Magic Software Enterprises Ltd

NASDAQ:MGIC

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to Magic Software Enterprises' 2024 Second Quarter Financial Results Conference Call. Magic's second 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. [Operator Instructions]

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 have been 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, 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 have been provided in the press release issued before the market opened this morning.

A replay of this call will be available 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. Asaf, please go ahead.

[Asaf Berenstin, executive]

Thank you, operator, and thank you, everyone, for joining us today as we report our second quarter 2024 financial results. During the call today I will review highlights from our second quarter results and provide an overview of our outlook.

Revenues in the second quarter of 2024 decreased to $136.3 million, down approximately 1% from the second quarter of 2023. On a constant currency basis calculated based on the average currency exchange rate for the 3 months ended June 30, 2023, revenues for the second quarter of 2024 would have increased by approximately 0.4% to $138.1 million.

This quarter showcased solid execution with Israel delivering sequential mid-single-digit growth of 6.6%, and North America delivering sequential double-digit growth of 11.1%, primarily resulted from the addition of Theoris, Inc. at the beginning of the -- acquired at the beginning of the second quarter.

Theoris, Inc. is an IT and engineering consulting firm based in Indiana, with extensive IT industry experience who specialize in delivering strategic IT solutions, application development, cloud and staff augmentation services across diverse sectors including health care, life science, financial services, retail and manufacturing. Theoris' management has worked together for many years and it is a great addition to our operations in the U.S.

As I mentioned in the previous calls, the reduction in our second quarter and first half revenues compared to last year results is primarily driven by 2 factors. Currency headwind caused mainly by the continued devaluation of the New Israeli Shekel relative to the U.S. dollar, amounting to 2.1% year-over-year for the quarter and 2.8% for the 6-month period, which along with the devaluation of other foreign currencies reduced the reported revenues by $1.9 million for the second quarter and by $4.5 million for the 6 months period.

And more important, the substantial and unexpected decline in demand for professional services from several of our important U.S.-based blue-chip customers which, due to internal reasons unrelated to our services, decided during the second half of 2023 and going forward to suspend significant parts of their active time-and-materials-based projects, particularly in the face of softer demand and budget constraints.

That said, over the past 6 to 9 months, client sentiment in the U.S. has remained stable, with no significant changes either positive or negative. While we have not yet seen material market improvement, we believe that an improving U.S. economy could serve as a catalyst for growth in our U.S. operations. Although our full year guidance does not currently account for any macroeconomic improvements, we are confident that we are on the right path and momentum is building.

Despite these difficulties working against us, we continue to plow forward with our worldwide dedication and confidence that we can continue to execute on the sales of our world-class suite of products and in providing related services. Our AI low-cost, no-code and service 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 for the second quarter held strong at approximately 13.4% of our revenues, same as in the second quarter of 2023. Our operating margin for the first half of 2024 increased by 40 basis points to 13.6% compared to 13.2% in the same 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 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 solution and services. We similarly continue to see excellent execution by our teams.

Setting aside the factors that slowed us 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 it made our vision to help businesses choose the best cloud migration strategy and avoid the pitfalls associated with moving to the cloud. We apply industry-leading best practices to ensure that our clients' cloud deployments meet their highest standards of performance, scalability, security and reliability.

Our suite of managed cloud services is designed to address critical aspect of cloud operations and client business continuity, enabling our clients to focus on their core competencies while leaving the management and optimization of their cloud and IT system 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 the deep domain expertise, a customer-centric approach, and a proven track record of delivering successful cloud migration and transformation. We have approximately 400 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.

Proceeding to address our second quarter financial results. In the second quarter of 2024, our revenues in North America amounted to $58 million, which is approximately $11.2 million or 16.2% lower compared to Q2 of 2023, and $5.8 million or 11.1% higher compared to Q1 of 2024. Revenues in North America accounted for 43% of our overall quarterly revenues.

Revenues from our Israeli operation amounted to $58.2 million, up by 12.6% compared to $51.7 million reported on the same period last year. This demonstrated strong performance in the region and reconfirms our long-term strategic decision to focus on mature, stable and technology-driven sectors, which allows us to partially compensate for the slowdown we experienced from the second half of 2023 in North America. Revenue from our Israeli operations accounted for 43% of our overall quarterly revenue.

Turning now to profitability. Our gross margin for the second quarter of 2024 amounted to 29.4% of revenues or $40.1 million, compared to 30.3% in the same corresponding quarter of 2023 or $41.6 million for the same period last year. On a semiannual basis, our gross margin for the first half of 2024 amounted to 29.4% or $78.4 million, up by 20 basis points from 29.2% in the same period last year.

The breakout of our revenue mix for the 6-month period of 2024 was approximately 19% related to our Software Solutions with a gross margin of approximately 65%, and 81% related to our Professional Services with a gross margin of approximately 20%. The breakdown of our gross profit mix for the 6-month period of 2024 was approximately 43% related to our Software Solutions and 57% related to our Professional Services.

