Magic Software Enterprises Ltd. (NASDAQ:MGIC) Q4 2022 Earnings Call Transcript

Magic Software Enterprises Ltd. (NASDAQ:MGIC) Q4 2022 Earnings Call Transcript March 9, 2023

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises 2022 Fourth Quarter and Full Year Financial Results Conference Call. Magic’s fourth quarter 2022 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. As a reminder, this conference is being recorded. With us on the line today are Magic’s CEO, Mr. Guy Bernstein; Magic’s CEO €“ the CFO, Mr. Asaf Berenstin; and Magic’s CTO, Mr. Yuval Lavi. Magic’s fourth quarter 2022 earnings release was issued before the market opened this morning and it has been posted on the company’s website.

Before we start, I would like to remind everyone that this conference call may contain projections or other forward-looking statements. The safe harbor provision provided in the press release issued today also applies to the context 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 our Investor Relations section of the company 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 fourth quarter and full year 2022 financial results. During the call today, I will review highlights from our fourth quarter results and provide an overview of our achievements. We appreciate your continued support and look forward to sharing our progress with you. During the year, we continued to make big strides across multiple fronts of our business, which is reflected by our record-breaking results exceeding $500 million in revenues for the first time and with double-digit growth recorded across all of our key financial indices for the year, revenues, gross profit, operating income, EBITDA, net income and dividends distributed to our shareholders.

Our strong results demonstrate the growing investments made by enterprises and organizations worldwide even during challenging macroeconomic environment. We leverage our digital technologies and cloud-based platforms, creating high demand for our innovative software solutions and services, which together with the outstanding execution by our teams led to another year of strong performance recorded across our business. This quarter, Magic delivered its strongest fourth quarter top line and bottom line results, with revenues increasing by 10.6% year-over-year to approximately $147.1 million, exceeding market expectations and non-GAAP net income increasing by 9.9% year-over-year to a fourth quarter record-breaking result of $13.9 million. Growth in Q4 was mainly driven by our North American operations, growing in double digits, accompanied by a strong pipeline, offsetting the negative impact of the Jewish New Year holiday season, which this year resulted in a decrease of approximately 6.5 billable working days equivalent to approximately $2.8 million in our Israeli market operations compared to the same period last year and 4 billable working days equivalent to approximately $1.2 million compared to the third quarter of 2022.

On a constant currency basis, revenues for the fourth quarter of 2022 would have increased by 16.5% year-over-year to $155 million with 69.6%, reflecting organic growth. Magic fourth quarter results strongly demonstrate our sustained profit-oriented approach. We continue supporting our existing loyal customers, as well as closing new deals. The continued strategic focus on the execution of our priority of top line growth resulted in yet another strong performance for the quarter. Our strategy allows us to carefully balance our growth, resources, investment and risk across regions and markets. Our solid execution in the fourth quarter and throughout this year validates our strategy of building a broad business portfolio, which provides for the foundation of our sustained solid performance and growth as we continue supporting our customers throughout their innovative digital transformation journey based on our long-term engagement cycle.

Photo by Danial Igdery on Unsplash

Despite seeing some caution in the recent months in the high-tech sector, we are still witnessing a healthy demand and maintaining a solid pipeline to deliver continued growth also in 2023 as our customers increasingly engage us as a preferred partner for innovative digital information initiatives. And as such, we continue to fortify our position as a leading software solution and IT service global vendor. We are extremely proud of the positive results we continue to demonstrate, particularly from our organic growth and from achieving this quarter another growth milestone crossing for the first time, the $500 million in annual revenue. This is a significant milestone, which serves as a key evidence to our continued success. We are certain that ever we are – certain than ever that we have all the tools in place for sustained growth.

