company-specific challenges, the sequential improvement in our top-line results reflect that the vast majority of our customers continue to value our unique proposition and resume to engage us to an increasing degree as a preferred partner for innovative digital transformation initiatives.

Furthermore, even in this challenging environment, our non-GAAP operating margin held strong at approximately 13.9% of our revenues, 90 basis points higher compared to the margin during the first quarter of 2023 and 50 basis points higher compared to the full year of 2023. This shows the inherent scalability and defensibility of our business model and our ability to maintain and even improve our operating margin, whether our revenues rise or fall. We believe that our ability to maintain the profitability of our operations will keep our balance sheet strong and will enable us to invest in order to drive revenue growth in the future. As we look at our business, we see that we continue to leverage our digital technologies and cloud-based platforms to create strong demand for our initiative software solutions and services.

We similarly continue to see excellent execution by our team. Setting aside the factors that slowed down our revenues in North America, which were beyond our control, we experienced another quarter of solid performance recorded across all other parts of our business. We continue to see exciting opportunities and growth potential in the dynamic realm of cloud technology and managed services. We have made it our vision to help businesses choose the best cloud migration strategy and avoid the pitfalls associated with moving to the cloud. We understand that the cloud is not just a technology shift, it’s a transformative journey that requires expertise, dedication and innovation. We apply industry-leading best practices to ensure that our clients’ cloud deployments meet the highest standards of performance, scalability, security, and reliability.

Our suite of managed cloud services is designed to address critical aspect of cloud operation and client business continuity, enabling our clients to focus on their core competency, while leaving the management and optimization of their cloud and IT systems environment to us. Our services include NOC-as-a-Service, SOC-as-a-Service, DevOps-as-a-Service, FinOps-as-a-Service and much more. What sets Magic apart is its deep domain expertise, the customer-centric approach and a proven track record of delivering successful cloud migration and transformation. Our team of seasoned professional leverages their expertise across the three major cloud platforms, AWS, GCP and Azure, and we are well equipped to provide our customers with the optimal solution tailored to their unique needs.

We have over 350 satisfied customers across various industries and geographies who trust us with their cloud journey. We are committed to delivering excellence, innovation and value to our customers, and we are confident that we can help them achieve their cloud goals. Lastly, as you know, GenAI is a game changer in the cloud industry and the leading cloud providers, AWS, Azure and GCP, are investing heavily in it. We, at Magic, are strategically positioned to leverage their solutions and offer them to our customers with our value-added services and expertise. Moreover, the cloud vendors are partnering with us to implement their solutions to customers, recognizing our strong market presence and reputation. Proceeding to address our first quarter financial results.

In the first quarter of 2024, our revenues in North America amounted to $52.3 million, which is approximately $19.9 million or 27.4% lower compared to Q1 of 2023 and $1.4 million or 2.7% higher compared to Q4 of 2023. Revenues in North America accounted this quarter for 40% of our overall quarterly revenues. Revenues from our Israeli operations amounted to $59.2 million, up by 11.1% compared to $53.3 million reported in the same period last year. The impact of the continued devaluation of the new Israeli shekel versus the U.S. dollar reduced the increase recorded in our dollar reported Israeli market revenues. On a constant currency basis, calculated based on average currency exchange rate for the three months ended March 31, 2023, revenues for the first quarter of 2024 of our Israeli operation would have increased by additional $2.1 million year-over-year to $61.3 million, reflecting a year-over-year growth of 15% in real terms.

This demonstrates our strong performance in the region and reconfirms our long-term strategic decision to focus on mature, stable and technology-driven sectors, which allowed us to partially compensate for the current slowdown we experienced in North America. The revenues from our Israeli operations accounted for 45% of our overall quarterly revenues. Turning now to profitability. Despite continued currency headwinds and the slowdown in the U.S.-based revenues as of the second half of 2023, we were nevertheless able to increase our gross margin for the first quarter of 2024 by 110 basis points to 29.3% of revenue or of $38.3 million compared to 28.2% in the corresponding quarter of 2023, in which it was $40.1 million. The breakdown of our revenue mix for the first quarter of 2024 was approximately 19% related to our software solutions, with a gross margin of approximately 64%, and 81% related to our professional services with a gross margin of approximately 21%, same as in 2023 as a whole.

