Magic Software Enterprises Ltd. (NASDAQ:MGIC) Q4 2023 Earnings Call Transcript March 13, 2024
Magic Software Enterprises Ltd. beats earnings expectations. Reported EPS is $0.24, expectations were $0.2. MGIC isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises 2023 Fourth Quarter and Full Year Financial Results Conference Call. Magic’s fourth quarter 2023 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 CEO, Mr. Guy Bernstein; Magic CFO, Mr. Asaf Berenstin; and Magic 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 content 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 fourth quarter 2023 financial results. During the call today, I will review highlights from our fourth quarter results and provide an overview of our outlook. Revenue in the fourth quarter of 2023 decreased to $125.5 million, down approximately 14.7% from the fourth quarter of 2022. As we already mentioned in the past calls during the year, the effect of the currency fluctuations over the course of the year was and still is 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 December 31, 2022, revenues for the fourth quarter of 2023 would have decreased by approximately 11.2% compared to the fourth quarter of 2022, to $130.6 million, $5 million more higher than our reported revenue figure for the quarter.
As we described in the third quarter results conference call on November 14th, the reduction in our third quarter and fourth quarter revenues was caused primarily by two factors. One, the currency headwind caused by the significant devaluation of the new Israeli shekel relative to the U.S. dollar in 2023, reaching 9.7% for the year and 9.3% for the fourth quarter, which has hurt our Israeli shekel-denominated operations by $5.6 million for the fourth quarter and $29 point — $22.9 million for the year. And second, a substantial and unexpected decline in demand for our professional services from several of our important U.S.-based blue chip customers, which without any advance notification and due to internal reasons unrelated to our software services decided during the second half of the third quarter and going forward to immediately suspend significant parts of their active time and materials-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. We also noted a significant post-third quarter event, the outbreak of the Israeli war against the terrorist organization Hamas, which among other things has currently led to the drafting to active military service of approximately 200 out of our 1,700 Israeli employees. We keep on standing with Israel in its fight and wish our employees who are fighting and the entire Israeli armed forces continued success at eliminating the terrorist organization that slandered and conducted the brutal murder of 1,400 Israeli civilians and continues to hold 134 Israeli hostages. The absence of our Israeli employees who were drafted for active military services since the beginning of the war on October 7th, together with the decline in demand for our software services from several of our important U.S.-based blue-chip customers and the continued challenging macroeconomic environment of high interest rates, persistent inflation and reduced capital spending have caused us to report significantly lower revenues for the fourth quarter and for the second half compared to the same period last year.
Having said that, I would like to highlight that our fourth quarter revenues have reached the higher end of our fourth quarter revenue guidance target. Despite all of those difficulties working against us, we continue to plow forward with our worldwide dedication and confidence that we can continue to execute on sales of a world-class suit 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 customers are facing macro and company-specific challenges, we believe we have the right set of offerings to address our clients’ needs. We have seen even in this challenging environment that outstanding execution by our teams and our adherence to our cost structure enable us to improve our profitability, despite the lower revenues.
In the fourth quarter of 2023, our non-GAAP operating margin held strong at approximately 14.1% of our revenues, 80 basis points higher compared to the margin during the first half of 2023 and 140 basis points higher compared to the corresponding period last year. This shows the inherent scalability and the sensibility 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 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 demands for our innovative software solution and services.
We similarly continue to see excellent execution by our teams. Setting aside the factors that slow us 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. Since the first days of Magic Software, we have been characterized by our ability to take complex IT processes and make them simple. Today, we put our focus on helping our clients to transition seamlessly to the cloud, enhance their Software-as-a-Service capabilities and deliver acceptation value to our comprehensive suite of managed cloud services. We have made it our mission to assist businesses in overcoming the challenges associated with migrating to the cloud and achieving through SaaS excellence.