Our non-GAAP operating income for the second quarter of 2024 was $18.2 million, compared to $18.4 million in the same period last year. This reflects an operating margin of 13.4% for the quarter, same as in the second quarter of 2023. On a constant currency basis calculated based on average currency exchange rate for the 3 months period ended June 30, 2023, non-GAAP operating income for the second quarter of 2024 would have reached $18.4 million, same as it was in the second quarter of 2023.

Financial expenses. During the quarter, we had financial debt interest expenses of $1.1 million related to our $75 million financial debt, compared to $1.1 million of interest expenses recorded in the same quarter last year related to a total financial debt of $70 million. The increase in our financial expenses mainly resulted from foreign currency exchange rate fluctuation income of approximately $0.8 million recorded with respect to monetary assets and liabilities denominated in foreign currency in the respective quarters.

Net income attributable to noncontrolling interest. As our business combination model occasionally relies on keeping former shareholders in acquired entities as minority stakeholders, in addition to their managerial roles in such entities, we are allocating a portion of our net income to minority shareholders. Non-GAAP net income attributable to non-GAAP -- to noncontrolling interest slightly increased to $2 million, compared to $1.8 million for the same period last year.

Our non-GAAP net income for the second quarter decreased by 13.6% to $11.7 million or $0.24 per fully diluted share, compared to $13.5 million or $0.28 per fully diluted share in the same period last year, mainly resulting from currency exchange rate fluctuation income of approximately $0.8 million recorded with respect to monetary assets and liabilities denominated in foreign currency in the respective quarters, and increase in our tax expenses.

Turning now to the balance sheet. As of June 30, 2024, cash and cash equivalent and short-term bank deposits amounted to approximately $108.4 million, compared to $106.7 million as of December 31, 2023. Our total financial debt as of June 30, 2024 amounted to approximately $65 million, compared to $81.2 million as of December 31, 2023. Our cash flow from operating activity during the 6-month period of 2024 was $41.1 million, compared to $42.6 million in the same period of 2023.

Moving to our guidance. 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]

[Operator Instructions] The first question is from Maggie Nolan of William Blair.

[Margaret Nolan, analyst]

Congrats on reiterating the guidance here. I wanted to ask you about what you're seeing with your customer base, maybe how those conversations around demand for your services have evolved since you saw the weakness last quarter. And am I right in perceiving that you have a little bit of increased optimism around North American customers in particular?

[Guy Bernstein, executive]

So basically, in Israel and in Europe, especially in Israel, we see a phenomena where we continue to grow, the demand is very strong, although what's happening in Israel. In the States, right now we see it stable, with some first signs for improvement. But we see that the sales cycle is still quite long compared to what it used to be like 1.5 years ago.

[Margaret Nolan, analyst]

Okay. That's helpful. And then on the margins, good to see that you can pull on some levers to help improve them, even in the face of year-over-year revenue declines. But what are you thinking is kind of a normalized level of operating margin on more of like a multiyear basis for the business?

[Guy Bernstein, executive]

I think if we live, let's say, in a stable environment, I would probably -- I think 14% is achievable. But right now, we have a situation where we don't see a big improvement in the States, which is a big market for us. We definitely see improvements in Israel. And in parallel, of course, we continue to invest in our new products. So we are a bit less than that.

[Asaf Berenstin, executive]

Just to emphasize, between 13.5% and 14% is for the operating margin. And for the gross margin, it will be something between the 29% and 30%.

[Operator]

The next question is from Chris Reimer of Barclays.

[Chris Reimer, analyst]

Thanks for taking my questions. I have 2; one on margins. You guys have pretty consistently delivered margin expansion over the last year. And I'm just wondering if there was anything specific in this quarter that operating margin was flat, gross margin was down a bit. Is it just because of the revenue mix, or is it due to the acquisition that you mentioned earlier?

And then following on that, if you could just touch on the acquired business a little more in detail.

[Asaf Berenstin, executive]

So in terms of the margins, eventually, this quarter, we had less billable days in the Israeli market. In the first quarter, we had around 65 billable days; in the second quarter, we had 69 billable days because of the Passover holiday season. As Israel is 43%, same as the U.S. sector that we work, that influences our gross margin and takes it down a bit.

We managed to still maintain a solid margin, as you mentioned, because of the sales of our software licenses, which basically covered for the missing profitability in the Professional Service division. So this is with respect to the margin.

With respect to the operations that we have acquired, again, it's a company that provides software services, staff augmentation, works mainly from its headquarters in Indiana, serving, again, some blue-chip customers, like Johnson & Johnson, Securitas and other U.S. companies, but they are working also with global companies.

For example, on the opposite side, because they're also working with SMBs, they were less impact by the economic -- macroeconomic situation today in the U.S. which hinders mainly large organizations that we work with. And with them, we are positive that, and we are seeing that, they managed to maintain their profit and grow from 1 year to another.

So for us, it's another good addition for operations in North America. And as we normally do from 1 year to another, we look for this kind of operation, this kind of businesses, and we hope to acquire them.

[Operator]

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

[Guy Bernstein, executive]

Yes. So thanks again for everyone to joining our call. And we sure hope to have you on our next call next quarter and bring some good news. Thank you.

[Operator]

Thank you. This concludes Magic Software Enterprises Limited 2024 Second Quarter Results Conference Call. Thank you for your participation. You may now go ahead and disconnect.