We have a well-established track record of growth, profitability and high cash generation and the Magic team worldwide, which this year has crossed for the first time, the 4,000 employee and contractor headcount mark is committed to executing our strategy to deliver growth and continue improving our shareholders’ value. On the M&A front, we continue to explore M&A opportunities in the fields that we operate in, as well as in fields that we target and identify growth opportunities as we have in the past. Moving to the financials and starting with the geographical breakdown of our revenues. During the fourth quarter, North America accounted for 55% of total revenues, Israel 37%; Europe 6% and APAC and the rest of the world accounted for 2% of our fourth quarter revenue.

Our revenues in North America reached a record high of $84.9 million, up 20% compared to $70.6 million in the same period last year with 12% organic growth year-over-year. On a sequential basis, North America revenue grew by 7.5% from $79 million in Q3 2022 with 0.2% sequential organic growth. Revenues in Israel reached $48.2 million, down 7% compared to $52.1 million in the same period last year. On a constant currency basis, revenues in Israel increased by approximately 3.2% compared to the same period last year and despite the negative impact of the New Year Jewish holiday season. Turning now to profitability. Despite the significant currency headwind and the negative impact of the Jewish holiday season, we were able to deliver growth in our gross profit, as well as in our gross margin as our non-GAAP gross profit for the fourth quarter of 2022 reached $43.2 million, up approximately 11.5% compared to $38.7 million in the fourth quarter of last year.

Our non-GAAP gross margin for the fourth quarter of 2022 increased 20 basis points from 29.1% in the fourth quarter of 2021 to 29.3% in the fourth quarter of 2022. The breakdown of our revenue mix for the year of 2022 was approximately 17.4% related to our software solutions with gross margins of approximately 64% and 82.6% related to our professional services with gross margin of approximately 21%. While in 2021, 20% of our revenues were attributable to our software solutions segment with a gross margin of approximately 64% and 80% related to our professional services with gross margin of approximately 20%. The increase in the percentage of our professional services is due to the continued strong demand for our professional experts, driving our professional service revenue stream, as well as the acquisition of TGG concluded during the third quarter of 2022.

The breakdown of our gross profit mix for the year was approximately 39% related to our software solutions and 61% related to our professional services compared to 44% and 56% in the same period last year. Moving to operational costs. Our non-GAAP operating income for the fourth quarter of 2022 decreased by 2.9% to $19.2 million compared to $19.8 million in the same period last year and $18.5 million in the third quarter of 2022. This reflects an operating margin of 13% for the quarter compared to 14.9% in the fourth quarter of 2021 and 13.1% in the third quarter of 2022. Financial expenses. During the quarter, we had financial debt interest expenses of $684,000 resulted from our $51 million financial debt compared to $200,000 recorded in the same period last year for a total financial debt of $37 million.

As interest rates are still expected to rise, we expect our interest expenses to continue growing. Net income attributable to non-controlling interest as our business combination model has often relied on keeping former shareholders in acquired entities as minority stockholders. In addition to the managerial role in such entities, we are allocating a portion of our net income to these minority shareholders. Net income attributable to non-controlling interest amounted this quarter to $1.5 million compared to $1.8 million in the same period last year. Our non-GAAP tax expenses this quarter totaled $2.5 million compared to a tax expense of $3.9 million in the fourth quarter of 2021. Our effective tax rate for the year was approximately 18% compared to 17.8% recorded in 2021.

We expect an effective tax rate in 2022 to be in the range of 19% to 20%. Our non-GAAP net income for the fourth quarter increased 9.9% to $13.9 million or $0.28 per fully diluted share compared to $12.6 million or $0.26 per fully diluted share in the same period last year. Turning now to the balance sheet. As of December 31, 2022, cash and cash equivalents, short and long-term deposits and marketable securities amounted to approximately $87 million compared to $88.8 million in the same – in the previous quarter. Our total financial debt as of December 31, 2022, amounted to $51.1 million compared to $59.1 million in the previous quarter. During the fourth quarter, our cash flow from operating activities reached $12.1 million compared to $5.9 million in the same period last year.