Like many others, we recognize that the cloud is not just technology shifts. It’s a transformative journey that demands expertise, dedication and innovation to which we bring industry-leading best practices, ensuring that our clients’ cloud deployments meet the highest standards of performance, scalability, security and reliability. Our suite of managed cloud services, which includes services such as NOC-as-a-Service, SOC-as-a-Service, DevOps-as-a-Service, FinOps-as-a-Service and much more tailored to address critical aspects of cloud operation and clients’ business continuity, empowering our clients to focus on their core competencies, while leading the management and optimization of the cloud and IT system environments to us. The global cloud services market continues to experience rapid growth with businesses of all sizes recognizing the benefit of migrating to the cloud.
The managed cloud service market, in particular, is projected to witness substantial expansion with double-digit CAGR during — due to the increasing complexity of cloud environments and the need for specialized expertise. As of today, Magic has over 300 logos consuming its managed cloud services. What sets Magic apart is its deep domain expertise, a customer-centric approach and a proven track record of delivering successful cloud transformation. Our team of seasoned professionals leverages their expertise across the three major cloud platforms, AWS, GCP and Azure, and are well positioned to provide our customers with optimal solutions tailored to their unique needs. Our strategic focus centers on being industry leaders in artificial intelligence, AI and generative AI.
This strategic alignment allows us to cater to a diverse clientele, ranging from digital native technology companies to traditional enterprises. By harnessing the power of AI and generative AI, we aim to empower businesses to enhance efficiency and competitiveness in their respective domains. Proceeding to address our fourth quarter financials, in the fourth quarter of 2023, our revenues in North America amounted to $51.3 million, which is approximately $30.4 million or 37% lower compared to the fourth quarter of 2022 and $7.2 million or 12% lower compared to the third quarter of 2023, mainly due to additional cutbacks made by several clients in the U.S., among which some of our largest customers during the second half of the third quarter, which decided to reduce expenses and put on hold IT investment decisions resulting in a decrease of close to 600 of our U.S. specialists compared to the respective quarter last year.
Revenue from our Israeli operation amounted to $54.3 million, up by 9.5%, compared to $49.6 million reported in the fourth quarter of 2022. The impact of the continued devaluation of the new Israeli shekel versus the U.S. dollar was a material factor in reducing the increase of our dollar reported Israeli market revenue. On a constant currency basis, calculated based on the average currency exchange rate for the three months ended December 31, 2022, revenues for the fourth quarter of 2023 of our Israeli operation would have increased by an additional $5.6 million to $59.9 million overall, reflecting a year-over-year growth of 20.8% 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 such as healthcare, which accounts for 20% of our business, high-tech, which accounts for 25%, defense 10%, finance 15%, and the public sector 5%, which allowed us to partially compensate for the current slowdown we experience in North America.
Turning now to profitability, despite the significant currency headwind and the problems with our U.S.-based revenues during the second half of 2023, we were nevertheless able to increase our gross margin for the fourth quarter of 2023 by 150 basis points to 30.8% of revenues or $38.6 million, compared to 19 — 29.3% in the corresponding quarter of 2022, in which it was $43.2 million. The breakdown of our revenue mix for the year of 2023 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%. In 2022, approximately 17% of our revenues were attributable to our software solutions segment, with a gross margin of approximately 64%, same as this year, and 83% related to our professional services, with a gross margin of approximately 21%, again, same as this year.
The breakdown of our gross profit mix for the year was approximately 42% related to our software solutions and 58% related to our professional services, compared to 39% and 61% in the same period last year. Our non-GAAP operating income for the fourth quarter of 2023 fell on an absolute basis, while increasing on a percentage basis, compared to the corresponding period of 2022. It was $17.7 million, compared to $18.7 million in the same period last year. This reflects an operating margin of 14.1% for the quarter, compared to 12.7% in the fourth quarter of 2022. On a constant currency basis, calculated based on average currency exchange rates for the three-month period ended December 31, 2022, non-GAAP operating income for the fourth quarter of 2023 would have decreased by 2.8% to $18.2 million for the quarter.