The breakdown of our gross profit mix for the first quarter was approximately 42% related to our software solutions and 58% related to our professional services, same as in 2023 as a whole. Our non-GAAP operating income for the first quarter of 2024 fell on an absolute basis while increasing on a percentage basis compared to the corresponding period of 2023. It was $18.1 million compared to $18.5 million in the same period last year. This reflects an operating margin of 13.9% for the quarter compared to 13% in the first quarter of 2023. On a constant currency basis, calculated based on average currency exchange rates for the three month period ended March 31, 2023, non-GAAP operating income for the first quarter of 2024 would have reached $18.5 million same as it was in the first quarter of 2023.

Financial expenses: During the quarter, we had financial debt interest expenses of $1.5 million related to our $80 million financial debt compared to $0.7 million of interest expenses recorded in the same quarter last year related to a total financial debt of $50 million. The increase in our financial expenses mainly resulted from the increase in our overall debt during 2023. And in our interest rate level as the majority of our debt bears variable interest rate, which has been subject to higher interest rate in Q1 2024 compared to the same period last year. Net income attributed to non-controlling interest, as our business combination model has often relied on keeping former shareholders in acquired entities as minority stakeholders in addition to their managerial role in such entities, we are allocating a portion of our net income to these minority shareholders.

Non-GAAP net income attributed to non-controlling interest slightly decreased to $1.6 million compared to $1.9 million for the same period last year. Our non-GAAP net income for the first quarter decreased by 10.4% to $11.3 million or $0.23 per fully diluted share compared to $12.6 million or $0.26 per fully diluted share in the same period last year, mainly resulting from the increase in our financial expenses resulting from increased level of debt and increased bank interest rates. Turning now to the balance sheet. As of March 31, 2023, cash and cash equivalent and short-term bank deposits amounted to approximately $126 million compared to $107 million as of December 2023. Our total financial debt as of March 31, 2024 amounted to $78 million compared to $81 million out of — as of December of 2023.

Our cash flow from operating activities was $27.7 million during the first quarter of 2024, compared to $18.8 million in the same period of 2023 and $12.4 million in the fourth quarter of 2023. In our press release issued today, we announced that Magic Board of Directors has declared a semi-annual cash dividend in the amount of $0.204 per share or in the aggregate amount of approximately $10 million, reflecting approximately 70% of our net income for the second half of 2023. The dividend will be paid on July 11, 2024 to shareholders of record as of June 27, 2024. Finally, today, we are reiterating our 2024 guidance. We expect 2024 full year revenue in the range of $540 million to $550 million. I will now turn the call over to the operator for questions.

Operator: Thank you. [Operator Instructions] The first question is from Maggie Nolan of William Blair. Please go ahead. Maggie?

Q&A Session

Unidentified Analyst: Hi, guys. Hi, this is Jesse on for Maggie Nolan. Thanks for taking our questions. We had a few for you today. So first, to start, could you talk about how this quarter compared to your expectations? And what gives you confidence in achieving full year guidance?

Asaf Berenstin: I think that first of all, yes, it met our expectation. We need to remember that still, although it’s on a reduced level, we still have around 70 people, at the highest level, it was 200 people back in October, November. Now it went down in December to around 120 and now 70 people that are still on reserve duty. We saw, except for — I would say, if we compare it to last year, except for the U.S. market, though we saw improvement compared to Q4, we — in the Israeli market, we see a significant improvement and continued improvement. We also saw that in 2023, 15% on a constant currency basis year-over-year. We see our backlog, which is increasing. We see strong demand for our services and good execution by our teams.

And with that, we feel confident that we meet — that we will meet the guidance that we provided for 2024. We also mentioned that we expect 2024 to act as that — in a way that the second half would be much stronger than the first half and 80% of the growth will come from the second — during the second half rather than from the first half. So, this is something that we communicated also in prior calls.

Unidentified Analyst: That’s great. And then, one of my follow-up questions was on the execution you’re seeing. Could you elaborate on just the execution you’re seeing? Is there anything going on in the sales or delivery organization that you’re proud of?