Our cash flow from operating activities for the year reached $49.6 million compared to $37.8 million in 2021. In accordance with our dividend distribution policy, our Board of Directors has declared a semi-annual cash dividend in an amount of $0.30 per share and in an aggregate amount of approximately $14.7 million, which together with the dividend distributed for the first half of 2022 in an amount of approximately $42.2 million reflects 71% of the company’s net income attributable to its shareholders for the year. In closing, I would like to turn to our guidance for 2023. As we are witnessing a healthy demand and developing a growing pipeline to deliver continued growth in 2023, we anticipate revenues in the range of between $585 million to $593 million, reflecting annual growth of 3.2% to 4.6%.

This growth takes into consideration anticipated organic growth, the current macroeconomic environment and the current devaluation of foreign currency exchange rate versus average rates in 2022. Based on 2022, average currency exchange rates, Magic 2023 annual revenue guidance would have been between $600 million and $608 million, reflecting annual growth of 5.9% to 7.3%. Internally, this was a strong challenging and overall exceptional year of execution on many fronts, and we want to congratulate the Magic global team for their outstanding performance in 2022. The results we delivered show that our strategy is working and that by focusing on our investment to deliver profitable growth, we can significantly enhance shareholder value. With that, I will now turn the call over to the operator for questions.

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Q&A Session

Operator: Thank you. The first question is from Chris Reimer of Barclays. Please go ahead.

Chris Reimer: Yeah, hi. Congratulations on the strong quarter. And thanks for taking my questions. Just touching on operating expenses, we’ve seen double-digit increases over the past few quarters. Do you expect this to level out at some point? Or is there some other investment going into there? Is it just macro related? Just wondering what the moving parts around the operating expenses are and how you see that going forward?

Asaf Berenstin: The majority of the increase in our operating expenses related to our sales and marketing, some of it, a portion of that, or one third of that was from the acquisitions that we did, especially TGG, which contributed around $3 million to our sales and marketing expenses in 2022 versus 2021. And all other increases are mainly related to our investments in increasing our sales team and our recruitment teams and the bonuses that we pay as part of the growth that we experienced in our revenues and our gross profit.

Chris Reimer: Understood. And just touching on the headcount and your employees levels. How do you feel like you’re positioned now? And how do you see the trends in staffing? Is it still hard to – to acquire any new employees? Or do you find maybe that they’re staying longer? Just any of the trends around that and how you see your employee levels going forward?

Asaf Berenstin: I think we see that the trend is changing still the chasing after the tenant is still a challenge. But let’s say that the regular IT players are easier to get on one hand. On the other hand, we see some habitants from the – from customers because of the economical uncertainty. So on one hand, it’s easier for us to find the employees, on the other hand, some hesitance in the market.

Guy Bernstein: I would add to that, one thing is that when normally we serve as subcontractors to our customers, so on a difficult macroeconomic environment where there is this you know, wins of recession, the customers tend to go with their sub-contractors rather than with increasing their internal headcount, and this works for our benefit. When there is actual recession, then you first try them and you know, and minimize the responsibility of the sub-contractor. So currently, we only see winds of recession or sound for recession, but we don’t actually see it in the demand for our services.

Chris Reimer: Got it. That’s it from me. Thank you.

Operator: The next question is from Kate Cranston of William Blair. Please go ahead.

Kate Cranston: Hi, guys. Congrats on the nice quarter. This is Kate Cranston on from Maggie Nolan. My first question is, can you guys talk through a bit the foreign currency mix and revenue and the cost base right now?

Asaf Berenstin: Yes. Basically, we have experienced significant devaluations in the 45% of the – of our businesses – as 55% of our business relates to the U.S. to North America. So this is something that doesn’t affect us. But something around 35% to 40% of our business is still done in Israel, and we experienced almost 11% devaluation of the exchange rate between the dollar and the shekel. Now every 100 of the change in the exchange rate has a $700,000 negative impact over our top line. And since eventually, we have Israelite Israeli employees that carries out projects in the Israeli territory, it goes down also and devaluate the operating margin. So every 100 you know, every 100 change basis points in the exchange rate gives – reduces our operating profit by around $80,000, $75,000 to $80,000.