Financial expenses, during the quarter, we had financial debt interest expenses of $1.5 million, related to our $81 million financial debt, compared to $0.7 million of interest expenses recorded in the same period last year, related to a total financial debt of $51 million. The increase in our financial expenses mainly resulted from the increase in our overall debt in 2023, and in our interest rate level, as the majority of our debt bears variable interest rates, which has been subject to higher interest rates in 2023, compared to the same period last year. Net income attributable to non-controlling interest. As our business combination model has often relied on keeping formal 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 those minorities’ shareholders.
Net income attributable to non-controlling interest increased $1.5 million, compared to $1.6 million for the same period last year. Our non-GAAP net income for the fourth quarter decreased by 24% to $11.6 million or $0.24 per fully diluted share, compared to $13.4 million or $0.27 per fully diluted share in the same period last year, which was a product of the reduction in our operating income and increase in financial expenses resulting from increased level of debt and increased bank interest rate. Turning now to the full year results for the 12 months that ended December 31, 2023. 2023 revenues decreased to $535.1 million, down approximately 5.6% for $568.8 million in 2022. As we already mentioned, during the year the effect of the currency fluctuation on our revenues over the course of the year was significant compared to the corresponding year.
On a constant currency basis, calculated based on the average currency exchanges for the 12 months ended December 31, 2022, revenues for 2023 would have decreased by approximately 1.6% to $557.9 million compared to 2022, $22.8 million higher than our reported revenue figures for the year. Turning now to profitability, despite the significant currency headwind, the problems — and the problems with our U.S.-based revenues during the second half of 2023, we were nevertheless able to increase our gross margin for the year by 120 basis points to 29.6% of revenues or $158.4 million, compared to 28.4% in 2022, in which it was $160.8 million. Our non-GAAP operating income for the year fell on an absolute basis while increasing on a percentage basis compared to the corresponding period of 2022.
It was $71.8 million, compared to $74.5 million in the same period last year. This reflects an operating margin of 13.4% for the year, compared to 13.1% in 2022. On a constant currency basis, calculated based on average currency exchanges for the 12 months period ended December 31, 2022, non-GAAP operating income for the year would have reached to $74.5 million same as last year. Our non-GAAP net income for the year decreased by 6.5% to $48.4 million or $0.99 per fully diluted share, compared to $51.7 million or $1.05 per fully diluted share in 2022, which was a product of the reduction in our operating income and increased financial expenses resulting from increased level of debt and increased bank income. Turning now to the balance sheet, as of December 31, 2023, our cash and cash equivalents and short-term bank deposits amounted to approximately $107 million same as of September 30, 2023.
Our total financial debt as of December 31, 2023 amounted to $81 million, compared to $88 million as of the end of the previous quarter. Our cash flow from operating activities was $12.4 during the fourth quarter of 2023, compared to $12.1 million in the same period of 2022. Our cash flow from operating activities for the year increased 29% to $77.9 million, compared to $60 million, excluding payments of deferred and contingent considerations related to acquisitions recorded under cash flow from operating activities. In closing, I would like to turn to our annual revenue guidance for 2024. As we stated on our third quarter earnings call, as of the third quarter, our business activity in North America experienced a significant slowdown side-by-side to the outbreak of Israeli war against the terrorist organization Hamas, which, among other things, has led to drafting to active military service of approximately 200 of our 1,700 Israeli employees.
We acknowledge that while short-term conditions are not ideal, we are nevertheless optimistic that in 2024, once the major part of the war in Israel would also be behind us, we expect to return to our normalized historical growth rate in the mid-term. As such, we anticipate 2024 revenues to be in the range between $540 million and $550 million, based on current currency exchange rates. This guidance for 2024, when measured against our annualized 2023 fourth quarter revenue on a go-forward basis, reflects an annual growth of 7.5% to 9.5%. Magic has a well-established track record of growth, profitability and high cash generation. Across the globe, our dedicated team is resolutely focused on executing our strategic vision to not only restore but compress our previous height, thereby ensuring sustained growth and the continual enhancement of shareholders’ value.