Asaf Berenstin: I think that basically things are working in plan. Again, we did some adjustment in the U.S. operations, of course, because of the situation that we currently face with our customers there. But in the Israeli market, of course, we push on sales and we see the contribution and the return on our investment in terms of the revenues that we record and that we explained to you about.

Unidentified Analyst: Okay. That makes sense to me. And then, the last one we had, we saw one of your subsidiaries acquired a staffing and technology services firm based in the United States back in April. Can you talk about the strategic decision behind the acquisition? Do you think you’ll continue pivoting the business to more of a services company than a software company?

Asaf Berenstin: I don’t think it’s a question of pivoting in the way that the current state of the business, we have 80% of our operations, which are mainly services, and 20% of the business, which is relying on mostly our technology, proprietary technology. So, this is not something that we call that now we are pivoting towards services. In the U.S., market, if you look back, you would see that we traditionally did the acquisitions there and mostly in the staffing area, we are acquiring market share. These are companies that, for us, it’s are very easily to [indiscernible] with our current operations. And we manage — once we buy them, we manage to improve them in terms of their margins, and we manage to push their business forward with — depending on the regions that we are acquiring, but enhancing, let’s say, the clientele and enhancing the operation.

So, this is something that we normally do, and we intend to continue doing. And hopefully, with the situation today, the macroeconomic situation in the U.S., perhaps we will find additional opportunities and continue to even buy more as the time progress. But this is very — depends on the situation.

Unidentified Analyst: Awesome. Thanks for taking our questions.

Operator: The next question is from Chris Reimer of Barclays. Please go ahead.

Unidentified Analyst: Hi. Thanks for taking my questions. Glad to see the reiteration of the year-end guidance. I was wondering if you could give any color on the pipeline and maybe where you’re seeing strength. And then, just touching on the U.S. customers who reduced their interactions with you over last year, do you see them coming back to the table at some point? Are there ongoing discussions? Just any color on that would be great. Thanks.

Guy Bernstein: Okay. So, I’ll relate first to the strong demand that we see here in the Israeli operation and in Europe. Definitely, we see a lot of traction around the cloud, around defense, all digital areas, it’s all growing, and we see a strong demand. As for the U.S. customers, we usually work with, I would call them, probably Fortune 1000 in the U.S. Due to the interest level somewhere beginning of last year, they stopped many of the projects. I think now we saw that it was stabilized and they are starting to hire again. They are way more cautious. So, as long as the interest is high, they are way more cautious. By the way, on the small businesses that we work with, we do see a strong demand. On the bigger ones, I think it will take a bit of time. But all in all, it’s — the reduction in force has stopped. And they started to hire, but not at the same scale that we were used to.

Unidentified Analyst: Got it. And then just touching on your AI strategy, you mentioned the partnerships with the large cloud vendors. Can you just give some color on where you’re seeing AI touch the business and some potential use cases that come out of that?

Yuval Lavi: Okay. We see the strong change in the GenAI — sorry, in the GenAI area. I think the concept of GenAI brought a big change to the enterprise customers and to the industry with the fact that we can actually bring a business value using this type of solution, okay? It’s no longer like a long journey with hoping of a result. This is a short journey with quick evidence of results, maybe even a failure, but then getting up again and jumping on the next iteration. And we have the partnership with AWS, Azure and GCP on that, and we implement some of our technology in a combination with their technology, taking it into our customers, since most of our business or a lot of our business is evolving around the data and the organizational data.

And since we are coming with customers that have data on-prem and they are moving to the cloud, all this combination is putting us in the perfect place of actually bringing value to our customers in all different areas via in the cloud or on-prem, on their data or the cloud data. So, we see it very fast happening.

Unidentified Analyst: Got it. Thanks. That’s it from me.

Operator: [Operator Instructions] There are no further questions at this time. Mr. Bernstein, would you like to make your concluding statement?

Guy Bernstein: Thank you, everyone, for joining the call. I’m glad that we start to see the positive shift again in our business. And hopefully, we’ll be able to bring you some good news in the near future. Thank you.

Operator: Thank you. This concludes the Magic Software Enterprises Ltd. 2024 first quarter results conference call. Thank you for your participation. You may go ahead and disconnect.