I would like to thank our clients and shareholders for their continued support and trust, and we look forward to continue to deliver results on your behalf. With that, I will turn the call over to the Operator for questions.
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Q&A Session
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Operator: Thank you. [Operator Instructions] The first question is from Chris Reimer of Barclays. Please go ahead.
Chris Reimer: Hi. Thanks for taking my questions and congratulations on the strong results. I was wondering if you could provide any color on the outlook and maybe some of the contributing factors in arriving at your revenues range.
Asaf Berenstin: Basically, if we separate between the U.S. market, the North American market and the Israeli market, in the Israeli market, we saw in 2023 compared to 2022 a continued strong momentum, by the way, despite the events that we are currently experiencing in Israel and the fact that we had all through the quarter a significant amount of employees drafted to the Israeli effort against Hamas. I think that what drove our revenues significantly higher was, first of all, the fact that we are operating in strong sectors in Israel, like the finance sector and the high-tech sector and the — and of course, the defense sector, which, because of the events in Israel, had to accelerate projects, deliverables and even increase the level of operations that we had with them prior to the happenings in Israel.
And with that, I would say that, when we show guidance for growth next year between 7.5% to 9.5%, still I think that the second half is expected to be significantly higher than in the first half. If I need to assume, I would assume that 20% to 25% of the growth will happen during the first half and the rest will happen during the second half of 2024.
Chris Reimer: Got it. And how would you describe the environment in the U.S. versus the last two quarters? Have you seen any change? A – Guy Bernstein I think we are — we saw that things have come down a bit, so we don’t face any more cuts. And we’re trying, it’s a bit, we don’t want to tend to sound too optimistic, but we start to see new hirings. But, yes, it’s on a small scale, therefore we prefer to be conservative.
Chris Reimer: Got it. Thanks a lot. That’s it for me.
Operator: The next question is from Maggie Nolan of William Blair. Please go ahead.
Maggie Nolan: Hi. Thank you for all the detail. Can you talk about talent management and your utilization and margin targets for 2024, given the changes in the client base, as well as the draft in Israel?
Asaf Berenstin: I think that currently, and again, looking forward next year, as we said, in the mid-term to return to our regular pace of the operation or growth level, I think that our gross margins should remain relatively stable at around 29%. As I mentioned during the call, our gross margin from the software side of our operation is, if you look back for three years, five years, seven years back, you see that it is around 64%. Our gross margin from our professional services is around between 21% or 22% also going forward. I think that those margins are pretty stable going forward. The shift sometimes on our weighted average gross margin is, as in this year, goes because of the changes, because of the mix between those two operations, because of the fact that the level of our professional services went down significantly in the U.S. market, lowering our lowest part of the margin business, we managed to experience higher margins on average.
Again, looking back, I think that the 13% operating margin is what we are currently always aiming to be around or at that level.
Maggie Nolan: Thank you. With respect to your revenue guidance for the year, what are the foreign currency assumptions baked into that guidance?
Asaf Berenstin: As I mentioned on the call, we take the current — we don’t try to anticipate the fluctuation of the currency. Otherwise, we would have been in other parts of business, not in IT. We use the current level of the currency exchange rate.
Maggie Nolan: And on a year-over-year basis, what is roughly the impact using the current level?
Asaf Berenstin: Basically, the average in 2023 was around 3.69. The current exchange rate is 3.65. That’s low, I don’t, so currently, there shouldn’t be any significant difference except for Q4, where the average rate was around 3.8. Today, we are at 3.65. So again, on the Israeli side of our operation, 40% of our revenues today that should pick up our profit a little bit.
Maggie Nolan: Thank you.
Operator: [Operator Instructions] There are no further questions at this time. Mr. Bernstein, would you like to make your concluding statement?
Guy Bernstein: Yeah. So, thank you everyone for joining the call. We hope to bring good news in the near future and thank you for joining us.
Operator: Thank you. This concludes the Magic Software Enterprises Ltd. 2023 fourth quarter results conference call. Thank you for your participation. You may go ahead and disconnect.
